Abstract
We study the welfare effect of tax-optimizing portfolio decisions in a life cycle model with unspanned labor income and realization-based capital gain taxation. For realistic parameterizations of our model, certainty equivalent welfare gains from fully tax-optimized portfolio decisions are less than 2% of present financial wealth and lifetime income compared to a heuristic portfolio policy ignoring the taxation of profits (capital gains, interest and dividend payments). Compared to a heuristic portfolio policy that only ignores the realization-based feature of capital gain taxation and instead assumes mark-to-market taxation, these gains are less than 0.5%. That is, our work provides a justification for ignoring taxes in life cycle portfolio choice problems - a wide-spread assumption in that literature. However, if capital gains are forgiven at death (as in the U.S.), investors with strong bequest motives face substantial welfare costs when not tax-optimizing their portfolio decisions towards the end of the life cycle.
Originalsprog | Engelsk |
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Tidsskrift | Journal of Economic Dynamics and Control |
Vol/bind | 37 |
Udgave nummer | 11 |
Sider (fra-til) | 2217-2240 |
ISSN | 0165-1889 |
DOI | |
Status | Udgivet - nov. 2013 |
Emneord
- Portfolio choice
- Life cycle asset allocation
- Taxation
- Unspanned labor income