New Evidence on the Tax Elasticity of Capital Gains

This study updates previous research estimating the persistent effect of tax changes on capital gains realizations by using a large panel of tax returns from 1999 to 2008. Similar to earlier studies in the literature, we use the Type II Tobit model to address the sample selection problem and we address the endogeneity problem in the tax variables, but we improve the identification of the tax elasticity by using an exclusion restriction: the presence of carryover loss. The preferred persistent elasticity estimate is –0.72 and is statistically significant and robust to a number of sensitivity tests. We also compare the results of our model to results from the original model applied to contemporary data, and estimate our model on sub-periods. Unlike prior research, this study estimates the tax elasticity of other types of capital gains. We find that pass-through capital gains are highly sensitive to persistent tax changes, but gains from mutual fund distributions are extremely insensitive.