Lock-In Vs. Capitalization Market Reactions to Tax Changes

Document Type

Article

Department or Administrative Unit

Finance and Supply Chain Management

Publication Date

2018

Abstract

In 1997, investors were surprised by the announcement that the Clinton administration had reached an agreement with Congress to lower the marginal rate on capital gains taxes. This announcement was not preceded by rumors of the forthcoming reduction and no other tax rates were changed. Therefore, this presents an ideal situation to study the equity market reactions to an announced tax reduction. Two competing forces could possibly explain changes in stock prices relative to this announcement. The "lock-in effect" could explain negative equity re-valuations, and the capitalization effect could influence positive price adjustments. The possible effects of both effects are tested on the announcement date and the information date, and the findings are presented in this paper. We provide evidence which would support both the lock-in and capitalization effects on stock price reactions to the announced change in capital gains tax rates. As we move into a new administration, with the 20 year anniversary of this change, the notion of changes in the tax code arises again. If capital gains once again become an avenue of change, the potential outcome of this change once again becomes relevant.

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This article was originally published in Journal of Applied Financial Research.

Journal

Journal of Applied Financial Research

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