Mid-way into the twentieth century, the American economy (and other modern societies) began to shift from an industrial base to a knowledge base. That meant, somewhat simplistically, that the majority of work shifted from fabrication, assembly, and other physical-labor-intensive “manufacturing” tasks to labor of a more knowledge-intensive nature. As the nature of the work changed, so too did the nature of the workers.
With the decline of the industrial base of the American economy, attention of scholars shifted to the new worker in what is variously called the “Information Age,” the “Knowledge Economy,” and the “Post-Industrial Society.” Drucker (1968), Bell (1972), and Mankin (1978), for example, described a new generation of “knowledge workers.” Others (Deming, 1982; Senge, 1990; Tingstad, 1991; Sapienza, 1995; Horibe, 1999; Tapscott and Ticoll, 2003; Glen, 2003; Bennet and Bennet, 2004; Davenport, 2005) described how the characteristics of these new workers demand new patterns of organizational structures and transactions, new ways of designing and managing work systems, and new paradigms of leadership and management. Etzioni (1968) saw the emerging preeminence of knowledge as a force that would reshape societies as a whole.
Toffler (1970, 1980, 1990), Naisbitt (1982, 1996), and others (Naisbitt and Aburdene, 1990) introduced this phenomenon to the popular press.
Our objective in this paper is to study the optimal dynamic portfolio policy in the presence of capital-gains tax when using the exact tax basis. This is an important problem given that most investors face taxes on their stock holdings. Moreover, the magnitude of the capital gains tax is quite large it typically ranges from twenty percent to forty percent and so is much larger than transactions costs, which are usually less than one percent.
In spite of the importance of this problem, the optimal portfolio policies in the presence of capital gains tax using the exact tax basis have not been studied in the literature. The main reason for this is that computing the optimal portfolio policy of an investor subject to capital gains taxes is a challenging task. The difficulty is that the tax to be paid depends not only on the selling price, but also on the price at which the securities were purchased, that is, the tax basis. As a consequence, the optimal policy is path dependent and the size of the problem grows exponentially with the number of time periods.
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