Sobia Jafry (Toronto) presents Death and Taxes: Does the Lock-in Effect Fade when Capital Gains Must be Taxed at Death? at Toronto, as part of its James Hausman Tax Law and Policy Workshop Series hosted by Ben Alarie:

This paper examines how changes in capital gains tax rates affect individual and household realization behaviour, using Canada as a natural setting. Canada taxes unrealized gains at death, partly eliminating the deferral incentive that exists in systems with forgiveness of tax at death. Using theoretical and empirical evidence, this paper shows that the lock-in effect arising from realization based taxes is low in Canada. I implement a difference-in-differences design, using deceased individuals, who realize their entire stock of accrued gains, as a comparison group for living individuals, who choose how much to realize. If the living respond to lower tax rates by increasing the fraction realized out of their stock of accrued gains, differences between the two groups’ realization changes capture that effect. This novel identification strategy addresses the challenge that tax reforms are often preceded by changes in capital markets that affect the stock of accrued gains – an omitted variable, proxied in this paper by realizations of the dead, who are matched to living realizers on observable characteristics. I study the year 2000 reduction in Canada’s capital gains tax using a 20% random sample of administrative tax records. The results show a dynamic realization response: a significant short-term increase in realizations, but no lasting effect in the medium to long run. Overall, the findings suggest that, in the absence of preferential treatment of gains at death, changes in capital gains tax rates only lead to retiming effects and cause no permanent change in realization behaviour.