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

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  • Scott E. Hein
  • Jeffrey M. Mercer

Abstract

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.

Suggested Citation

  • Scott E. Hein & Jeffrey M. Mercer, 2003. "Are TIPS really tax disadvantaged? Rethinking the tax treatment of U.S. Treasury Inflation Indexed Securities," FRB Atlanta Working Paper 2003-9, Federal Reserve Bank of Atlanta.
  • Handle: RePEc:fip:fedawp:2003-9
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    References listed on IDEAS

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    1. Campbell, John Y. & Chan, Yeung Lewis & Viceira, Luis M., 2003. "A multivariate model of strategic asset allocation," Journal of Financial Economics, Elsevier, vol. 67(1), pages 41-80, January.
    2. Zvi Bodie, 1988. "Inflation, Index-Linked Bonds, and Asset Allocation," NBER Working Papers 2793, 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. 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.
    5. 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 266-276, June.
    6. Robert Jarrow & Yildiray Yildirim, 2008. "Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 16, pages 349-370 World Scientific Publishing Co. Pte. Ltd..
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    Keywords

    Investments ; Taxation ; Securities ; Interest rates ; Income tax;

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