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This article discusses the ongoing case of Moore v. United States, which is currently being argued before the U.S. Supreme Court. The case revolves around the interpretation of the Sixteenth Amendment and whether it allows Congress to tax unrealized sums without apportionment among the states. The amicus briefs in the case focus on the original meaning of the phrase "taxes on incomes" and whether it includes a realization requirement. The outcome of the case could have significant implications for various tax provisions. The article provides a historical overview of the case and examines the arguments made by both sides regarding the historical understanding of the Constitution's language. It also explores the history of state income taxes and academic discussions surrounding the definition of income at the time of the amendment's adoption. The article concludes that there was no publicly understood consensus that realization was a requirement for an income tax, and that the Supreme Court's interpretation of the Macomber case to establish a universal realization requirement would be inconsistent with the intent of the Sixteenth Amendment. [Extracted from the article]

According to Modern Monetary Theory (MMT), modern governments finance their spending primarily through the creation of money rather than from the proceeds of taxation and bond sales. This article emphasizes that the government has the responsibility to create economic sustainability and analyzes MMT from the perspective of sustainable finance for economic sustainability. In the policy framework of the European Union (EU), sustainable finance refers to the institutional process of taking environmental, social, and governance (ESG) considerations into account when financial institutions or government authorities make investment decisions to promote sustainability. In principle, public enterprises owned by the government are required to comply with the standards of sustainable finance. During the global transition to achieve the Sustainable Development Goals (SDGs), public enterprises can be employed in a timely manner to complement private companies lacking a sustainable vision or whose promotion of sustainable activities has been delayed. This article points out that the government can not only set sustainable guidelines for private companies, but can also directly initiate the state default, i.e., public enterprises, in the promotion of economic sustainability. [ABSTRACT FROM AUTHOR]

This article provides an empirical decomposition of the default, liquidity, and tax factors that determine expected corporate bond returns. In particular, the risk premium associated with a default event is estimated. The intensity-based model is estimated using bond price data for 104 US firms and historical default rates. Significant risk premia on common intensity factors and important tax and liquidity effects are found. These components go a long way towards explaining the level of expected corporate bond returns. Adding a positive default event risk premium helps to explain the remaining error, although this premium cannot be estimated with high statistical precision. [ABSTRACT FROM AUTHOR]

We examine whether tax incentives influence where U.S. multinational locate their interest deductions worldwide. Our sample includes international bond offerings by U.S. multinationals during 1987-1997 denominated in the currencies of Australia, Canada, France, Germany, Italy, Japan, or the United Kingdom. Our results suggest that U.S. multinationals' debt location decisions take into account the effect of jurisdiction-specific tax-loss carryforwards and binding foreign tax credit limitations on the value of debt tax shields. Our results are also consistent with U.S. multinationals locating interest deductions in different tax jurisdictions as a mechanism to achieve tax-motivated income shifting. [ABSTRACT FROM AUTHOR]

Changes in the capital gains tax rules facing individual investors do not affect the incentives for "window dressing" by institutional investors, but they can affect the incentives for year-end tax-induced trading by individual investors. Empirical evidence for the 1963 to 1996 period suggests that when the tax law encouraged taxable investors who accrued losses early in the year to realize their losses before year-end, the correlation between early year losses and turn-of-the-year returns was weaker than when the law did not provide such an early realization incentive. These findings suggest that tax-loss trading contributes to turn-of-the-year return patterns. [ABSTRACT FROM AUTHOR]

Copyright of FinanzRundschau is the property of De Gruyter and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use. This abstract may be abridged. No warranty is given about the accuracy of the copy. Users should refer to the original published version of the material for the full abstract. (Copyright applies to all Abstracts.)

When finding the after-tax yield to maturity of a bond, it is customary to use the approximate relationship: after-tax yield = (1 - tax rate) x (before-tax yield). This paper provides a theoretical justification for this simplified formula by showing that, for premium bonds, it can be obtained from the complex implicit function defining the exact after-tax yield by using a first-order Taylor series approximation. Such simple approximations normally result in potentially large errors, and this is indeed what our simulation results show. Nevertheless, the approximation formula's error possesses the desirable properties that it is consistent in sign and bounded. Hence, the approximate formula, although easy to apply, should be used with caution. [ABSTRACT FROM AUTHOR]

The article reports on the pricing of premium bonds and comments on the paper, "The Pricing of Premium Bonds," by M. Livingston. The author claims that Livingston offers an analysis of the coupon effect on yield to maturity in premium bonds that is wrong. Coupon bonds, annuities, and discounted notes give only positive payments and there is a corresponding discount rate or yield to maturity for market price. The discounted notes implicit in discount bonds, as well as premium bonds, have a tax on the discount from par.

The article analyzes the differential effect of inflation on the rates of return for taxable corporate bonds and tax-exempt municipal bonds. Empirical methods are used to examine the impact of expected inflation on rates of return on taxable bonds, common stocks, and tax-exempt municipal bonds. Results show that nominal taxable yields and tax-exempt yields respond differently to expected inflation. The subperiods of 1959-1965 and 1966-1980 are discussed in terms of the conventional "Fisher Effect."

Are nominal bonds appropriately discounted for taxes? Empirical estimates of the response of nominal interest rates to changes in inflation, the Fisher effect, have failed to produce a definitive answer. Four reasons have been put forward as possible explanations: (i) Tobin effects, (ii) fiscal illusion, (iii) peso problems, and (iv) different estimators. Utilizing data on taxable and tax-exempt bond interest rates and several different estimators, we find that the Fisher effect estimates are always larger for the taxable bond relative to the tax-exempt bond, suggesting that fiscal illusion and different estimators cannot account for the previous results. [ABSTRACT FROM AUTHOR]

This comment describes the U.S. federal income tax treatment of corporate bonds that are indexed for inflation and argues that these bonds do not have a tax-induced clientele in the United States. [ABSTRACT FROM AUTHOR]

This paper shows that the sharp narrowing with maturity of the spread between taxable and tax-exempt yields leaves room for tax arbitrage. At times, tax-exempt forward rates have exceeded taxable forward rates. At such times, only expectations of higher taxes on Treasury than on municipal bonds would eliminate profit opportunities. The authors develop the idea of forward tax rates and compute forward tax rates for 1955 through 1984. They also outline tax-arbitrage mechanisms involving private forward sale of long municipal bonds or the use of the Municipal Bond Futures Contract and show the potential profits. [ABSTRACT FROM AUTHOR]

The article shows that, faced with uncertain taxable income and progressive taxation, the investor expresses a preference for a unique combination of taxable and tax-exempt bonds. A risk-averse investor will not hold tax-exempt bonds unless they offer a return greater than the expected after-tax return on similar taxable securities since taxable bonds provide a hedge against fluctuations in after-tax income, which tax exempt bonds do not offer. The required risk premium depends upon risk aversion, the progressivity of the tax schedule, the after-tax return on taxable bonds, and the variance of taxable income.

This study offers an alternative method of calculating marginal personal tax rates through the pairing of nontaxable (industrial development and pollution control) and taxable corporate bonds. This procedure is shown to produce matched bond pairs that are comparable. Two hundred pairs of bonds are examined from the second quarter of 1973 through the second quarter of 1983. Testing of the marginal tax rate relationships indicates that the marginal personal tax rate is less than the corporate statutory tax rate. [ABSTRACT FROM AUTHOR]

It is shown that coupon bonds alone are not sufficient to span time-dated claims on ordinary income, capital gains, and non-taxable wealth. In an incomplete bond market where the pure dated claims are not spanned by existing bonds, marginal rates of substitution between present consumption and pure dated claims on ordinary income, capital gains income, and non-taxable wealth, respectively, can differ across bondholders. However, the relative pricing of coupon bonds in each of these countries is shown to be consistent with the tax status of the major (non-tax-exempt) holders of government debt. [ABSTRACT FROM AUTHOR]

In a 1979 article in this journal, Livingston [5] examined the tax treatment of original-issue deep-discount bonds (OIDs), and concluded that this tax treatment made the bonds "highly disadvantageous to potential bondholders and firms." Nevertheless, from March 1981 through April 1982, almost 14% of the funds raised in the domestic bond market were raised with bonds issued at deep discounts from their par values. These OIDs had yields to maturity below comparable bonds being issued at par with coupons reflecting current interest rates (i.e., current coupon bonds, or CCBs). To explain the attractiveness of OIDs to investors, market analysts have noted that the bonds were less likely to be called by the issuer, that they had a more certain yield to maturity, and that an inverted yield curve made OID cash flows more appealing. This note reexamines the perceived tax disadvantages on OIDs issued prior to July 1, 1982 and shows that it applies most strongly to the purchase of new OIDs by taxable investors. However, after some seasoning, OIDs will become attractive to taxable investors because they begin to produce capital gain income. In fact, original holders who are nontaxable may be able to earn very high holding-period returns by selling seasoned OIDs to taxable holders in the secondary market. Although the Tax Equity and Fiscal Responsibility Act of 1982 eliminates this advantage on new issues, older issues will still benefit from it. [ABSTRACT FROM AUTHOR]

In many highly organized financial markets, investors can substitute easily between alternative financial assets. Differences in asset yields tend to reflect differences in term to maturity (or duration), in risk arising either from possible default or from illiquidity, or in the tax treatment of investment returns. During the 1961–77 period, the average yield on privately placed corporate bonds exceeded those on publicly issued corporate bonds—of roughly similar quality, duration, and tax treatment—by about 50 basis points. Higher flotation costs in public offerings and increased flexibility for borrowers in private placements account for most of this average private-public yield spread of 50 basis points. However, the level of the spread did not remain fixed at 50 basis points but varied over the 1961–77 period from a quarterly low of 5 basis points in 1970:2 to a quarterly high of 94 basis points in 1962:4. While lower flotation costs and greater convenience seem adequate to explain most of the average private-public yield spread, changes in relative cost and convenience do not seem sufficient to explain changes in the spread. The purpose of this paper is to analyze private placement yields relative to yields on public offerings of roughly similar quality and duration. The parameters of a reduced form private placement yield model are estimated using quarterly data from the 1961–74 period. The empirical results indicate how private placement rates, relative to public rates, are affected by the level of the public rate, changes in this rate, the supply of credit relative to demand in the private market, and interest rate expectations adjusted for uncertainty about future rates. These results provide information about the degree of segmentation between the private and public markets, the impact of interest rate expectations and uncertainty about future rates on private placement rate negotiations, and the rate of adjustment o... [ABSTRACT FROM AUTHOR]

In recent years, an increasing interest has been shown in pure discount bonds. A number of papers have looked at corporate capital structure in an option pricing framework, assuming the issuance of pure discount bonds by corporations. Merton has presented a theoretical discussion of the impact of default risk upon pure discount bonds. Racette and Lewellen have argued that long-term pure discount bond issues could present special tax advantages to corporations. Fisher and Weil have suggested that long-term pure discount bonds would be very attractive to holders of bond portfolios in order to immunize these portfolios against changes in interest rates. A similar position is taken by Caks. In spite of the claimed advantages of pure discount bonds from the viewpoint of both potential bondholders and stockholders, in the United States long-term pure discount bonds are not issued by corporations or governments. This paper will provide an explanation of this non-issuance by showing that the tax treatment of original issue pure discount bonds is highly disadvantageous to potential bondholders and firms. U.S. tax law requires the original purchaser of a long-term pure discount bond to amortize as regular income over the bond's life the difference between the purchase price and the face value (to be received at maturity). One purpose of this paper is to show that this tax law implies that, in equilibrium, pure discount bond issue prices would have to be negative for a wide spectrum of tax rates. Corporations would never issue bonds at negative prices, since the corporation would never receive any cash inflows. Secondly, it will be shown that pure discount bonds initially issued at positive prices can subsequently have negative prices if interest rates were to rise. Consequently, such bonds would be very risky to potential purchasers. [ABSTRACT FROM AUTHOR]

Empirical studies have found a wide variety of shapes of bond yield to maturity curves (showing yield to maturity versus maturity) for coupon-bearing bonds. It is widely believed that zero coupon bond yield curves will have similar shapes. The relationship between yield curves for zero coupon bonds and coupon-bearing bonds is important because the majority of the theoretical work on bond pricing is developed for zero coupon bonds, but virtually all bonds (with maturities exceeding one year) are coupon-bearing bonds. This paper will analyze the relationship between the yield curves for coupon-bearing bonds and zero coupon bonds in a world with differential taxation of coupons and capital gains. The relationship between coupon-bearing and zero coupon yield curves (and forward rates) is quite complex in the general case. To provide some insights into the relationships, this paper will examine two special cases: (1) level before-tax zero coupon yield curves, and (2) level after-tax zero coupon yield curves; it will be assumed in both cases that tax rates and bond coupon levels will be the same for all maturities. [ABSTRACT FROM AUTHOR]

The article reports on industrial revenue bonds, which are used as a source of long-term financing by many large corporations in the United States. Industrial revenue bond financing, which provides low-cost capital for expansion or investment, are securities issued by local governments. The funds are used to buy or improve facilities which are then rented to companies on long-term leases. The bonds can be a general obligation of the local government or secured transactions. The advantage is low interest payments for corporations. Five factors used in considering a company for industrial revenue financing, advantages to the bondholders, opposition to this type of financing from the Treasury Department and Wisconsin Congressman Henry S. Reuss, and Armco Steel Corporation are mentioned.

The most important factor that has been affecting both the size and nature of the potential market for tax-exempt bonds is the rising ratio of "take home" interest on these bonds, compared to that on taxable bonds. The reasons behind this sharp rise in the ratio in recent years are examined and measures that must be taken in order to take advantage of this changing market are investigated. The investor's choice between purchasing taxable and non-taxable bonds is explored, and the implications of ensuing market changes are considered.

Municipal bonds are held in taxable accounts because the interest is tax-exempt, but gains and losses are subject to complex tax treatment. The author explains how selling at a loss when the market value falls below the investor's tax basis can improve after-tax performance. The hold value, which can differ substantially from the market price, is a key part of calculating the potential benefit from sale. The difference between the sale proceeds and the hold value shows the benefit of selling. If the benefit is positive, the question is whether to act now or wait for a possibly better opportunity. The answer lies in the transaction's tax efficiency, which compares the benefit captured to the value of the tax option (i.e., the right to take a tax loss at any time). The latter's value depends on interest-rate volatility and transaction costs. The author recommends selling only if the benefit captures a high percentage of the forfeited tax option (i.e., if the tax efficiency is sufficiently high). [ABSTRACT FROM AUTHOR]

This paper seeks to explore what we can learn from the experience of the Build America Bond program about optimal federal tax policy for municipal bonds. It examines the effect of repealing the tax-exempt status of municipal bonds on their yields by comparing tax-exempt bonds issued by state and local governments with the limited-period BAB program. The authors use an empirical model testing the effect of the tax-exempt status on the municipal bond yield, controlling for other yield determinants. The data for estimating this model are collected from the Municipal Securities Rulemaking Board for Texas for the period August to December 2010. The results from estimating the model show that the net effect of removing tax exemption on municipal interest costs is positive before considering the BAB direct subsidy. This indicates that the cost of long-term borrowing for state and local governments is likely to be affected by removing tax exemption. The authors also find that the yield spread between taxable and tax-exempt bonds narrows with longer bond maturities and the credit rating of bonds. The size of the bond issue, risk-free interest rates, call options, and yield to first call increase the yield spread between tax-exempt and taxable bonds. Additionally, the results suggest that the BAB program's uniform subsidy of 35% of municipal bond interest cost was much larger than the cost difference between taxable BAB and tax-exempt municipal bonds. [ABSTRACT FROM AUTHOR]

The EU Savings Directive has been celebrated as a major political breakthrough in coordinating taxation in Europe. Against this background, the present paper evaluates the real-world effects of this directive. The directive has left a loophole by providing grandfathering (exemption from withholding tax) for some securities. In this paper, we compare the pre-tax returns of exempt bonds and comparable taxable bonds. If working around the Savings Directive is difficult for income tax evaders in Europe, then investors should be willing to pay a premium for bonds that are exempt from the withholding rate. Conversely, if such a premium is absent, then this suggests that the supply of existing loopholes (exempt bonds included) is large enough to allow tax evaders to continue evasion at no additional cost. The findings of our study are in line with this latter interpretation. [ABSTRACT FROM AUTHOR]

The last 30 years have witnessed an enormous growth in fixed-income markets. How long-term fixed-income strategies should be implemented for the welfare of investors has become a major concern of bond managers. This study makes use of stochastic optimal control to formulate a multi-period portfolio selection model and implements it using backward recursion algorithm to find numerically the optimal allocation of wealth between long- and short-term bonds for an investor with power utility and an investment horizon of 10 years. By way of a technical manipulation, this study uses the fact that the long rate and the spread (difference between long rate and short rate) are uncorrelated to simplify model formulation and parameter estimation. The results show that an investor would increase his/her holding of short-term bond if his/her investment horizon becomes shorter or if he/she is more risk averse, or both. [ABSTRACT FROM AUTHOR]

Copyright of Canadian Tax Journal / Revue Fiscale Canadienne is the property of Canadian Tax Foundation and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use. This abstract may be abridged. No warranty is given about the accuracy of the copy. Users should refer to the original published version of the material for the full abstract. (Copyright applies to all Abstracts.)

Abstract: NiCl2·6H2O efficiently catalyzes the C–S bond formation by the cross-coupling of aryl iodides with thiols in tetrabutylammonium bromide (TBAB) in excellent yield. The reaction functions in air and the NiLn-TBAB can be recovered and recycled without the loss of activity. [Copyright &y& Elsevier]

This study examines a sample of 12,562 dual-rated local government bond issues including 6,104 split-rated issues to determine which rating agency has the greatest impact on yields. Using a database of municipal bond issues from 1986 to 2002, we show that Moody’s rated significantly more issues than S&P, and that Moody’s ratings were more conservative. However, from 1993 to 1997, there was a reduction in ratings disagreements and in Moody’s market share. Beginning in 1995, Moody’s received negative publicity related to a Department of Justice anti-trust investigation. Moody’s appears to have responded by sharply increasing their relative conservatism in 1997. From 1986 to 1994, Moody’s ratings had a greater impact on bond yields than S&P ratings, but their dominant influence on yields disappears in the recent sample period from 1995 to 2002. [ABSTRACT FROM AUTHOR]

The authors examine the factors that influence risk-adjusted returns for bond mutual funds. The data set is divided into two groups: taxable bond funds and municipal bond funds. The factors are grouped into three categories: fund or portfolio characteristics, management-controlled factors, and bond market variables. Taxes, fund age, and operating expenses significantly affect the risk-adjusted returns for taxable bond funds. Portfolio concentration is statistically significant for municipal bond funds, but has a minor influence on taxable fund returns. Fund expenses and the average duration of the bonds in the portfolios are key determinants of municipal bond fund returns. It is concluded that portfolio managers can enhance bond fund shareholder returns.Journal of Asset Management (2007) 7, 429–442. doi:10.1057/palgrave.jam.2250053 [ABSTRACT FROM AUTHOR]

Term structure models have often been criticized for failing to explain satisfactorily the yield spread between corporate and Treasury bonds. A potential problem is that the personal tax effect is ignored in these models. In this paper, we employ a structural model to investigate the role of personal taxes on both debt and equity returns in capital structure decisions and assess their impact on corporate bond yield spreads. It is shown that personal taxes affect the firm's optimal capital structure, and the tax premium explains a substantial portion of yield spreads, especially for high-grade bonds. The predictive ability of the model for yield spreads is much improved when personal tax effects are accounted for. In controlling for the liquidity effect, we obtain implied personal income tax rates closely in line with Graham's (1999) estimates. [ABSTRACT FROM AUTHOR]

The Tax Reform Act of 1986 extensively revised the Internal Revenue Code and, in the process, "thoroughly overhauled" the IRC's tax-exempt bond provisions. The IRS has raised legitimate questions as to valid tax-exempt status, resulting in the determination of taxability, and ultimately forcing issuers, counsel, underwriters, and conduit borrowers to pay significant amounts in taxes, penalties, and liability claims. Because the IRS is unlikely to reduce its efforts in this area, attorneys who represent issuers and purchasers of tax-exempt bonds must be aware of the general process by which the IRS and its agents approach a tax-exempt bond examination, and they should be able to recognize when expert bond counsel is necessary. This paper provides an agent's perspective of the basic process by which the IRS examines tax-exempt bond issuances. [ABSTRACT FROM AUTHOR]

Discusses the Steele versus Industrial Development Board of Metropolitan Government Nashville court case on the application of religiously restrictive secular-use provisions in tax-exempt revenue bond financing. Decision made for the case; Consideration taken by the U.S. Sixth Circuit Court of Appeals in making its decision; Factor important in determining the range of uses to which religious institutions may constitutionally apply aid proceeds.

The article comments on the paper "The Effect of the Expected Holding Period on the Market Reaction to a Decline in the Capital Gains Tax Rate," by Jia-Wen Liang, Steven R. Matsunaga, and Dale C. Morse. Liang et al. investigate cross-sectional differences in the stock market reaction to the 1997 capital gains tax rate reduction. Based on tax capitalization theory that predicts stock prices should reflect investor-level capital gains taxes, Liang et al. hypothesize that dividend-paying stocks and stocks with a longer expected holding period have a less positive reaction to the surprise announcement of the rate reduction. Liang et al. also hypothesize that as a stock's expected holding period increases, the negative effect of dividend-paying status weakens, i.e., the difference in the reaction between dividend-paying and non-dividend-paying firms decreases. Liang et al. address an interesting topic using an event study methodology. This methodology, which can only be used effectively because of the surprise nature of the 1997 capital gains tax rate reduction, avoids potential problems associated with price level studies such as spurious scale effects and potential correlated omitted variables bias.

We use the market reaction to capital gains tax rate reduction in the 1997 Tax Relief Act to investigate the market reaction to a change in investor-level tax rates. We find that the positive market reaction was lower for dividend-paying securities and securities with longer expected holding periods. Our results also support the hypothesis that a longer expected holding period reduces the impact of the dividend-paying status. These results are consistent with the tax capitalization model and suggest that the expected holding period is a significant variable in explaining the market reaction to a change in capital gains tax rates. [ABSTRACT FROM AUTHOR]

The article details two approaches to tax managing municipal bond portfolios through selling strategies in the U.S. Topics discussed include the sale of municipal bonds that were purchased at a high premium whose price has fallen below the current cost basis of the investor, the sale of a municipal bond purchased at a deep discount whose price has surged, and the calculation of the potential benefit of active tax strategies bond by bond.

The article determines whether zero coupon bonds and other original issue discount bonds (OIDB) issued before July 1, 1982 may provide potential profit opportunities to investors. Non-taxable holders of such bonds may be able to sell them before maturity date at attractive prices, producing a much higher-than-expected rate of return over their holding period while taxable investors may be able to buy these bonds at prices that produce attractive after-tax returns. There is a difference between the linear accretion schedule used by the U.S. Internal Revenue Service (IRS) and the market accrual schedule and this difference can become profit opportunities. As an OIDB becomes seasoned, the discrepancy between the IRS benchmark price and the price to yield widens, which increases the potential capital gain of the second buyer. Since capital gains are valuable to taxable investors, taxable buyers who avoided the new OIDB will become interested in OIDB in the secondary market.

The study discusses the factors that determine the value of call provisions on various types of bonds which also influence the yield spread between otherwise identical callable and non-callable securities. The author presents an alternative approach regarding the value of call option which makes use of information in the yield curve to provide a measure of expected future interest rates. The yield curve was used to generate forward rates that provide a direct estimate of expected future rates. It was revealed that factors such as the shape of the yield curve, the coupon level, and the dispersion in future bond prices determine the compensation demanded by the investor for the inclusion of a call feature. It was also demonstrated that the tax treatment associated with the exercise of the call option has an important impact upon the value of the call option.

The numbers calculated in this exercise are intended mainly to serve as inputs for further econometric work. Nevertheless, they are of some interest in their own right. Table 1 shows that the composite tax rates for bond interest, although initially greater than the standard rate, generally fell below that level after the introduction of very high rates of tax during the second world war. No doubt this change was due to the increase in holdings of national debt by untaxed bodies, and the movement out of bonds by wealthy individuals. The composite tax rates on dividends are higher than the standard rate throughout the period, but the difference between the two rates expressed as a percentage of the standard rate has tended to fall from the range 40-50 per cent in the 1920s and I930s to the range 20-30 per cent in the 1950s and 1960s. This trend reflects both the changing structure of the tax system, in particular the higher general level of the standard rate, and changes in the distribution of equities among sectors. Finally, it is evident that scales of taxation and effective marginal rates have both fluctuated very widely, and no doubt unpredictably, in a period no longer than many a man's business life. This suggests that personal taxation deserves more attention than it has received hitherto as a major source of uncertainty affecting financial decisions. Kingston Polytechnic London School of Economics. [ABSTRACT FROM AUTHOR]

This article presents an investigation which examined the case for indexation of capital gains in the perspective of the experience of investors who bought an average stock at its lowest price in each of the years going back to 1950, and who sold it at a common terminal price, in June 1990, the highest level of 1990. Before-tax real rates of gain for most of the holding periods considered were lackluster--less than 3.5 percent for investments initiated in any of the years from 1950 through 1973. After 1973, real returns were more robust, averaging nearly 5 percent for investments started from 1974 to 1979, and 10 percent for those begun from 1980 to 1989. Poor investment results, of course, are what investors risk when they enter the market in hopes of gain. Investors are not entitled to compensation for disappointment. However, they may legitimately expect equitable treatment under the tax laws. Most of the current debate concerning capital gains has centered on the pros and cons of taxing gains at lower rates than apply to ordinary income. Only one argument against indexation was found to have merit, the offsetting effects of the tax deductibility of interest for investors buying securities with borrowed funds. Not all investors avail themselves of borrowed capital, however, and margin requirements constrain those who do to a fraction of the amounts invested. Thus, offsetting is incomplete. The analytically correct solution is to index both capital gains and investment interest, but this is administratively feasible only for prospective investments. Therefore, partial indexing, on the order of two-thirds, is the suggested compromise solution for investments initiated in the past.