Hidden Stimuli to Capital Formation: Debt and the Incomplete Adjustment of Financial Returns

33 Pages Posted: 21 May 2004 Last revised: 10 Aug 2010

See all articles by Robert S. Chirinko

Robert S. Chirinko

University of Illinois at Chicago, Department of Finance; CESifo (Center for Economic Studies and Ifo Institute)

Robert R. King

Independent

Date Written: August 1985

Abstract

There is a common belief that the disappointing economic performance in the 1970s can be attributed in good part to the interaction of tax rules, inflation, and capital formation. In this paper, we reassess the relationships between inflation, the tax code, and investment incentives because previous results are based on a number of tenuous assumptions whose impact has not been fully appreciated. We also question the appropriateness of the conventional user cost formulation, and derive an alternative measure taking explicit account of the role of debt -- acquisition,retirement, and net-of-tax interest payments -- and the equity holders' ownership of the firm. Our numerical results show that previously reported disincentives for acquiring capital goods in generaland against longer-lived capital in particular are attenuated, and in a number of cases reversed, under various sets of assumptions. Differences in results stemming from the conventional and modified user costs are highlighted, and are illustrated by a comparison of the U.S. Treasury's tax reform proposals under the two formulations.

Suggested Citation

Chirinko, Robert S. and King, Robert R., Hidden Stimuli to Capital Formation: Debt and the Incomplete Adjustment of Financial Returns (August 1985). NBER Working Paper No. w1684. Available at SSRN: https://ssrn.com/abstract=338765

Robert S. Chirinko (Contact Author)

University of Illinois at Chicago, Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

HOME PAGE: http://tigger.uic.edu/~chirinko/

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Robert R. King

Independent

No Address Available

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