The cost of inattention

deadline and media effects on implicit taxes

Abstract

We provide evidence that the capitalization of taxes in share prices depends on investor attention and can create additional implicit taxes for inattentive investors. Interpreting a German capital gains tax reform as a natural experiment, we identify investor attention by the temporal distance to the deadline (deadline effect) and media coverage (media effect). Although the reform was announced 18 months in advance, we find evidence for large abnormal returns around the deadline. In the two days preceding it, daily returns (share prices, trading volumes) of treated stocks increased abnormally by 2.5 pp (7.0%, 296.7%). The cumulative abnormal return CAR one day before the deadline was 10.7%. The media coverage also abnormally increased returns and trading activity. In the last months of 2008, 20 additional articles per week on the reform resulted in a CAR of about 2% in one week. Inattentive investors paid abnormally high prices in periods of high attention, implying an implicit tax burden of up to 67.9% of realized and 130.5% of expected returns one day before the deadline.