, over that same 10 year time period, however, a 100 percent price inflation has occurred in the economy, the $900 received in year ten had a purchasing power of only $450 in year one dollars. The real capital gain in year one dollars, therefore, was $350, as opposed to the nominal capital gain of $800 in year ten dollars. An alternative method of determining the amount of the real capital gain in this example involves the revaluation of the acquisition price into year ten dollars. In this instance, the acquisition price would be adjusted to $200, and the real capital gain in year ten dollars would be $700.
Asset depreciation is also affected by inflation. The cost of a depreciable asset may be deduced from income by business firms over some specified period of time.4 The Internal Revenue Service in the United States and most other national taxing
3R. H. Gordon, "Inflation, Taxation, and Corporate Behavior," The Quarterly Journal of Economics, (March 1984): 313 327.
4L. Schall, "Taxes, Inflation, and Economic Decisions," Tax Digest, 6 (1989): 1 4.
authorities in other countries requires that assets be depreciated on the basis of historical, or actual acquisition, costs, as opposed to replacement costs (which will be higher than historical costs, because of the effects of inflation). The contention is, thus, that, because of inflation, assets are under depreciated, and that, in turn, this distortion causes effective tax rates to be higher than they would otherwise be.5
The contention that asset depreciation, and in turn business taxes, are distorted by inflation, is based upon the concept of cost. In the broadest context, cost refers to the amount of resources expended or obligated in the process of acquiring or producing goods or services.6 The traditional approach to the determination of cost values is the use of historical, or actual, costs.7 Historical costs are recorded in financial accounting records. The ...