Does Differential Taxation of Short-Term Relative to Long-Term Capital Gains Affect Long-Term Investment?

Abstract

Pressure from short-horizon investors can hurt investments in innovative, long-run value-increasing projects. We explore the efficacy of a commonly proposed tax-based policy tool to mitigate this problem: the imposition of differentially greater taxes on short-term capital gains vis-à-vis long-term capital gains. Using a panel of 30 OECD countries in which seven countries exhibit 21 shocks to differential capital gains taxation over 1991-2006, we find that rewarding longer-term ownership through lower taxes is associated with greater innovation. The evidence adds to our understanding of the real effects of taxation of investor trading and should be of interest to lawmakers and regulators.

Keywords: capital gains taxes, real effects, myopia, investment, short termism, innovation

JEL Classification: G38, H20, H24, O31