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Tax-exempt investors and the asset allocation puzzle

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  • Jack Mintz
  • Michael Smart

Abstract

Investors frequently hold equity in tax-exempt savings vehicles such as pension plans, despite the prediction of the standard model that they hold only bonds. We provide a new explanation for this empirical puzzle based on differences between pensions and taxable assets in the tax treatment of capital losses. We show how limits on refundability of losses on taxable equities leads to diversity of investors' preferences for corporate leverage on the basis of tax rates. In the simplest equilibrium of the model, tax-exempt savers hold risky, highly leveraged equities, while low-bracket taxable savers hold bonds and high-bracket taxpayers hold relatively safe, unleveraged equities. We discuss the implications of tax-exempts for risk taking and agency costs within the firm.

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Bibliographic Info

Paper provided by University of Toronto, Department of Economics in its series Working Papers with number msmart-98-04.

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Length: 15 pages
Date of creation: 25 May 1998
Date of revision:
Handle: RePEc:tor:tecipa:msmart-98-04

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  1. George M. Constantinides, 1983. "Optimal Stock Trading with Personal Taxes: Implications for Prices and the Abnormal January Returns," NBER Working Papers 1176, National Bureau of Economic Research, Inc.
  2. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
  3. Stiglitz, Joseph E., 1983. "Some aspects of the taxation of capital gains," Journal of Public Economics, Elsevier, vol. 21(2), pages 257-294, July.
  4. DeAngelo, Harry & Masulis, Ronald W., 1980. "Optimal capital structure under corporate and personal taxation," Journal of Financial Economics, Elsevier, vol. 8(1), pages 3-29, March.
  5. Milgrom, Paul & Shannon, Chris, 1994. "Monotone Comparative Statics," Econometrica, Econometric Society, vol. 62(1), pages 157-80, January.
  6. James M. Poterba & David A. Wise, 1998. "Individual Financial Decisions in Retirement Saving Plans and the Provision of Resources for Retirement," NBER Chapters, in: Privatizing Social Security, pages 363-401 National Bureau of Economic Research, Inc.
  7. James M. Poterba, 1989. "Venture Capital and Capital Gains Taxation," NBER Working Papers 2832, National Bureau of Economic Research, Inc.
  8. James M. Poterba, 1989. "Tax Reform and the Market For Tax-Exempt Debt," NBER Working Papers 2900, National Bureau of Economic Research, Inc.
  9. Mark Gertler & R. Glenn Hubbard, 1991. "Corporate Financial Policy, Taxation, and Macroeconomic Risk," NBER Working Papers 3902, National Bureau of Economic Research, Inc.
  10. Auerbach, Alan J. & King, Mervyn A., 1982. "Corporate financial policy with personal and institutional investors," Journal of Public Economics, Elsevier, vol. 17(3), pages 259-285, April.
  11. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March.
  12. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
  13. Burman, Leonard E. & Ricoy, Peter D., 1997. "Capital Gains and the People Who Realize Them," National Tax Journal, National Tax Association, vol. 50(3), pages 427-51, September.
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Cited by:
  1. Clemens Fuest & Thomas Hemmelgarn, 2003. "Corporate Tax Policy, Foreign Firm Ownership and Thin Capitalization," CESifo Working Paper Series 1096, CESifo Group Munich.
  2. John B. Shoven & Clemens Sialm, 1999. "Asset Location in Tax-Deferred and Conventional Savings Accounts," NBER Working Papers 7192, National Bureau of Economic Research, Inc.

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