“The Externality of Taxing the ‘Rich’: Evidence from Hedge Funds” by Prof. Vikas Agarwal
Prof. Vikas Agarwal
Bank of America Distinguished Chair of Finance
J. Mack Robinson College of Business
Georgia State University
This study examines whether increases in the personal income tax rate disincentivize hedge fund managers to exert effort. Using plausible exogenous variations in federal and state statutory tax rates, we find that fund managers’ marginal income tax rates are negatively associated with fund performance. The results are similar when we analyze the effect of a major U.S. federal income tax increase in 2013 and use non-U.S. fund managers as a control group. In response to a tax hike, fund managers hold stocks with lower information asymmetry and trade less. We further find that higher incentives from compensation contracts help mitigate tax-induced effort shirking. Our study sheds light on the externalities of taxing the affluent and informs the debate on tax system design.