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Taxation and bond market investment strategies: Evidence from the market for Government of Canada bonds

  • Author(s) / Creator(s)
  • This article shows that, contrary to the suggestion of some investment advisers, for an individual Canadian investor subject to personal income taxation, the after-tax yield on a discount bond is always higher than (or, at worst, equal to) the yield on a premium bond. This follows because the tax rate on capital gains is lower than the tax rate on coupon income in Canada. It is also shown that a decline in the capital gains tax rate raises the after-tax yield on discount bonds but reduces the after-tax yield on premium bonds, and may even cause the yield on premium bonds to become negative. Further, a cut in the tax rate on interest income raises the after-tax yield on all bonds, but raises the yield on premium bonds relative to discount bonds. While the lower after-tax yields on highercoupon bonds might be expected to cause the pre-tax yields on these bonds to rise, no evidence of such tax capitalization is found using a large data set of matched pairs of government of Canada bonds for the period 1986-2006. The observed near-equality of pre-tax yields since 1995 for bonds with different coupons implies that individuals in Canada earn a significantly smaller after-tax yield from holding premium bonds than discount bonds.

  • Date created
    2008-01-01
  • Subjects / Keywords
  • Type of Item
    Article (Published)
  • DOI
    https://doi.org/10.7939/R3W08WZ84
  • License
    Attribution-NonCommercial 4.0 International
  • Language
  • Citation for previous publication
    • Landon, S., & Smith, C.E. (2008). Taxation and bond market investment strategies: Evidence from the market for government of Canada bonds. Canadian Tax Journal/Review fiscale Canadienne, 56(2), 337-366.
  • Link to related item
    http://www.ctf.ca/ctfweb/Documents/PDF/2008ctj/08ctj2-smith.pdf