Investment Behavior and the Biased Perception of Limited Loss Deduction in Income Taxation

Abstract:     
We use a laboratory experiment to study the extent to which investors‘ choices are affected by limited loss deduction in income taxation. We first compare investment behavior in the no tax baseline to a tax control setting, in which the income from investments is taxed. We find that investors significantly reduce their risk-taking as predicted by theory. Next we compare the baseline investment choices to choices under three different types of income taxation. We observe that risk-taking is significantly increased with partial and with capped loss deduction, but is unaffected by a tax system that allows no loss deduction. Since in all these treatments the after tax outcomes of the prospects were identical, we conjecture that investors have a positively biased perception of partial and capped loss deduction that promotes their willingness to take risks.

Number of Pages in PDF File: 31

Keywords: Risk-Taking Behavior, Distorting Taxation, Tax Perception

JEL Classification: C9l, Dl4, H24

working papers series