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Capital Gains Taxes and Asset Prices: Capitalization or Lock-in?

Authors

  • ZHONGLAN DAI,

  • EDWARD MAYDEW,

  • DOUGLAS A. SHACKELFORD,

  • HAROLD H. ZHANG

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      Zhonglan Dai is at the School of Management, University of Texas at Dallas, Edward Maydew is at the Kenan-Flagler Business School, University of North Carolina, Douglas A. Shackelford is at the Kenan-Flagler Business School, University of North Carolina and NBER, and Harold H. Zhang is at the School of Management, University of Texas at Dallas. We thank Ashiq Ali, Robert Kieschnick, Suresh Radhakrishnan, Scott Weisbenner, Yexiao Xu, Rob Stambaugh (the editor), an anonymous referee, and seminar participants at the 2006 NBER Behavioral Response to Taxation/Public Economics Program Meeting, the 2006 UNC Tax Symposium, and the University of Texas at Dallas for helpful comments. All errors are our own.


ABSTRACT

This paper demonstrates that the equilibrium impact of capital gains taxes reflects both the capitalization effect (i.e., capital gains taxes decrease demand) and the lock-in effect (i.e., capital gains taxes decrease supply). Depending on time periods and stock characteristics, either effect may dominate. Using the Taxpayer Relief Act of 1997 as our event, we find evidence supporting a dominant capitalization effect in the week following news that sharply increased the probability of a reduction in the capital gains tax rate and a dominant lock-in effect in the week after the rate reduction became effective.

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