THE SENSITIVITY OF THE TAX ELASTICITY OF CAPITAL GAINS TO LAGGED TAX RATES AND MIGRATION

THE SENSITIVITY OF THE TAX ELASTICITY OF CAPITAL GAINS TO LAGGED TAX RATES AND MIGRATION Tim Dowd and Robert McClelland May 2024 ABSTRACT Understanding how capital gains realizations respond to changes in capital gains tax rates is critical for understanding the potential revenue effects of these changes. [...] The inclusion of the tax rate in the future year is important, because taxpayers can realize capital gains in advance of a pending tax increase or defer realizations in advance of a pending tax cut1. [...] CONCLUSION In this paper we use a panel dataset of individual tax returns to test the sensitivity of the tax elasticity of capital gains to different specifications. [...] The DMM model used three tax rates to estimate the permanent elasticity: the lagged tax rate, the current tax rate, and the one-year-ahead tax rate. [...] We find evidence that the inclusion of additional lagged tax rates reduces (in absolute value) the estimated tax elasticity of capital gains from -0.75 to an average of approximately -0.56 across the four different lag specifications, with the smallest in absolute value occurring with the three lagged tax rates and the largest occurring with just one lagged tax rate.