Use of Depreciation as a Tax Policy Device to Control Inflation

The United States Internal Revenue Code contains many provisions for credits, deductions, and other tax advantages intended to achieve various economic goals considered desirable by the U.S. Congress. The depreciation allowance is one such deduction, frequently used to compensate taxpayers for the effects of inflation and to promote economic growth. The government uses it extensively as a part of tax-incentive programs based on the theory that tax benefits stemming from depreciation reduce the cost of doing business, and thus stimulate capital formation by allowing tax-free recovery of capital by businesses. Capital formation increases productive capacity by providing resources to those companies that can use them to expand business operations. The expected increase in productivity would result in more goods and services in the economy, which in turn would act to keep prices down and help suppress inflation. Congress has realized the importance of capital formation to control inflation and thus, over time, has extended significant tax advantages to businesses through depreciation. This paper examines the effectiveness of depreciation as a means of stimulating capital formation and of controlling inflation