Do Personal Taxes Affect Investment Decisions and Stock Returns?

Abstract

This paper studies the causal effects of personal investment taxes on stock demand, stock returns, and the financial decisions of companies. I exploit a change in legislation in 2013 which allowed stocks listed on the Alternative Investment Market, a sub-market of the London Stock Exchange, to be held in capital gains and dividend tax-exempt investment accounts for the first time. Using a difference-in-differences and factor model approach, I find that stock demand temporarily doubled, excess stock returns decreased by their pre-legislation change effective tax rate, dividends increased by a quarter, and that the capital structure and shareholder composition changed post-legislation.

Keywords: Personal taxes, tax capitalization, tax clienteles, equity premium, pay-out policy

JEL Classification: G11, G12, G14, G35, G50