The Tax Elasticity of Capital Gains Realizations: Evidence from a Panel of Taxpayers

This paper examines a newly available six-year panel of tax return data to see what light it sheds on the tax elasticity of capital gains realizations. Panel data are a particularly valuable source of evidence for this question, because they can help to distinguish short-run from long-run effects and because they track the behavior of individuals when faced with varying tax systems. We find consistent, although not overwhelming, support for an inverse response of capital gains realizations to changes in their rate of taxation. The response to deviations from past tax rates generally exceeds the response to persistent tax changes. The estimated magnitude of the realization response is large enough to substantially mitigate the revenue loss that a tax reduction would otherwise cause and may, especially in the short run, be large enough to generate an increase in revenues. These results, however, must be qualified by their nonrobustness to specification changes along a number of dimensions and by the fact that a more general dynamic specification does not yield plausible results.