The effects of taxation of capital gains on the pricing of financial assets

12/02/2018 |  Stein Roy
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Finacial Markets and Financial Stability
The capital gains taxation structure in its current format was applied gradually in the beginning of 2003, following the Rabinovich Committee Report. That was the first time that individuals in Israel were obligated to pay tax on capital gains. Since then, tax rates have been increased twice. The most recent increase during the sample period (2000–14) was at the end of 2011. The main feature of such taxation in Israel is a distinction in taxation tracks, between nominal and real assets. Since tax considerations are one of the components that impact on investors’ economic and financial decisions, it is important to estimate the tax effect on both financial asset pricing and on the worthwhileness of holding such assets. As such, this research studies several issues in the Israeli capital market's taxation system, and attempts to assess the bias in the pricing and the holdings structure of financial assets due to tax considerations. Among other things, this paper will focus on possible biases incorporated in the pricing and the holding of bonds with various indexation bases. The results indicate that the dual-track tax method implemented in Israel affects asset pricing and serves as a significant consideration in investment decisions regarding various financial assets. The results also indicate that the increase in the tax rate had a significant effect on the size and composition of the financial asset portfolio in Israel.
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