It is now widely recognized that inflation distorts corporate taxation. Governments’ approaches to coping with these distortions have differed from country to country. In the U.S., for example, use of LIFO accounting for reporting and tax purposes has enabled companies to dampen some of the worst effects of inflation; prior to 1975, practically all other industrial countries required FIFO accounting, which created tremendous liquidity problems for business. On the other hand, the U.S. has lagged in the area of tax incentives for investment.
Britain has instituted extremely generous tax incentives, including 100 per cent first-year depreciation on new investment in plant and equipment. Unfortunately, these measures came too late to reverse mounting business conservatism. British business investment has continued to fall in the face of weak demand; the government’s expansive monetary policy, intended to produce a takeoff in industrial development, has ended up fueling a real estate boom instead.
Since 1975, American corporations have begun to adopt financial policies almost as conservative as those prevalent in Britain. U.S. firms are now emphasizing liquidity rebuilding and balance sheet strength, rather than expansion of plant and equipment. If U.S. tax laws continue to aggravate the problems introduced by inflation, the U.S. too could settle into a long period of permanently slower growth, with a highly conservative business sector providing funds for further expansion of consumption.