The Effect of the Timing and Direction of Capital Gain Tax Changes on Investment in Risky Assets

Posted: 14 Sep 2012 Last revised: 18 Jun 2018

See all articles by Diana Falsetta

Diana Falsetta

University of Miami - Department of Accounting

Tim Rupert

Northeastern University - Accounting Group

Arnold Wright

Northeastern University - Accounting Group

Date Written: September 13, 2012

Abstract

This study examines the effect of timing (gradual versus immediate) and direction (tax increase or decrease) of a tax change on taxpayer behavior. Specifically, we focus on capital gain tax changes and preferences for investment in riskier assets. We run an experiment with 117 participants who allocate investment dollars between two funds of differing risk. Drawing on mental accounting and hedonic editing (Thaler 1985, Thaler and Johnson 1990), we posit that a tax decrease (a “gain”) implemented gradually over several years will result in a greater increase in risky investment once the decrease is fully implemented than when the tax change is implemented all at once. In contrast, once a tax increase (a “loss”) is fully implemented, a smaller decrease in risky investment will result when the change occurs all at once rather than gradually. Our findings support these expectations, suggesting that the manner of implementing a tax law change may impact decisions.

Keywords: Capital gains, hedonic editing, investments, mental accounting, prospect theory, tax

JEL Classification: H21, H24, K34, M40

Suggested Citation

Falsetta, Diana and Rupert, Tim and Wright, Arnold, The Effect of the Timing and Direction of Capital Gain Tax Changes on Investment in Risky Assets (September 13, 2012). Accounting Review, March 2013, Available at SSRN: https://ssrn.com/abstract=2146126

Diana Falsetta (Contact Author)

University of Miami - Department of Accounting ( email )

Coral Gables, FL 33146-6531
United States
305.284.8642 (Phone)
305.284.5737 (Fax)

Tim Rupert

Northeastern University - Accounting Group ( email )

360 Huntington Ave.
Boston, MA 02115
United States

Arnold Wright

Northeastern University - Accounting Group ( email )

406 Hayden Hall
United States

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