Capital Gains Tax Rate Research Articles

World Dividends and Tax Shocks

For a sample of 28,895 firms across 30 countries and 29 years, there is a negative relation between dividend tax rates and dividend payout. Firms increase dividend payout in response to both absolute and relative (to capital gains tax rates) decreases in dividend tax rates. This negative relation is robust to both increases and decreases and both shocks and continuous variation in dividend tax rates and affects both dividend payer status and dividend payout level. However, dividend payers do not increase dividend payout levels following decreases in dividend tax rates. The negative relation between dividend tax rates and dividend payout is stronger in countries and firms with better governance and suggests a dividend taxation elasticity of −0.45.

The Politics of Oligarchy: Taxation, Financial Regulation, Power Resources, and the Super-Rich in the United States, 1918-2012

The rise of the super-rich in the United States during the last thirty years has rekindled concerns about oligarchic political influences. Following recent theoretical work by Winters (2011), we conceptualize oligarchy as a defense against threats to income accumulation by the super-rich. We focus on two threats: taxes and financial regulations. In addition, we consider the potential role of countervailing power resources: Democratic Congressional power and unions. Using annual multiple time-series data covering 1918 through 2012 and Vector Autoregression (VAR) analysis, we find that the pre-tax income of the top 0.1% decreases in response to shocks in capital gains tax rates and marginal income tax rates, but not estate tax rates. Financial deregulation, the loss of Democratic seat share in Congress, and declines in labor union membership have likewise enhanced the income share of the top 0.1%. While tax rates on regular incomes and capital gains do not respond to the power of oligarchs, estate tax cuts, financial deregulation, and declines in Democratic seats in Congress accelerate following a windfall for the top 0.1%. Overall, the results imply that as oligarchs get richer, they minimize income and wealth loss due to the estate tax while enhancing their ability to extract rents in financial markets. But at the same time, the power resources of labor and society have important impacts on oligarchic incomes and top tax rates.

The Dividend Clientele Hypothesis: Evidence from the 2003 Tax Act

This paper provides evidence that dividend and capital gains tax rates importantly influence household portfolio choices. Using data from the Surveys of Consumer Finances around the 2003 dividend tax reductions, I estimate the relationship between taxes and household portfolio dividend yields. I find that a one percentage point decrease in the dividend tax rate relative to the long-term capital gains tax rate causes household portfolio dividend yields to increase by 0.04 percentage points. The results suggest that high income households significantly increased their portfolio dividend yields in response to the 2003 dividend tax rate reductions. (JEL D14, G11, G35, H24)

Review of System of Deferral for Small and Medium Enterprises and Capital Gains Tax Rate in Merger by Absorption : Supreme Court Decision, 2012Du17520, February 14, 2013

Review of System of Deferral for Small and Medium Enterprises and Capital Gains Tax Rate in Merger by Absorption : Supreme Court Decision, 2012Du17520, February 14, 2013

Asymptotics for Merton Problem with Small Capital Gain Tax and Interest Rate

We consider the problem with capital gain taxes. Since closed-form solutions are generally unavailable, we provide asymptotic expansions with small interest rate and other parameters, and then obtain an explicit investment and consumption strategy that effectively approximates the optimal strategy. The expansions also offer qualitative and quantitative insights about the effects of various parameters on the optimal strategy. Moreover, we find that the optimal tax-deflated fraction of initial wealth in the risky asset is higher than the Merton line.

Summaries of Papers in this Issue

Summaries of Papers in this Issue

Tax Planning after the American Taxpayer Relief Act of 2012

For more than a decade taxpayers have enjoyed a 15-percent tax rate on long-term capital gains. The 15-percent rate was the lowest maximum tax rate on long-term capital gains since 1954. On January 2, 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA). ATRA permanently increased the top capital gain tax rate to 20 percent (up from 15-percent) for single filers with taxable incomes above $400,000 and married couples filing jointly with taxable incomes exceeding $450,000. In addition as part of the Health Care legislation a new 3.8-percent Medicare surtax applies on net investment income, which includes capital gains.This results in an overall rate for higher-income taxpayers of 23.8 percent — a staggering 58.69-percent increase in 2013 from 2012 tax rates.The real kicker is the application of the capital gains tax rates to trusts. A trust is hit with the increased rate on any income the trust does not distribute over $11,950. This is significantly less than the $400,000/$450,000 taxable incomes from the American Taxpayer Relief Act of 2012 and the $200,000/$250,000 adjusted gross income from the Health Care legislation that is applicable to individuals. Many trusts accumulate capital gains in the trust and pay tax within the trust. Generally in the past the capital gain rate in the trust and the rate that would be applicable to the beneficiary were the same 15-percent. Therefore, generally the tax paid would be the same amount. Under the new rules in 2013 it is possible that the trust may be paying a capital gains tax at a 23.8-percent rate while the individual might be taxed at a 15-percent.With a 58.69-percent increase in 2013 and beyond, high-income taxpayers and trusts might look to ways to defer the recognition of the capital gain in the current tax year. In addition trusts in certain instances might look to have capital gains be part of the distributable net income (DNI). This article examines strategies to defer the recognition of the gain and the ability to monetize the position. Strategies that are examined are as follows:Variable Prepaid Forward ContractCollars Buy a Put and Sell a CallNonrecourse Loan against Publicly Traded StockEstablishing a Short-against-the-box after 1997Use a short-against-the-box to defer taxable gains from 2013 to 2014Charitable Gain Harvesting to offload gain to charitySale to an ESOPCharitable Remainder TrustsCapital Gains in a trust to be included in DNI.

Trading and enforcing patent rights

We study how the market for innovation affects enforcement of patent rights. We show that patent transactions arising from comparative advantages in commercialization increase litigation, but trades driven by advantages in patent enforcement reduce it. Using data on trade and litigation of individually owned patents in the United States, we exploit variation in capital gains tax rates across states as an instrument to identify the causal effect of trade on litigation. We find that taxes strongly affect patent transactions, and that trade reduces litigation on average, but the impact is heterogeneous. Patents with larger potential gains from trade are more likely to change ownership, and the impact depends critically on transaction characteristics.

Determinants of Stamp Duty Revenue in Indian States

This article exploits a panel data set from 18 Indian states over the period between 1993–1994 and 2009–2010 and identifies a set of parameters significantly affecting stamp duty revenue collection in the states. It turns out that among all the parameters, the per capita income of the state has the most significant impact on stamp duty revenue collection. The administrative reforms at the states’ stamp duty and registration departments, like introduction of franking machines and e-governance, have a positive impact on stamp duty revenue collection as well. It is found that the central government’s choice of capital gains tax rate creates an externality on stamp duty revenue collection in the states. The results are used to critically assess the policy of lowering of stamp duty rates and introducing administrative reforms as part of the Urban Reform Incentive Fund implemented by the central government since 2003–2004 (later subsumed under the Jawaharlal Nehru National Urban Renewal Mission (JNNURM)). JEL Classification: H21, H71, H77, C33

Capital Gains Taxes and Stock Return Volatility

ABSTRACTThis paper presents an empirical investigation of the impact of capital gains taxes on stock return volatility. We predict that the more stock returns are subject to capital gains taxation, the greater the increase in return volatility following a capital gains tax rate cut due to reduced risk-sharing in firms' cash flows between shareholders and the government. Consistent with this prediction, we find larger increases in the return volatility for more appreciated stocks than for less appreciated stocks and for non-dividend-paying stocks than for dividend-paying stocks after both 1978 and 1997 capital gains tax rate reductions. The findings imply that capital gains taxes convey a heretofore overlooked benefit of lower stock return volatility.

Technical Note: Tax Capitalization, Beta, and the Cost of Equity

In the context of a tax-adjusted reformulation of the capital asset pricing model, this article examines the extent to which capital gains taxes are impounded in the rates of return required by stockholders. Consistent with extant literature, the cost of equity capital is shown to be positively related to the capital gains tax rate. However, the induced increase in the cost of equity is lower (higher) for higher (lower) beta shares. An intuitive explanation is provided for this phenomenon in terms of greater risk-sharing, with the fiscal authority stimulating an increased stockholder propensity to bear the risk of share ownership.

Break-Even Point Between Short-Termand Long-Term Capital Gain (Loss) Strategies

A loss sale of stock allows investors to take a capital loss deduction. However, it has always been unclear whether it is advisable for individual investors to engage in loss sales of stock to take advantage of the tax benefit. Indeed, determining at what point the investment becomes indifferent as it relates to short-term and long-term capital gains (losses) is the focus of this article. The authors use three important variables to develop a model to help investors reach a conclusion regarding the loss sale quandary: tax rate, life of investment, and capital-gain (loss) growth rate. The break-even equation used in this research identifies the relationship among these variables, and the resulting model enables investors to make an optimum choice between short-term and long-term investment strategies. Ultimately, the model shows that a short-term investment strategy is more preferable for a longer-life investment, with a lower short-term capital gain tax rate, and a higher capital-gain growth rate. In contrast, a long-term investment would favor a shorter-life investment, with a higher short-term capital-gain tax rate, and lower capital-gain growth rate. The article also applies the model to the current stock market downturn and sudden climb.

DO TAX SENSITIVE INVESTORS LIQUIDATE APPRECIATED SHARES AFTER A CAPITAL GAINS TAX RATE REDUCTION?

Using data on institutional investors' portfolio composition before and after the capital gains tax rate cut in the Taxpayer Relief Act of 1997, we find evidence that, relative to less tax sensitiv...

Investment Effects of Capital Gains Taxation Under Simultaneous Investment and Abandonment Flexibility

The influence of capital gains taxes on investment decisions is a central issue of accounting and public finance research. However, the implications of capital gains taxes on investors' willingness to invest in irreversible projects with entry and exit flexibility have not yet been a focal issue. As a result, the effects of taxing capital gains on the interdependencies of investment and divestment decisions have to be identified, especially under timing flexibility. This paper closes this gap by simultaneously analyzing investment timing and abandonment decisions for risky irreversible investment projects with uncertain cash flows under differential tax rates for ordinary income and capital gains. We investigate whether capital gains taxes affect immediate and delayed investment asymmetrically. Furthermore, we investigate the impact of capital gains taxation on the optimal abandonment decision. Performing extensive numerical simulations we find that varying the liquidation proceeds affects the decision whether or not to postpone the investment decision. Higher cash flow volatility favors delayed investment. We find that the introduction of capital gains taxation tends to be harmful for immediate investment. Moreover, we show that taxing capital gains may induce a tax paradox for delayed investment. Depending on the pre-tax parameter setting the future value of delayed investment may even increase in absolute terms for increasing capital gains tax rates. For sufficiently high liquidation proceeds capital gains taxation tends to favor continuation of a project. We find taxing capital gains mainly induces other, but not necessarily less arbitrary distortions than exempting capital gains.

Further evidence from ex-dividend days

We tested how dividend pricing is impacted by the reduction in capital gains tax rate to 20% (May 1997) and the move to trading in 6.25¢ (June 1997). Price behaviour does not support tax clienteles but is consistent with transaction costs-based explanation. Raw returns, for all groups, are within or close to weak no-arbitrage bounds and are unchanged around these events. We find that taxes may impact investor behaviour but they do not impact marginal dividend pricing.

Capital Gains Taxes and Expected Rates of Return

Prior literature predicts a positive relation between firms' expected pre-tax rates of return and investor-level capital gains tax rates. We show that this relation is more nuanced than suggested by prior literature and that in three circumstances the relation can actually be negative. The first circumstance is when a firm's systematic risk is very high. The second circumstance is when the market risk premium is very high. The third circumstance is when the risk-free rate of return is very low. The circumstances arise because, in addition to reducing investors' expected after-tax cash proceeds, capital gains taxes reduce the risk that investors associate with the expected after-tax cash proceeds.

Capital gains tax, supply‐driven trading and ownership structure: direct evidence of the lock‐in effect

AbstractThis study investigates the effect of differential capital gains tax rates on investor trading and share prices in a unique market setting that facilitates the resolution of conflicting prior evidence of holding period tax incentives. In particular, we examine whether the concessionary tax treatment of long‐term capital gains increases the supply of shares that qualify for long‐term status, thereby causing downward price pressure. We find evidence of abnormal seller‐initiated trading following the 12‐month anniversary of listing for IPO firms that appreciate in price (‘winners’) and report no such evidence for firms that decline in price (‘losers’). Consistent with the tax concessions being greater for individual than institutional investors, we report that abnormal seller‐initiated trading is mitigated by higher levels of ownership by institutional investors. We also report limited evidence, for winners, of declining share prices upon qualifying for long‐term tax status.

Dividend Taxation Changes and Stock Returns: Analysis of Canadian Stocks from 1987-2010 and Comparison to US Stocks

This article examines the relationship between dividends and capital gains taxation differences and annual stock returns of Canadian public companies. Using the Compustat and Datastream databases over an 18-year period (1995-2012), we find this relationship to be positive for all stocks on the Toronto Stock Exchange and when using only the largest companies in Canada (S&P/TSX composite index firms), supporting a dividend tax premium being capitalized into stock returns. While our results are consistent with previous US studies, these findings were not obvious at the outset because in Canada the taxation of dividends and capital gains is different from the approach used in the US and because the difference between the dividend and capital gains tax rates is substantially smaller relative to the differences used in the long time series US studies. Our findings will be useful for investors and corporations because stock returns are affected by the method of payout used by corporations. In addition, Canadian policy makers will note that tax rules can affect capital markets. Our findings are robust to using two different methods of empirical investigation.

Erratum to: The interaction of corporate dividend policy and capital structure decisions under differential tax regimes

We develop a valuation model that integrates corporate capital structure and dividend payout policies. The resulting “extended” Miller (J Financ 32:261–297, 1977) model explicitly incorporates the different tax rates on corporate income, personal interest, dividends, and capital gains. We apply the model to ten different U.S. tax regimes since 1979 and generate several testable predictions. When the dividend tax rate exceeds the capital gains tax rate, dividend payout can partially offset value-enhancing effects of leverage. When the two rates are close, dividend payout loses its moderating influence. Using the S&P 1500 universe, we obtain empirical results that are consistent with the model’s predictions.

Forecasting the US Capital Gains Tax Rate Using Markov Chains

Using Markov-chains (formally a Markov process or Markov system) we will show how to estimate the probabilities of a capital gains tax rate changing from its current rate to another rate within a certain number of years. It is important to recognize that capital gains rates in the United States have their origins in every elected administration of the government that had the power to influence tax policy. The outcome of government elections is dependent on chance factors such as periods of war and peace, economic recession and expansion, current fiscal and monetary policy, changes in population demographics, just to name a few. The delicate balance between the government and the dynamic society that shapes tax policy is difficult to predict using deterministic modeling. Therefore, we look to stochastic modeling using the Markov-Chain processes to see if it could be of use in creating a useful model for capital gains tax rates in the United States.