Capital Gains Taxation and Stock Market Investments: Empirical Evidence

By Akindayomi, Akinloye | Accounting & Taxation, July 1, 2013 | Go to article overview

Capital Gains Taxation and Stock Market Investments: Empirical Evidence


Akindayomi, Akinloye, Accounting & Taxation


ABSTRACT

The objective of this study is to examine stock market investments responses to changes in capital gains tax rate. A priori, rational taxpayers are expected to respond to changes in this tax rate. For example, a reduction (increase) in capital gains tax rates may make taxpayers to unlock (lock-in) substantial amounts of accrued (realizable) appreciated gains. The findings of this study however reveal that capital gains realization and not capital gains tax rates impacts stock market investments in the U.S.

JEL: M40, M41

KEYWORDS: Stock Market Investment, Capital Gains Tax Rates, Realized Capital Gains

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

In many countries, including the U.S., the concept of deferral is central to capital gains taxation. That is, capital gains are taxed when 'realized' after sale or exchange of the eligible capital assets. On one hand, Haig-Simons 'pure net accretion' regime demands that capital gains (losses) should be subject to tax (deduction) in the year they accrue thereby requiring taxpayers to estimate realizable value of appreciated taxable assets. This may force taxpayers into untimely and inefficient liquidation of some assets in order to meet ensuing capital gains tax liability and obligations. Undoubtedly, this violates the fairness principles inherent in the U.S. taxation system. On the other hand, the double taxation argument ideally suggests a zero capital gains tax on capital accumulation. In corollary, incomes from capital gains enjoy preferential tax treatments.

Arguably, the preferential treatment of capital gains income (especially of long term character) contradicts tax equity doctrine, which suggests that all income (capital gains or ordinary income) should be taxed at same rates. It becomes pronounced if one considers the tax treatment of the 'carried interest' component of the compensation package of hedge fund managers. In fact, the Congressional Budget Office estimates that the treasury will bring in over $20 billion dollars additional tax revenue between 2012 and 2021 if'carried interest' is treated as ordinary income and taxed at ordinary income rates (CBO, 2011). No wonder then that the literature on desirability of capital gains tax is at best inconclusive in terms of its desirability and optimum capital gains tax rate level that maximizes economic efficiency.

It is widely believed that high-end taxpayers with long-end holding period and substantially appreciated capital assets have the tax and financial incentive to postpone otherwise efficient realization of capital gains in order to defer capital gains tax liability, and that in some cases avoid it by waiting until death in order to enjoy the step-up basis associated with estate taxation. This is a classical manifestation of the lock-in effect rule (Ivkovich et al., 2004. See also Elton et al., 2010) as this allows for resetting the capital assets' tax bases (including the unrealized capital gains) at death. In addition to potential loss in tax revenue, this rule certainly distorts optimal investments portfolio and diversification strategy as capital could be trapped in inefficient investment outcomes. However, the extent at which investors believe in the ability of current tax rates to predict future tax liability remains an empirical question.

Focusing mainly on capital gains generated through stock market transactions, this study attempts to empirically examine whether, on aggregate, investors/taxpayers fully and truly respond to the interaction between changes in capital gains tax rate and capital assets liquidation in a 'rational' way. A priori, rational taxpayers are expected to respond to changes in this tax rate. For example, a reduction (increase) in capital gains tax rates may make taxpayers to unlock (lock-in) substantial amounts of accrued (realizable) appreciated gains. This study specifically finds that on aggregate, total capital gains realized and not necessarily capital gains rate affect stock market investments in the U. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Capital Gains Taxation and Stock Market Investments: Empirical Evidence
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Author Advanced search

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.