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Notes on the Effect of Capital Gains Taxation on Non-Austrian Assets

  • Daniel J. Kovenock
  • Michael Rothschild

This paper is an attempt to assess the effect of capital gains taxation on non-Austrian assets, such as claims to profits of continuing enterprises. As compared to taxation on an accrual basis, the capital gains tax discourages sales of appreciated assets. This is the "lock-in" effect. Because assets subject to capital gains taxation are generally held a long time, conventional estimates suggest that the effective rate of capital gains taxation is low. We contend that conventional estimates could seriously underestimate the effective rate of capital gains taxation because they ignore uncertainty. We construct a model which allows us to calculate the value of being able to actively manage a portfolio and use this model to calculate the effective rate of capital gains taxation. For several plausible parameter values the effective rate is significantly higher than estimates under certainty. We also discuss some of the ways in which the lock-in effect may distort the allocation of investment funds and the efficient workings of the capital market.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1568.

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Date of creation: Feb 1985
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Publication status: published as Kovenock, Daniel J. and Michael Rothschild. "Notes on the Effect of Capital Gain Taxation on Non-Austrian Assets," Economic Policy in Theory and Practice, ed. by Assaf Razin and Efraim Sadka. Hong Kong: Macmillan Press Ltd. , 1987, pp. 309-339.
Handle: RePEc:nbr:nberwo:1568
Note: PE
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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. George M. Constantinides, 1979. "Multiperiod Consumption and Investment Behavior with Convex Transactions Costs," Management Science, INFORMS, vol. 25(11), pages 1127-1137, November.
  3. Feldstein, Martin & Slemrod, Joel & Yitzhaki, Shlomo, 1980. "The Effects of Taxation on the Selling of Corporate Stock and the Realization of Capital Gains," The Quarterly Journal of Economics, MIT Press, vol. 94(4), pages 777-91, June.
  4. Daniel J. Kovenock & Michael Rothschild, 1981. "Capital Gains Taxation in an Economy with an "Austrian Sector"," NBER Working Papers 0758, National Bureau of Economic Research, Inc.
  5. Goldman, M Barry, 1979. "Anti-Diversification or Optimal Programmes for Infrequently Revised Portfolios," Journal of Finance, American Finance Association, vol. 34(2), pages 505-16, May.
  6. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
  7. Joseph E. Stiglitz, 1983. "Some Aspects of the Taxation of Capital Gains," NBER Working Papers 1094, National Bureau of Economic Research, Inc.
  8. Joel Slemrod, 1978. "The Lock-In Effect of the Capital Gains Tax: Some Time Series Evidence," NBER Working Papers 0257, National Bureau of Economic Research, Inc.
  9. Choi, E. Kwan & Menezes, Carmen F., 1985. "On the Magnitude of Relative Risk Aversion," Staff General Research Papers 10604, Iowa State University, Department of Economics.
  10. Feldstein, Martin & Yitzhaki, Shlomo, 1978. "The effects of the capital gains tax on the selling and switching of common stock," Journal of Public Economics, Elsevier, vol. 9(1), pages 17-36, February.
  11. John L. Evans & Stephen H. Archer, 1968. "Diversification And The Reduction Of Dispersion: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 23(5), pages 761-767, December.
  12. Protopapadakis, Aris, 1983. "Some Indirect Evidence on Effective Capital Gains Tax Rates," The Journal of Business, University of Chicago Press, vol. 56(2), pages 127-38, April.
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