Pg 164 (in Equity Portf. Mgment section): “Reported earnings often overstate their real economic value…Corporate income taxes and capital gains tax rates are typically not inflation indexed, so inflation can cut into investor’s after tax real returns unless the share prices fully reflect (through lower prices) the interaction of inflation and taxation.” I would think that if a company is able to raise prices to keep up with inflation, and taxes are not adjusted, that the effect would essentially be a wash, in real terms?
I think the issue is the original investment (share price) is not inflation indexed for tax purposes. So if the company makes 10% and inflation was 3%, in real terms, you made only 7%. For tax purposes, however, you are taxed on the entire 10% income. If the tax rate is 40%, you essentially net a paltry 3% in real terms.
Thirty years ago you would get an 8% return on your stock, and, because your taxable income was $60,000, you’d pay 20% income tax, leaving you with 6.4% net. Today you get an 8% return on your stock, and, because your taxable income is $120,000 (the inflation-adjusted equivalent of $60,000, 30 years ago), you pay 35% income tax, leaving you with 5.2% net.
If the income levels for tax brackets were indexed to inflation, you’d be paying the same 20% tax on the equivalent (inflation-adjusted) income; because they’re not indexed to inflation, your tax rate goes up even though your purchasing power remains unchanged.