Capital Gains Taxes and Trading Incentives
55 Pages Posted: 10 Jan 2020 Last revised: 16 Jan 2020
Date Written: January 15, 2020
Deferring the realization of gains is generally tax-efficient for stocks, but not for other important asset classes including taxable bonds and noncorporate business assets. These assets make up roughly half of all capital gains-producing financial assets held by households. I develop a simple framework that provides intuition on when tax deferral is advantageous. When it is advantageous, the strength of the resulting lock-in effect should vary predictably across asset classes. I verify this prediction by showing that property-casualty insurers are more reluctant to realize gains on tax-exempt bonds than on taxable bonds. My findings have important implications for portfolio optimization and for ongoing tax policy debates on distortions, revenue, and optimal taxation.
Keywords: capital gains, taxes, tax deferral, lock-in effect, trading
JEL Classification: H24, H21, G11, G12, G22
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