Mark-to-Market (or Wealth) Taxation in the U.S.: Evidence from Options

Abstract

Recent U.S. tax proposals under various names (e.g., wealth taxes, estate tax reform, etc.) center on mark-to-market (MTM) taxation, which eliminates investors’ ability to defer or avoid capital gains taxes. To provide insight on potential effects of these tax proposals, we exploit a unique U.S. setting where “index” options on the S&P 500 Index (SPX) face MTM taxation whereas nearly identical “non-index” options on the exchange traded fund (ETF) tracking the S&P 500 Index (SPY) do not. We find new evidence of asset price consequences to MTM taxation, suggesting that MTM taxation depresses asset prices as investors appear to avoid assets subject to MTM near year-end. Additional analysis suggests this result is driven by tax, rather than administrative, costs of MTM. From a policy perspective, this suggests that 1) MTM taxation has negative, unintended market consequences in the U.S. and 2) U.S. investors will engage in actions to avoid MTM taxation. Both attributes caution policymakers in any attempts to broaden MTM taxation.