Evidence on the Tax Effects of Inflation Under Historical Cost Accounting Methods

It is often argued that the failure to use indexation (i.e., the use of historical cost accounting methods) implies that real income tax rates will vary directly with rates of inflation. This substantive effect of mere bookkeeping methods is often predicted even though it is recognized to have some adverse implications. This is the tax effects of inflation hypothesis. The major objective of this paper is to examine the descriptive adequacy of this hypothesis using a variety of macro- economic data for the years 1929-74. My empirical results appear to be substantially inconsistent with the tax- effects hypothesis