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Evidence of Implicit Taxes on Equity Using Data from Futures Markets to Control for Risk

In this paper we investigate the existence and magnitudes of implicit taxes on equity. Specifically, using futures market data to control for risk, we test whether the pre-tax returns on bonds are higher than the pre-tax returns on four stock indices during the period 1993-1999. We compare the risk-free stock index returns (on perfectly hedged portfolios) to risk-free returns on taxable bonds, and estimate implicit taxes on equity. We find a moderate but significantly positive implicit tax for each stock index. Moreover, we find that cross-sectionally, implicit taxes are much larger for the low-dividend NASDAQ 100 than for the other three, substantially higher dividend-yielding indices. We also find that estimated implicit taxes have fallen significantly during the sample period. Our findings are consistent with a multiple clientele explanation, in which more than one tax clientele is the marginal investor in the stock market.