Understanding Capital Gains Responses to Taxes using Transaction-Level Data

We study how individuals retime capital gains  using administrative transaction-level data on all taxable sales of broker-traded financial assets between 2015 and 2019. Our empirical design leverages a simple, large and salient tax notch: in the U.S., assets held beyond one year qualify for a 10-20% reduction in capital gains tax rates.  

We find that: (1) approximately 25% of eventually taxed financial gains represent higher-taxed short-term gains; (2) retiming responses around the notch are weak and individuals make clear misoptimization errors by realizing gains just before the notch; and (3) this pattern cannot be explained with rational expectations about the rates of return, instead, the behavior is consistent with inattention and trading style rigidities.