Abstract
We investigate the stock price and trading volume effects of differential capital gains taxes applied to short and long-term capital gains when firms disclose public information. We extend the theoretical framework developed in Shackelford and Verrechia (2002) linking differential CGT to price and volume, allowing for positive and negative news and incorporating exogenous non-taxable, uninformed traders. Our model, like SV, indicates that price responses to public information are magnified and volume inhibited during tax capital gain tax regimes in which the difference between short-term capital gains tax rates and long-term capital gains tax rates are larger. However, the degree of magnification/inhibition for price reaction and trading volume differs across multiple well-defined regions of public signal and supply change realizations. We use actual stock price and trading data to empirically investigate these predictions. Our results provide strong support for the price response predictions, but at best marginal support for the volume predictions.
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