Capital Gains Taxes and Realizations: Evidence from a Long Panel of State-Level Data

We estimate how capital gains realizations respond to marginal tax rates on capital gains using a panel of aggregate data for U.S. states for the years 1957 through 2007. In specifications controlling for state fixed effects and year fixed effects, where identification comes from difference-in-differences variation in effective state marginal tax rates, our point estimate of the elasticity of capital gains realizations with respect to the marginal tax rate is -0.66 with a standard error of 0.21. This point estimate suggests a significant and policy-relevant responsiveness of capital gains realizations to incentives, implying that the revenue gain from a capital gains tax increase would be in the ballpark of one-third as large as it would have been in the absence of the behavioral response, and is based on a relatively more convincing identification strategy than has been used in the previous literature. When we remove state and / or year fixed effects, relying on cross-state variation in tax rates and / or federal time-series variation tax rates for identification, our estimates of the elasticity of capital gains to the marginal tax rate are larger in absolute value, but also potentially subject to greater concerns about omitted variable bias.