Tax avoidance and asset returns: some theoretical results on the tax clientele effects

Mutual funds are held by investors in both conventional taxable savings accounts and tax-deferred retirement accounts, and some investors fall in higher tax brackets than others. Recent empirical research investigates how the marginal tax rate of a mutual fund affects the fund's tax avoidance behavior and asset returns. This paper studies theoretically the tax clientele effects on the tax avoidance and performance of mutual funds. It finds that when the marginal tax rate of a mutual fund increases, the mutual fund is more prone to deferring the realization of capital gains, the before-tax return decreases, and the after-tax return also decreases.