Working Paper No. 19

Inflation, Taxation and Capital Cost

In times of inflation, most existing systems of taxation introduce new distortions into the allocation of resources. In this paper, the effects of inflation via taxes on the firm's east of capital are analyzed. The taxes considered are the corporate income tax and household taxes on dividends and capital gains. The first part of the paper presents the model of a firm aiming at maximizing the value of its shares in the portfolios of the stockholders. The nominal east of capital of this firm, financed by equity and debt in a given proportion, is derived. The east of equity and debt are then taken at their nominal values as the firm observes them on the capital market.

We then analyze the net real cost of capital, where market rates of return are adjusted for inflation. This makes it possible to determine the net effects of inflation on capital cost, recognizing several counteracting tendencies operating through the tax system. It turns out that for most reasonable assumptions, the real cost of capital will fall as a result of inflation when both profit tax and taxes on dividends and capital gains are taken into account.

In the last section finally, we present different ways of indexing the system of taxation to insulate it from inflationary distortions.

Interdisciplinary European Studies

The European Union and the Return of the Nation State


This book explores the complex and ever-changing relationship between the European Union and its member states. The recent surge in tension in this relationship has been prompted by the actions of some member state governments as they question fundamental EU values and principles and refuse to implement common decisions seemingly on the basis of narrowly defined national interests.

About the book


Seminars organized by IFN


To present ongoing research informal brown-bag seminars are held on Mondays at 11:30 am. This is an opportunity for IFN researchers to test ideas and results.

Academically oriented seminars are most of the time held on Wednesdays at 10 am. At these events researchers from IFN and other institutions present their research.

In addition, IFN organizes seminars open to the public. Topics for these are derived from the IFN research.

Research Institute of Industrial Economics, Grevgatan 34 - 2 fl, Box 55665, SE-102 15 Stockholm, Sweden | Phone: +46-(0)8-665 45 00 |