CAPITAL GAINS REDUX: WHY HOLDING PERIODS MATTER

Changes in the tax rate on capital gains have profound effects on the volume of gains individuals choose to realize. While much of the recent policy debate has focused upon the magnitude of taxpayer response, this paper investigates the mechanism that underlies it—changes in the holding period of capital assets. A simple model of asset turnover is presented that captures, in an intuitive way, some of the variables that influence taxpayers to sell appreciated assets. The theory is tested using a rich and unique data source and the results are used in a dynamic simulation model of realizations and revenues. Small changes in the (mean) length of time assets are held translate into dramatic changes in aggregate realizations. The implications of the theory presented here are strong, empirically verifiable, and generally predict recent historical experience well.