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Tax-Exempt Investors and the Asset Allocation Puzzle

  • Jack Mintz
  • Michael Smart

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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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2000/wp-cesifo-2000-01/WP242.PDF
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 242.

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Date of creation: 2000
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Handle: RePEc:ces:ceswps:_242
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  1. James M. Poterba, 1989. "Venture Capital and Capital Gains Taxation," NBER Working Papers 2832, National Bureau of Economic Research, Inc.
  2. 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.
  3. 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.
  4. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March.
  5. 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.
  6. 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.
  7. Mark Gertler & R. Glenn Hubbard, 1993. "Corporate Financial Policy, Taxation, and Macroeconomic Risk," RAND Journal of Economics, The RAND Corporation, vol. 24(2), pages 286-303, Summer.
  8. Poterba, J.M., 1989. "Tax Reform And The Market For Tax-Exempt Debt," Working papers 514, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. James M. Poterba & David A. Wise, 1996. "Individual Financial Decisions in Retirement Saving Plans and The Provision of Resources for Retirement," NBER Working Papers 5762, National Bureau of Economic Research, Inc.
  10. Joseph E. Stiglitz, 1983. "Some Aspects of the Taxation of Capital Gains," NBER Working Papers 1094, National Bureau of Economic Research, Inc.
  11. Milgrom, P. & Shannon, C., 1991. "Monotone Comparative Statics," Papers 11, Stanford - Institute for Thoretical Economics.
  12. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
  13. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
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