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Tax-exempt investors and the asset allocation puzzle

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  • Mintz, Jack
  • Smart, Michael

Abstract

Investors frequently hold equity in tax-exempt savings vehicles such as pension plans, despite the prediction of the standard model that they hold only bonds. We provide a new explanation for this empirical puzzle based on differences between pensions and taxable assets in the tax treatment of capital losses. We show how limits on refundability of losses on taxable equities leads to diversity of investors' preferences for corporate leverage on the basis of tax rates. In the simplest equilibrium of the model, tax-exempt savers hold risky, highly leveraged equities, while low-bracket taxable savers hold bonds and high-bracket taxpayers hold relatively safe, unleveraged equities. We discuss the implications of tax-exempts for risk taking and agency costs within the firm.
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  • Mintz, Jack & Smart, Michael, 2002. "Tax-exempt investors and the asset allocation puzzle," Journal of Public Economics, Elsevier, vol. 83(2), pages 195-215, February.
    • Handle: RePEc:eee:pubeco:v:83:y:2002:i:2:p:195-215
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    Cited by:

    1. Adam M. Lavecchia, 2018. "Tax-Free Savings Accounts: Who uses them and how?," Working Papers 1802E, University of Ottawa, Department of Economics.
    2. Fuest, Clemens & Hemmelgarn, Thomas, 2005. "Corporate tax policy, foreign firm ownership and thin capitalization," Regional Science and Urban Economics, Elsevier, vol. 35(5), pages 508-526, September.
    3. Shoven, John B. & Sialm, Clemens, 2004. "Asset location in tax-deferred and conventional savings accounts," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 23-38, January.
    4. Adam M. Lavecchia, 2019. ""Back-Loaded" Tax Subsidies for Saving, Asset Location and Crowd-Out: Evidence from Tax-Free Savings Accounts," Department of Economics Working Papers 2019-04, McMaster University.

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    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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