A Reexamination of the Tax Motivation for Closed-End Discounts

Abstract

Prior literature addressing the tax explanation for closed-end fund discounts can account for only a small portion of existing discounts even with relatively extreme assumptions. This paper reexamines the tax motivation for discounts via a nontraditional interpretation of the tax costs. In particular, this study estimates the cost to investors of lost tax options when fund management realizes and distributes gains that accumulate after the investor enters the fund. The study also compliments the earlier study by Malkiel (1977) who estimated the tax cost of unrealized appreciation that exists at the time of the investment in a closed-end fund. The findings suggest that the total discounts justifiable by tax costs are of a magnitude comparable to the average discounts of recent history.