Abstract

The proposition that the level of business fixed investment in the United States should be increased commands almost universal support. Increasing the rate of investment is widely seen as a panacea for a variety of economic problems including inflation, declining productivity, and the fall of the dollar. While there is agreement as to the inadequacy of business fixed investment, there is little agreement as to the causes of the shortfall. For example, in a recent proceedings volume of the American Economic Review, Alan Blinder concludes with Robert Hall that “The principal source of inadequate capital formation has been our failure to do anything about recessions, not our active use of anti-investment stimulative policies, ” while Martin Feldstein (1980) argues that the interaction of inflation and taxation accounts for much of the decline in corporate capital accumulation that has taken place over the last decade. This paper presents an overview of the issues connected with the relationship between tax policy and corporate investment, in the first section of the paper, post-war trends in capital formation and corporate sector profitability are examined. While the share of gross investment in GNP has remained almost constant, the rate of net productive investment expressed as either a fraction of GNP or of the capital stock has fallen sharply during the l970s. This decline has been associated with a substantial fall in the market price of corporate capital, and in the after-tax rate of return to investors in the corporate sector. The reduction in after-tax returns to corporate investors, while partially related to a fall in the pre-tax rate of return on capital, is in large part due to the interactions of inflation and our non-indexed tax system. The second section presents a cautious view of the social gains from increased corporate investment. Even a large increase in net

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