Tax Planning by Mutual Funds: Evidence from Changes in the Capital Gains Tax Rate

Abstract:     
We investigate whether open-end and closed-end mutual funds engage in tax planning by testing how they respond to changes in the capital gains tax rates. While previous evidence suggests that individual investors time capital gains realizations (Auerbach, 1988), we might not expect mutual fund managers to tax plan like individuals because fund managers have incentives to consider the tax liability of both current and potential investors. Our question is, conditional on balancing the interests of these two groups of investors, do mutual funds time their capital gains realizations to decrease taxes. Our analysis spans over forty-four years, and six major tax changes, allowing us to examine the effect of both tax rate increases and decreases. Overall, we find evidence consistent with tax planning by managers of both open-end and closed-end funds, and that both groups of fund managers appear to be more responsive to tax rate decreases than tax rate increases.

Keywords: Mutual Funds, Tax Planning, Capital Gains Taxes

JEL Classifications: M41, G23, H24

Working Paper Series