Capital Gains Taxes and Trading Incentives

Once all present and future tax consequences of a sale are included, the effective tax rate on capital gains and losses is almost always less than the statutory tax rate, and it is asset- and investor-specific. As demonstration, I compute the effective tax rates for taxable and tax-exempt bonds held by property-casualty insurers (0 to 10% versus 15 to 30%) and show empirically that because of the higher effective tax rate, property-casualty insurers are more reluctant to realize gains on tax-exempt bonds, compared to taxable bonds, even though all gains are taxed at a statutory rate of 35%.