Taxation and Household Financial Decisions: Evidence from the Bush Tax Acts

Thesis (Ph.D.)--University of Washington, 2013

This dissertation provides insights into the impact of differential taxation of financial assets on household portfolio decisions. To address endogeneity of household marginal tax rates, it exploits the structural tax rate changes created by the Bush-era tax acts in 2001 and 2003. In the first chapter, Taxation and Household Asset Location and Allocation: Evidence from the Bush Tax Acts, examines the effects of different tax treatments across different financial assets on household asset location and allocation decisions in taxable and tax-deferred accounts. The empirical results, based on the Survey of Consumer Finances data, indicate that households with greater tax rate differentials between interest and capital gains hold significantly lower shares of bonds in taxable accounts and greater shares of bonds in tax-deferred accounts by "risk-preserving" portfolio changes. These households also hold significantly more shares of stocks in their taxable portfolio. The second chapter, Dividend Taxation and Households' Dividend Portfolio Decisions: Evidence from the 2003 Bush Tax Act, examines how the different tax treatments across different types of financial income affect households' portfolio decisions. The empirical results, based on the Public Use Tax File, suggest that households in the upper tax bracket hold significantly greater shares of qualified dividends in their dividend income, whereas the preferential tax treatment and 60-day holding period required of qualified dividends significantly hamper households' capital gains realization in the short run. However, the significant effect of the preferential tax treatment of long-term capital gains over dividends on households' income composition disappears after the 2003 tax act. The third chapter, Effects of Uncertain Tax Rates on Households' Financial Decisions: Evidence from the Bush Tax Acts, investigates how tax rate uncertainty affects households' demand for dividend yields. During 2008−2010, persistent political debates and the late enactment of the tax cut extension creates great uncertainty for high-income households regarding their future tax rates. Empirical results indicate that high-income households significantly lower their dividend yields during the period of uncertainty because they face the potential of increased tax disadvantages for dividends relative to capital gains.