Capital Gains Taxation and Realizations: Evidence from Interstate Comparisons

Despite numerous studies of the relation between income taxes and capital garns realizations, the revenue consequences of reducing capital gains tax rates remain unclear. However, an important source of cross-sectional variation has been neglected in this line of research: since both the tax base and the tax rate vary among states, the marginal tax rate on capital gains differs among otherwise identical individuals located in different states. The interstate variation in the tax consequences of realizing capital gains implies that the incentive to realize gains varies across states. This paper documents the interstate variation in capital gains taxation and examines the relation between capital gains taxes and aggregated state-level realizations. For each state, we construct marginal tax rates on capital gains for the highest state income tax bracket for 1982 through 1990. Using state-level aggregated data rather than data on individual taxpayers alleviates the problem that the marginal tax rate is endogenous to the amount of capital gains realized. Panel estimates indicate that capital gains realizations are negatively related to capital gains tax rates. The estimated elasticity is smaller than that found by most researchers using panel data, with a point estimate of - 0.67 in our basic specification.