Treasury Bill Yield Reactions to the 1997 Capital Gains Tax Rate Reduction

Abstract

I provide evidence that changes in shareholder-level taxes influence investment returns even when income from the investment is not subject by statute to the rate that is changed. Using an equilibrium model of after-tax investment returns I predict the yields of Treasury bills, which are subject only to ordinary tax rates, will have an inverse reaction to changes in the capital gains tax rate as the income on them becomes increasingly tax-disadvantaged when compared to other investments. In a sample comprised of short-term Treasury bills, yields appear to increase in response to the May 7, 1997 surprise reduction in capital gains tax rates. The increase is statistically significant and is robust to other macroeconomic and institutional determinants of Treasury bills.

The Tax Disadvantage Of Ordinary Income: An Event Study On The Legislative Process Of JGTRRA

“…Although the available Federal Reserve Statistics does not indicate individual taxable investors to have a major holding in the overall Treasury securities market, the results in Guenther (1994) do suggest that taxable investors and their money managers influence the dynamics in the short-term Treasury bill market with their tax considerations. Novack (2005) analyzed the extent to which U.S. Treasury yields might be impacted by a change in the capital gain tax on stocks. He reports that Treasury bill yields increased on the day that Congress announced the 1997 reduction in the tax rate on long-term capital gains (May 2, 1997) and again on the day that the tax cut became effective ( May 7, 1997).…”