Depreciation, Inflation and Investment Incentives: The Effects of the Tax Acts of 1981 and 1982

BREE years after its enactment, controversy still surrounds the Economic Recovery Tax Act of 1981 (ERTA) and its successor, the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). On the one hand, the Reagan administration claims that the 1981 tax reductions substantially increased U.S. business investment and contributed to the strong recovery from the 1981—82 recession’. On the other hand, some commentators argue that the tax reductions have failed to increase business investment.2 Moreover, other critics of ERTA argue that, although investment has increased, it has done so in an unbalanced fashion: too few resources are going into plant, while too many are going into producers’ durable equipment.’ Omitted almost entirely from the debate over the effectiveness of the tax reductions has been the independent impact of the recent disinflation. That is, to what extent would investment have been increased simply by the decline of the inflation rate and how does such an influence come about?