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Are TIPS really tax disadvantaged? Rethinking the tax treatment of U.S. Treasury Inflation Indexed Securities

  • Scott E. Hein
  • Jeffrey M. Mercer

In 1997 the U.S. Treasury introduced Inflation Indexed (or Protected) Securities with substantial promotional fanfare. Yet, due in part to what some in the finance profession have described as a "tax disadvantage" placed upon TIPS, many are questioning whether they should appeal to a wide audience. Some, in fact, advise holding TIPS only in tax-deferred accounts. In this paper, the authors develop a framework that allows us to demonstrate that the tax treatment of TIPS is trivially different from that of conventional Treasury securities. Utilizing an after-tax valuation approach, they further show that under relatively conservative projections for inflation, TIPS generally have after-tax yields comparable to, if not exceeding, conventional fixed-rate Treasury securities.

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2003-9.

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Date of creation: 2003
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Handle: RePEc:fip:fedawp:2003-9
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  1. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-76, June.
  2. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 28-43 National Bureau of Economic Research, Inc.
  3. Richard W. Kopcke & Ralph C. Kimball, 1999. "Inflation-indexed bonds: the dog that didn't bark," New England Economic Review, Federal Reserve Bank of Boston, issue Jan, pages 3-24.
  4. Campbell, John Y & Chan, Yeung Lewis & Viceira, Luis M, 2001. "A Multivariate Model of Strategic Asset Allocation," CEPR Discussion Papers 3070, C.E.P.R. Discussion Papers.
  5. Jarrow, Robert & Yildirim, Yildiray, 2003. "Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(02), pages 337-358, June.
  6. Zvi Bodie, 1988. "Inflation, Index-Linked Bonds, and Asset Allocation," NBER Working Papers 2793, National Bureau of Economic Research, Inc.
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