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

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  • Daniel J. Kovenock
  • Michael Rothschild

Abstract

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.

Suggested Citation

  • Daniel J. Kovenock & Michael Rothschild, 1985. "Notes on the Effect of Capital Gains Taxation on Non-Austrian Assets," NBER Working Papers 1568, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1568
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    References listed on IDEAS

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    1. 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.
    2. Martin Feldstein & Joel Slemrod & Shlomo Yitzhaki, 1980. "The Effects of Taxation on the Selling of Corporate Stock and the Realization of Capital Gains," The Quarterly Journal of Economics, Oxford University Press, vol. 94(4), pages 777-791.
    3. Choi, E. K. & Menezes, C. F., 1985. "On the magnitude of relative risk aversion," Economics Letters, Elsevier, vol. 18(2-3), pages 125-128.
    4. Stiglitz, Joseph E., 1983. "Some aspects of the taxation of capital gains," Journal of Public Economics, Elsevier, vol. 21(2), pages 257-294, July.
    5. 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.
    6. Kovenock, Daniel J. & Rothschild, Michael, 1983. "Capital gains taxation in an economy with an `Austrian sector'," Journal of Public Economics, Elsevier, vol. 21(2), pages 215-256, July.
    7. 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.
    8. Protopapadakis, Aris, 1983. "Some Indirect Evidence on Effective Capital Gains Tax Rates," The Journal of Business, University of Chicago Press, vol. 56(2), pages 127-138, April.
    9. Constantinides, George M., 1984. "Optimal stock trading with personal taxes : Implications for prices and the abnormal January returns," Journal of Financial Economics, Elsevier, vol. 13(1), pages 65-89, March.
    10. George M. Constantinides, 1979. "Multiperiod Consumption and Investment Behavior with Convex Transactions Costs," Management Science, INFORMS, vol. 25(11), pages 1127-1137, November.
    11. Goldman, M Barry, 1979. "Anti-Diversification or Optimal Programmes for Infrequently Revised Portfolios," Journal of Finance, American Finance Association, vol. 34(2), pages 505-516, May.
    12. Constantinides, George M, 1983. "Capital Market Equilibrium with Personal Tax," Econometrica, Econometric Society, vol. 51(3), pages 611-636, May.
    13. 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.
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    Cited by:

    1. Auerbach, Alan J, 1992. "On the Design and Reform of Capital-Gains Taxation," American Economic Review, American Economic Association, vol. 82(2), pages 263-267, May.
    2. Klein, Peter, 1999. "The capital gain lock-in effect and equilibrium returns," Journal of Public Economics, Elsevier, vol. 71(3), pages 355-378, March.
    3. Klein, Peter, 2001. "The capital gain lock-in effect and long-horizon return reversal," Journal of Financial Economics, Elsevier, vol. 59(1), pages 33-62, January.
    4. Auerbach, Alan J., 1989. "Capital Gains Taxation and Tax Reform," National Tax Journal, National Tax Association, vol. 42(3), pages 391-401, September.

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