Tax Risk and Asset Prices

Little is known about how the risk of unexpected changes in tax policy is priced in financial markets. We develop a novel market-based measure of tax risk and quantify how tax risk is priced in asset returns.

Investors periodically face a significant amount of uncertainty regarding how their investment income will be taxed, as tax policy changes over time.

For example, the U.S. government introduced federal income taxes in 1861, but repealed them in 1872, then re-instated them in 1894, and finally deemed them unconstitutional in 1895.

There is little guidance on how tax risk should be measured and the magnitude of its effect, if any, on asset prices

Dual-class corporate bonds, tax risk, and asset prices.

We are the first to exploit data from a natural experiment from the 19th century in which many U.S. firms had issued both taxable and tax-exempt (i.e., dual-class) bonds, and when many investors faced federal income taxes for the first time to derive a novel, market-based measure of tax risk, to examine how it changes in response to tax policy, and to quantify how tax risk is priced in the cross-section of asset returns.