Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Algorithmic trading wikipedia , lookup
European Union financial transaction tax wikipedia , lookup
Investment fund wikipedia , lookup
Short (finance) wikipedia , lookup
Securities fraud wikipedia , lookup
Hedge (finance) wikipedia , lookup
Market sentiment wikipedia , lookup
Day trading wikipedia , lookup
Stock market wikipedia , lookup
2010 Flash Crash wikipedia , lookup
Capital Gains Tax Stock Market Distortion and Implications for Fiscal Policy O. Mikhail ECO 6226 Summer 2006 Jon Thorpe What is the Capital Gains Tax? • The tax paid on appreciated assets that are sold for a profit by individuals • Long term gains – those held more than a year – receive preferential treatment Current Rates Jobs and Growth Reconciliation Act of 2003 Effective May 6, 2003 Tax Bracket Short Term Long Term 10% 10% 5% 15% 15% 5% 25% 25% 15% 28% 28% 15% 33% 33% 15% 35% 35% 15% Stock Market Distortion • The “Lock-In Effect” • Investors hold their appreciated assets to qualify for preferential long-term treatment or to avoid the tax altogether • The supply of shares available for purchase decreases – not the total supply of outstanding shares Stock Market Distortion • The “Capitalization Effect” • Potential buyers require a lower price at every trading level to offset the impact of the tax on their expected gains • The demand for shares decreases Stock Market Distortion • Combined results of the “lock-in effect” and the “capitalization effect” in the stock market are: • Lower trading volume – decreased liquidity • Ambiguous change in price depending upon which effect dominates Market Pric e Lock-in Effect S Capitalization Effect D Volume of Traded Stock Evidence of “Lock-in” • Blouin, Raedy, and Shackelford (2002) • One-day reduction in price of 1.3% amidst heavy trading the first trading day after congress cut the maximum long term rate from 28% to 20% on assets held between 12 and 18 months in June of 1998. Evidence of “Lock-in” • Blouin, Raedy, and Shackelford (2003) • Value the holding incentive as ( STR LTR)( AssetAppreciation ) • Show a significant positive (negative) relationship between the holding incentive and price (volume) Which Effect Dominates? • • • • Dai, Maydew, Shackelford, and Zhang (2006) Taxpayer Relief Act of 1997 Cut maximum long term rate from 28% to 20% Leaked to the public a weak before it became effective • Perfect opportunity to test for dominance Testing for Dominance • Theory leads us to expect the capitalization effect to dominate the week after the leak and the lock-in effect to dominate after the cut becomes effective • Dai, Maydew, Shackelford, and Zhang (2006) document this empirically Fiscal Policy Implications • The stock market is correlated to aggregate investment • Sub-optimal liquidity may translate into reduced investment and reduced economic growth (GDP) • Do capital gains tax cuts spur economic growth? Measuring Fiscal Policy • How sensitive is the stock market to the tax rate? • How severe is the economic ripple effect to aggregate investment? • What kind of feedback does the stock market receive from aggregate investment? • Is this the source of the Laffer curve? Plan • Attempted to design a model to test the long run sensitivity of capital gains tax realizations to changes in the tax rate itself • Control for the economic environment using GDP and for the level of unrealized gains using the S&P 500 year-end valueweighted index • Differentiate between short run and long run effects of changes in the tax Analysis • Found the expected negative relationship between capital gains realizations and both tax variables, but the correlations were not significant. Conclusion • The short term effect of changes in the capital gains tax on the stock market is well documented. • The long term effect warrants further research to quantify its influence on aggregate investment and GDP.