Abstract
ABSTRACTIn this research, the traditional approximation that after‐tax yields equal before‐tax yields times one minus the tax rate is shown in general to be incorrect. The traditional relationship holds only for one‐year assets and perpetuities when a single tax rate applies to both ordinary income and capital gains. For all other multiperiod assets, the correct relationship is much more complex and is a function of the statutory tax rates on ordinary income and capital gains, the holding period, the dividend growth rate for common stocks, and any premium or discount on bonds. The direction of bond price changes is related inversely to the direction of the tax rate changes, but the direction of common stock price changes is related ambiguously to the direction of tax rate changes.
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