Accelerated Depreciation and the Efficacy of Temporary Fiscal Policy: Implications for an Inflationary Economy

The effect on investment of temporary tax rate changes depends on the age profile of depreciation deductions. If the depreciation allowance schedule is accelerated, then temporary cuts in the corporate tax rate could reduce investment. Inflation causes the age profile of real depreciation deductions to become accelerated and thus could make temporary tax cuts have a contractionary effect on investment. Two currently proposed reforms are shown to exacerbate this effect. Under each of these proposals, temporary tax cuts are likely to have opposite effects on investment in short-lived and long-lived capital, thereby complicating the conduct of countercyclical fiscal policy.