Capitalization of Capital Gains Taxes: Evidence from Stock Price Reactions to the 1997 Rate Reduction

39 Pages Posted: 23 Feb 1999 Last revised: 19 Sep 2012

See all articles by Mark H. Lang

Mark H. Lang

University of North Carolina at Chapel Hill

Douglas A. Shackelford

University of North Carolina Kenan-Flagler Business School; National Bureau of Economic Research (NBER)

Date Written: January 1999

Abstract

We empirically document that stock prices moved inversely with dividend yields during the May, 1997 week, when the White House and Congress agreed on a budget accord that included a reduction in the capital gains tax rate. The share prices of firms not currently paying dividends increased approximately 6 percentage points more over a five-day window than the share prices of other firms. Among firms paying dividends, the change in share prices was decreasing in dividend yields. The results are consistent with at least two related explanations. First, to the extent a stock's returns are expected to be taxed as capital gains, a reduction in the expected capital gains tax rate enhances the attractiveness of the investment to investors. Second, to the extent a firm's stock is held by shareholders subject to the capital gains tax, a reduction in the expected capital gains tax rate increases its market value. The findings present evidence consistent with neither a sell-off of appreciated securities following the rate reduction nor a reduction in the compensation for capital gains taxes that selling shareholders demand from buyers. The upward price pressure around the accord dominated any downward price pressure imposed by these factors.

Suggested Citation

Lang, Mark H. and Shackelford, Douglas A., Capitalization of Capital Gains Taxes: Evidence from Stock Price Reactions to the 1997 Rate Reduction (January 1999). NBER Working Paper No. w6885. Available at SSRN: https://ssrn.com/abstract=147014

Mark H. Lang (Contact Author)

University of North Carolina at Chapel Hill ( email )

Kenan-Flagler Business School
McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-1644 (Phone)
919-962-4727 (Fax)

Douglas A. Shackelford

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-3197 (Phone)
919-962-4727 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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