Notes on the Effect of Capital Gains Taxation on Non-Austrian Assets

This paper is an attempt to assess the effect of capital gains taxation on non-Austrian assets, such as claims to profits of continuing enterprises. As compared to taxation on an accrual basis, the capital gains tax discourages sales of appreciated assets. This is the "lock-in" effect. Because assets subject to capital gains taxation are generally held a long time, conventional estimates suggest that the effective rate of capital gains taxation is low. We contend that conventional estimates could seriously underestimate the effective rate of capital gains taxation because they ignore uncertainty. We construct a model which allows us to calculate the value of being able to actively manage a portfolio and use this model to calculate the effective rate of capital gains taxation. For several plausible parameter values the effective rate is significantly higher than estimates under certainty. We also discuss some of the ways in which the lock-in effect may distort the allocation of investment funds and the efficient workings of the capital market.