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Capitalization of Capital Gains Taxes: Evidence from Stock Price Reactions to the 1997 Rate Reduction

  • Mark H. Lang
  • Douglas A. Shackelford

We empirically document that stock prices moved inversely with dividend yields during the May, 1997 week, when the White House and Congress agreed on a budget accord that included a reduction in the capital gains tax rate. The share prices of firms not currently paying dividends increased approximately 6 percentage points more over a five-day window than the share prices of other firms. Among firms paying dividends, the change in share prices was decreasing in dividend yields. The results are consistent with at least two related explanations. First, to the extent a stock's returns are expected to be taxed as capital gains, a reduction in the expected capital gains tax rate enhances the attractiveness of the investment to investors. Second, to the extent a firm's stock is held by shareholders subject to the capital gains tax, a reduction in the expected capital gains tax rate increases its market value. The findings present evidence consistent with neither a sell-off of appreciated securities following the rate reduction nor a reduction in the compensation for capital gains taxes that selling shareholders demand from buyers. The upward price pressure around the accord dominated any downward price pressure imposed by these factors.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6885.

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Date of creation: Jan 1999
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Publication status: published as Journal of Public Economics, Vol. 76 (2000): 69-85.
Handle: RePEc:nbr:nberwo:6885
Note: PE
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  1. Cutler, David M, 1988. "Tax Reform and the Stock Market: An Asset Price Approach," American Economic Review, American Economic Association, vol. 78(5), pages 1107-17, December.
  2. Schipper, Katherine & Smith, Abbie, 1991. "Effects of Management Buyouts on Corporate Interest and Depreciation Tax Deductions," Journal of Law and Economics, University of Chicago Press, vol. 34(2), pages 295-341, October.
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  4. Landsman, Wayne R. & Shackelford, Douglas A. & Yetman, Robert J., 2002. "The determinants of capital gains tax compliance: evidence from the RJR Nabisco leveraged buyout," Journal of Public Economics, Elsevier, vol. 84(1), pages 47-74, April.
  5. Klein, Peter, 1999. "The capital gain lock-in effect and equilibrium returns," Journal of Public Economics, Elsevier, vol. 71(3), pages 355-378, March.
  6. Alan J. Auerbach, 1980. "Wealth Maximization and the Cost of Capital," NBER Working Papers 0254, National Bureau of Economic Research, Inc.
  7. Alan J. Auerbach, 1987. "Mergers and Acquisitions," NBER Books, National Bureau of Economic Research, Inc, number auer87-1, August.
  8. Hayn, Carla, 1989. "Tax attributes as determinants of shareholder gains in corporate acquisitions," Journal of Financial Economics, Elsevier, vol. 23(1), pages 121-153, June.
  9. Miller, Merton H. & Scholes, Myron S., 1978. "Dividends and taxes," Journal of Financial Economics, Elsevier, vol. 6(4), pages 333-364, December.
  10. David F. Bradford, 1979. "The Incidence and Allocation Effects of a Tax on Corporate Distributions," NBER Working Papers 0349, National Bureau of Economic Research, Inc.
  11. Bagwell, Laurie Simon & Shoven, John B, 1989. "Cash Distributions to Shareholders," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 129-40, Summer.
  12. Amoako-Adu, Ben & Rashid, M. & Stebbins, M., 1992. "Capital gains tax and equity values: Empirical test of stock price reaction to the introduction and reduction of capital gains tax exemption," Journal of Banking & Finance, Elsevier, vol. 16(2), pages 275-287, April.
  13. Landsman, Wayne R. & Shackelford, Douglas A., 1995. "The Lock-In Effect of Capital Gains Taxes: Evidence from the RJR Nabisco Leveraged Buyout," National Tax Journal, National Tax Association, vol. 48(2), pages 245-259, June.
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