Capital gains taxation and the lock-in effect: A probabilistic framework

The purpose of this study is to investigate and compare, from a theoretical point of view, the following two capital gains taxation systems: (a) The standard system under which the capital gains tax is paid at the time of sale. (b) The accrual capital gains taxation in which taxes are assessed and paid continuously in accord with changes in the asset’s value. Empirical studies suggest that under the standard capital gains tax system investors are ‘locked into’ previously purchased assets, and by employing an appropriate system of accrual taxation the lock-in effect can be mitigated. The paper examines the above hypothesis regarding the lock-in effect from a theoretical point of view in a probabilistic framework.