Inflation, taxes, and the durability of capital

Auerbach demonstrated that inflation can lead to interasset distortions, with the negative effects of higher inflation unambiguously declining with asset life in the case of geometric economic and tax depreciation. We show that, when tax depreciation is straight-line, higher inflation can have the opposite effect, discouraging investment in long-lived assets. Also, we present several examples showing that, under historically relevant U.S. tax rules, higher inflation can sometimes favor relatively short-lived equipment, although the bias is always small.