Estate Taxation, Capital Gains Taxations, and Taxpayer Behavior

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This project will investigate the effect of estate taxes and capital gains taxes on household financial decisions. The Taxpayer Relief Act of 1997 provides important new variation in the marginal estate, gift, and capital gains tax rates facing high net worth households. The Survey of Consumer Finances, which has been conducted every three years since 1983, and in comparable format since 1989, provides enough information on repeated cross-sections of high net worth households to permit analysis of how these taxes affect taxpayer behavior.The project is divided into three subprojects.The first considers how the current tax law provision allowing "basis step-up" for capital assets passed through estates affects inter vivos giving and capital gain realizations. The analysis will focus on the tradeoff between capital gains taxes and estate taxes. This tradeoff arises when an individual considers whether to sell an appreciated asset, and give the proceeds to children or other parties as inter vivos gifts, or alternatively to hold the asset until death, when it will be included in a potentially taxable estate but receive basis step-up. The central empirical focus of this project will be on the estimation of models for inter vivos giving, using data from the Survey of Consumer Finances. The hypothesis to be tested is that households with the most to gain by holding assets until they die are particularly unlikely to make inter vivos gifts. The empirical results will provide evidence on the degree to which capital gains tax rules and estate taxes induce asset "lock in" among high net worth households with appreciated capital assets.The second subproject will develop new evidence, also based on the Survey of Consumer Finances, on the probability of realizing accrued capital gains in a given time interval. This information will be used to explore how a change in asset values, such as the increase in corporate stock prices during the 1 990s, might affect realizations and capital gains tax revenues. It will also be used to develop new estimates of the effective accrual tax rate on realized capital gains. Existing estimates of this effective tax rate rely on aggregate data, rather than householdlevel information, and are based on dated information about asset realization rates.The third subproject will explore the effect of pass-through taxation of realized capital gains on the behavior of mutual fund investors. It will study the impact of a mutual fund's "tax efficiency" on the cash inflows to the fund, thereby generalizing previous studies that have analyzed how pretax returns affect cash inflows. It will also consider the factors that determine the tax efficiency of different mutual funds, and the impact of mutual fund distributions on federal tax receipts. More generally, this study will provide new evidence on whether investors consider the tax burdens on different investment options in making portfolio choices.