ISSUES RELATING TO THE TAXATION OF CAPITAL GAINS

The empirical evidence regarding the relationship between capital gain taxes and revenues flowing into the US Treasury is reviewed. First, a summary is presented of several of the major contributions to this debate. Some simple mathematics relating to holding periods, realizations, and tax revenues also are presented. Some useful results are derived that point to the salient feature of this simple model: longer holding periods do not necessarily mean reduced realizations. After discussing the relationship between holding periods and the aftertax rate of return, attention is turned to the problems with the present body of empirical work, some of which are econometric in nature and some that are solely due to the incorrect interpretation of the result. Some concerns with respect to the lack of any treatment of portfolio effects in much of the literature are discussed. Some light is shed on what, if any, the step-up in the cost basis that occurs when a decedent passes property along to an heir has on the decision to realize a capital gain on that property.