Optimal Consumption and Investment with Capital Gains Taxes

Dammon, Robert M.; Zhang, Harold H.; Spatt, Chester S.

doi:10.2139/ssrn.282756

Cited by 85 publications

(102 citation statements)

References 16 publications

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“…Namely, in Proposition 3.5 we prove that it is always optimal to realize capital losses whenever the tax basis exceeds the spot price. This property is observed in practice and is stated and embedded directly in the definition of the tax basis in [12]. We also prove the continuity of the value function (and even Lipschitz continuity, up to a change of variables).…”

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confidence: 53%

“…As in [12], the tax basis is defined as the weighted average of past purchase prices, and the taxation rule is linear, thus allowing for tax credits. However, we differ from [12] by considering an infinite horizon problem, as our main goal is to provide analytical tools for this class of problems. In particular, our model does not allow for tax forgiveness at death.…”

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confidence: 99%

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Merton Problem with Taxes: Characterization, Computation, and Approximation

Tahar¹,

Soner²,

Touzi³

2010

SIAM J. Finan. Math.

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Abstract. We formulate a computationally tractable extension of the classical Merton optimal consumptioninvestment problem to include the capital gains taxes. This is the continuous-time version of the model introduced by Dammon, Spatt, and Zhang [Rev. Financ. Stud., 14 (2001), pp. 583-616]. In this model the tax basis is computed as the average cost of the stocks in the investor's portfolio. This average rule introduces only one additional state variable, namely the tax basis. Since the other tax rules such as the first in first out rule require the knowledge of all past transactions, the average model is computationally much easier. We emphasize the linear taxation rule, which allows for tax credits when capital gains losses are experienced. In this context wash sales are optimal, and we prove it rigorously. Our main contributions are a first order explicit approximation of the value function of the problem and a unique characterization by means of the corresponding dynamic programming equation. The latter characterization builds on technical results isolated in the accompanying paper [I. Ben Tahar, H. M. Soner, and N. Touzi, SIAM J. Control Optim., 46 (2007), pp. 1779-1801. We also suggest a numerical computation technique based on a combination of finite differences and the Howard iteration algorithm. Finally, we provide some numerical results on the welfare consequences of taxes and the quality of the first order approximation.

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confidence: 53%

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confidence: 99%

Merton Problem with Taxes: Characterization, Computation, and Approximation

Tahar¹,

Soner²,

Touzi³

2010

SIAM J. Finan. Math.

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“…See Dammon, Spatt and Zhang (2001) for an analysis of how consumption and investment are distorted by capital gains taxation. 20 Our estimation implies that capital gains taxation reduces a firm's average Tobin's q -defined as the market value of the firm divided by the replacement cost of the firm, which reduce the incentive for company creation and investment.…”

Section: International Repercussions Of Capital Gains Taxationmentioning

confidence: 99%

Capital Gains Taxation and the Cost of Capital: Evidence from Unanticipated Cross-Border Transfers of Tax Bases

2012

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Abstract:In a cross-border takeover, the tax base associated with future capital gains is transferred from target shareholders to acquirer shareholders. Cross-country differences in capital gains tax rates enable us to estimate the discount in the takeover price on account of future capital gains. The estimation suggests that a one percentage point increase in the capital gains tax rate reduces the valuation of new equity by 0.136%. The implied average effective tax rate on capital gains is 4.57%, indicating that capital gains taxation is a significant cost to firms when raising new equity capital. Apart from the taxation of future capital gains, we also find that takeover prices are affected by capital gains taxation resulting from the accelerated realization of past capital gains by target shareholders.

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“…Recently in the US, many other studies also used the consumption-wealth ratio, such as Dammon et al (2001), Maenhout (2004), McQueen and Vorkink (2004), Peress (2004), Chacko and Viceira (2005), Lettau and Ludvigson (2005), Yao and Zhang (2005), Santos and Veronesi (2006), Lustig and Nieuwerburgh (2008), Campbell and Thompson (2008), Ghattassi (2008), Møller (2008, and Welch and Goyal (2008), among others.…”

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confidence: 99%

Consumption, Aggregate Wealth, and Expected Stock Returns in Japan

Tsuji¹

2009

IJEF

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This paper studies the role of fluctuations in the aggregate consumption-wealth ratio for predicting stock returns in Japan. Using quarterly Japanese stock market data, we find three main results that are different from US evidence. First, unlike in the US, fluctuations in Japan in the consumption-wealth ratio are not strong predictors of real and excess stock returns. Second, we find that the dividend yield is a much better forecaster of future stock returns at short and intermediate horizons than is the consumption-wealth ratio in Japan. This is also a different result than from the US. Third, as opposed to the US again, the relative risk-free rate in Japan shows almost no ability to predict excess stock returns in Japan, while the corresponding relative T-bill rate exhibits rather strong forecasting power for excess stock returns in the US.

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Optimal Consumption and Investment with Capital Gains Taxes

Cited by 85 publications

References 16 publications

Merton Problem with Taxes: Characterization, Computation, and Approximation

Merton Problem with Taxes: Characterization, Computation, and Approximation

Capital Gains Taxation and the Cost of Capital: Evidence from Unanticipated Cross-Border Transfers of Tax Bases

Consumption, Aggregate Wealth, and Expected Stock Returns in Japan

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