The Bank of England has published a staff working paper examining how realization-based capital gains taxation affects asset prices. A model estimated using US stock market data implies that capital gains tax cuts since 1975 increased price-dividend volatility by about 35% relative to its observed level, as stronger transmission of investor beliefs into prices outweighed reduced trading frictions. The paper identifies two offsetting effects. Lower taxes reduce lock-in and other realization-based trading frictions, which dampens volatility, but they also make prices more responsive to changes in expectations and can fuel self-reinforcing fluctuations. Policy experiments find that a revenue-neutral shift to an accrual-based capital gains tax at an average rate of about 7% would reduce valuation volatility by roughly 20%. A supplementary tax on unrealized gains also produces broad, monotonic stabilization, while a financial transaction tax has weak, mixed and potentially nonmonotonic effects.
2026-08-21Bank of England
Bank of England publishes research linking US capital gains tax cuts to a 35% rise in stock market volatility
A Bank of England staff working paper estimates that US capital gains tax cuts since 1975 increased price-dividend volatility by about 35% by strengthening the transmission of beliefs into prices. Model experiments suggest taxes on unrealized gains reduce volatility more reliably than financial transaction taxes.