Investment Taxes and Equity Returns
Posted: 16 Mar 2006 Last revised: 13 Jul 2008
Date Written: July 9, 2006
This paper investigates whether investors are compensated for the tax burden of equity securities. Effective tax rates on equity securities vary over time due to frequent tax reforms and cross-sectionally due to persistent differences in propensities to pay dividends. The paper finds an economically and statistically significant relationship between risk-adjusted stock returns and effective personal tax rates using a new data set covering tax burdens on a cross-section of equity securities between 1927 and 2004. Consistent with tax capitalization, stocks facing higher effective tax rates tend to compensate taxable investors by generating higher before-tax returns.
Keywords: Tax Capitalization, Limits to Arbitrage, Dividend Payments
JEL Classification: G12, G18, H24
Suggested Citation: Suggested Citation