Capital gains tax policy: The effect on investment company capital gains realizations

Preferential marginal tax rates on capital gains are used to: relieve the lock-in effect; improve the mobility of capital; and stimulate investment and economic growth. Individuals may defer the sale of appreciated assets that yield less than optimal returns to avoid taxation. This lock-in effect distorts investment decisions of individuals and impairs the mobility of equity capital. A capital gains tax policy aimed at and equity capital market that is no longer dominated by individual investors may not have the intended effects.; The goal of this dissertation is to determine the effect of preferential capital gains tax rates on investment company capital gains realizations and the resulting implications for the efficiency of the U.S. capital gains tax policy. The increasing influence of investment companies, both in terms of the large proportion of equity capital they control and the sizable trading volume they generate, motivated the research question. This dominance of trading activity can lessen the impact of a capital gains tax policy aimed at individual investors. In this study capital gains realizations of investment companies across three capital gains tax regimes are examined to obtain evidence of a lock-in effect and the tax policy impact.; Empirical tests on the cross-sectional time-series data (obtained by using the Fuller-Battese variance components model) provide evidence of the locking and unlocking effect of rises and declines in marginal capital gains tax rates on investment company capital gains realizations. Investment company capital gains realizations are higher during periods of low marginal tax rates on capital gains. The unlocking effect is greater when marginal capital gains tax rates are lower. The significant permanent effects estimated in the analysis are strengthened when transitory effects are introduced into the model. This research provides evidence that investment company portfolio managers consider the capital gains tax consequences to individual shareholders in rebalancing and consumption decisions.