We study how individuals’ trading behavior responds to tax incentives using administrative transaction-level data on all taxable sales of broker-traded financial assets between 2011 and 2019. Our empirical design leverages a simple, salient, timing-based tax notch: in the U.S., assets held beyond one year qualify for a 10-20% reduction in capital gains rates. The size and granularity of the data allow us to study how this capital gains tax rate differentiation shapes individuals’ trading behaviors across narrowly defined demographic and income groups. We find that: (1) retiming responses around the tax rate notch are weak in general; (2) individuals make clear misoptimization errors by realizing gains just before the notch; and (3) this pattern can be explained by both heterogeneous capital gains responses by asset type combined with rigidities in individual trading styles. Finally, we use our empirical results to show theoretically that the weak deferral elasticities imply that a revenue-maximizing government would eliminate short- vs long-term tax differentiation.

This talk is presented by the Public Finance Seminar, sponsored in part by the Department of Economics with generous gifts given through the Elizalde-Winikates Family Fund in Economics and the Economics Strategic Fund.