Social Sciences - Taxes and Portfolio Choice

Abstract

The three essays of this dissertation present complementary evidence that taxes influence the structure of household financial portfolios. Because an investment can deliver different after-tax returns to different investors, taxes may importantly affect how households structure their financial portfolios. Unlike most previous authors, I rely on policy-driven shifts in the tax system which allow for estimates that more plausibly capture tax effects. Understanding such responses is important for evaluating and designing tax policy. In the first essay, I examine the impact of the Jobs and Growth Tax Belief Reconciliation Act of 2003 the 2003 tax act) on household portfolio dividend yields. The dividend clientele hypothesis predicts that the 2003 tax act, which reduced the tax-disadvantage of dividend income differentially across the income distribution, would cause high income households to shift their portfolios toward dividend paying stocks. I find that the relationship between taxes and the types of equities that households choose is consistent with the hypothesis and that responses to the 2003 tax act were large and significant. In the second essay, I estimate the effect of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the 2003 tax act on the allocation of household financial wealth across asset classes. Together, the tax acts increased the tax advantage of directly held equities relative to interest-bearing assets. I find that households shifted their portfolio holdings towards stocks in response to the tax acts. In addition, changes to retirement account holdings are consistent with households using tax-deferred accounts to shelter their more heavily taxed assets. In the third essay, I consider whether equity portfolio responses to the 2003 tax act differed across households with different levels of financial sophistication. I construct a novel measure of financial sophistication based on the sources of financial advice that are used when making investment and borrowing decisions. I find little evidence of tax response heterogeneity by financial sophistication.

Source: http://www.socscience.com/economics/19498.html

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