The Impact of Tax Loss Harvesting on End of Year Trading Behavior

This paper investigates the effects of tax loss harvesting on stock trading behavior at year-end. I hypothesize that as the difference between the capital gains tax rate of long-term and short-term holdings shrinks, the volume of stocks traded at year-end will decrease due to a decline in the incentive to harvest losses. To test my hypothesis, I examine the years before and after the enactment of the Tax Reform Act of 1986. The act equalized the rates at which long-term capital gains and short-term capital gains were taxed, effectively lowering the incentive to recognize short-term losses. My results indicate that the trading volume of depressed stocks went down after 1986. The results provide support to theories that tax loss harvesting contributes to downward pressure of stock prices for stocks that have experienced an overall loss during the year