Capitalization of capital gains taxes: evidence from stock price reactions to the 1997 rate reduction

We empirically document that stock prices moved inversely with dividend yields during the May, 1997 week when the White House and Congress agreed on a budget accord that included a reduction in the capital gains tax rate. The findings are consistent with equity prices capitalizing expected capital gains taxes. Two scenarios are possible. First, to the extent returns are expected to be taxed as capital gains, a reduction in the expected capital gains tax rate enhances market value. Second, to the extent individuals hold a stock, a reduction in the expected personal capital gains tax rate increases market value.  2000 Elsevier Science S.A. All rights reserved.