Is Capital Gains Tax Law Biased Against Low Income Investors?

43 Pages Posted: 20 Nov 2011 Last revised: 30 Nov 2011

See all articles by Min Dai

Min Dai

National University of Singapore (NUS) - Department of Mathematics

Hong Liu

Washington University in St. Louis - Olin Business School; Fudan University - China Institute of Economics and Finance

Yifei Zhong

University of Oxford - Mathematical Institute; University of Oxford - Mathematical Institute

Date Written: November 20, 2011

Abstract

The current capital gains tax law stipulates that the tax rate for short-term investment (gains and losses) and long-term losses is equal to an investor's marginal ordinary income tax rate, which implies that this rate for low income investors can be significantly lower than that for high income investors. In an optimal consumption and investment model with asymmetric long-term/short-term tax rates, we show that even though capital gains tax rates for low income investors are always lower than those for high income investors, the current capital gains tax law is significantly biased against low income investors in the sense that these investors are willing to pay a substantial fraction of their initial wealth to gain the same capital gains tax treatment as high income investors have. This result is robust to various changes in model parameter values. Raising capital gains tax rates for low income investors to the levels for high income investors would reduce the bias and substantially increase stock market participation by low income households. With regard to the optimal tax realization strategy, in sharp contrast to most of the existing literature, we show that it can be optimal to defer short-term capital losses beyond one year and to realize short-term gains.

Keywords: Capital Gains Tax Law, Portfolio Selection, Consumption, Asymmetric Tax Rates

JEL Classification: G11, H24, K34, D91

Suggested Citation

Dai, Min and Liu, Hong and Zhong, Yifei, Is Capital Gains Tax Law Biased Against Low Income Investors? (November 20, 2011). Available at SSRN: https://ssrn.com/abstract=1962118 or http://dx.doi.org/10.2139/ssrn.1962118

Min Dai

National University of Singapore (NUS) - Department of Mathematics ( email )

Singapore

Hong Liu (Contact Author)

Washington University in St. Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-5883 (Phone)

Fudan University - China Institute of Economics and Finance ( email )

China

Yifei Zhong

University of Oxford - Mathematical Institute ( email )

Mathematical Institute
24-29 St Giles
Oxford, Oxfordshire OX1 3LB
United Kingdom

University of Oxford - Mathematical Institute ( email )

24-29 St Giles'
Oxford, OX1 3LB
United Kingdom

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