*Names in bold indicate Presenter
In this paper we examine changes in capital gains realizations from a longitudinal perspective using a Markov Chain model. Using a panel of tax returns from 1999-2009, we use the Markov chain framework to model transition probabilities between three states: positive capital gain realizations, zero capital gain realizations, and negative capital gain realizations. The transition probabilities between these three states were very similar prior to both the 2001 and 2008 recessions. For example, the continuation rate for positive capital gains was 72.7% in 2000 and 74.3% in 2007, while the continuation rate for capital losses was 51% in 2000 and 59% in 2007. The transition probabilities were also similar in the first year of both recessions, each showing a substantial decrease in the continuation rate for positive capital gains (49% in 2001 and 43% in 2008) and a substantial increase in the continuation rate for capital losses (63% in 2001 and 71% in 2008). The transition probabilities differ more in the second year the two recessions. Specifically, the continuation rate for taxpayers with positive capital gains declined only a little in 2002 (to 41%) but declined substantially in the Great Recession to 29.5% in 2009. The 2009 exit rate from positive capital gains to zero realizations was about 10 percentage points higher than in 2002, while the exit rate from capital gains to losses were similar in 2002 and 2009. We find no statistically significant difference in entry rates from either capital losses to capital gains or from no realization to capital gains in the second year of the two recessions.
The difference in the continuation rate for positive capital gains in the second year of the two recessions is somewhat surprising given that the stock market began to recover in 2009 while the stock market declined through 2002. The results suggest that the quicker decline in the stock market in 2008 relative to 2001 caused taxpayers to sell a greater amount of securities at a capital loss. In fact, capital loss carry-forwards from 2001 to 2002 were only $233 billion dollars compared with over $500 billion from 2008 to 2009.