Evidence on Tax‐Motivated Securities Trading Behavior

TLDR: In this paper, the authors provide evidence that decisions by investors as to the timing of the realization of capital gains and losses from their common stock investments are significantly affected by tax considerations, and that there is a clear tendency for trades by individuals which give rise to losses to be concentrated near the end of calendar years.

Abstract: Tax-loss selling by investors in common stocks near the end of calendar years has been proposed as an explanation for the turn-of-the-year effect in stock returns. Past analyses of this hypothesis have relied on inferential data. We provide here some direct data from a compilation of over 80,000 actual common stock investment round trips by a sample of 3000 individual investors. We find strong evidence of a concentration of loss-taking trades late in the year and milder evidence of a concentration just prior to the dates when investments become eligible for long-term tax treatment. THE QUESTION AS TO whether, and in what manner, the impostion of a tax on realized capital gains affects the securities trading behavior of investors who are subject to the tax has been a longstanding topic of research in the financial ecomonics literature. The original attention devoted to the matter was motivated primarily by a concern about resource allocation and federal tax revenue consequences and was directed toward the phenomenon of what has been termed the "lock-in" effect of a gains tax. That issue has remained an important public policy one and continues today as part of the ongoing debate about appropriate strategies for reducing the federal budget deficit. Particular additional interest in the topic has emerged in recent years, however, because securities transactions undertaken systematically for tax reasons have also been proposed as part of the explanation for certain observed anomalies in historical common stock returns-most prominently, the well-documented turn-of-the-year effect. Our purpose here is to provide some new evidence that decisions by investors as to the timing of the realization of capital gains and losses from their common stock investments are significantly affected by tax considerations. This evidence indicates that a difference in the tax rates applicable to realizations classified as short and long term influences the timing of individual investors' trades and, further, that there is a clear tendency for trades by individuals which give rise to losses to be concentrated near the end of calendar (which, for them, are also tax) years. While we cannot conclude that