Thread by @pauism

I've written a paper to show that part of the US’s financial turbulences witnessed since the 1980s are due to the fall in the Capital Gains Tax (CGT).

Without tax cuts, this is what would've happened 👇

Do you want to know why?

🧵 [1/10].

#EconTwitter #Econjobmarket

First, let me introduce the animal. It is my #Jobmarketpaper, written under the supervision of Prof. Albert Marcet at @IDEA_UAB, @CREIResearch, @bse_barcelona.

You can find it here: pau-belda.eu/wp-content/upl…
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The Fact. Despite the Great Moderation, stock and housing markets experienced more turbulence.

The Fact is challenging to explain for much of the theory. If prices reflect fundamentals and fundamentals became more stable…Why did prices become wilder? 🧐

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The hypothesis. The fall in the effective Capital Gains Tax (CGT).

The fall is due to: statutory tax cuts (e.g., Clinton, Bush) + tax avoidance (assets increasingly held in tax-free accounts).

The hypothesis breaks with the dominant view that CGT is destabilizing.

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The mechanism. Booms and busts are born from a feedback loop between expectations and prices that appears when agents learn about asset prices (because of imperfect info).

A CGT puts sand on the gears of this mechanism.

👇shocks propagation + proposition

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Tests. With the empirical time series for taxes and dividends, the model is asked to replicate the Fact + list of typical asset pricing statistics.

Results of the SMM estimation (if t-stat<1.96, data and model are statistically similar).

+ Many more tests in the paper!
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Optimal Policy (I). In the model, capital markets are inefficient, producing too much volatility. Origin: Imperfect info and Bayesian learning.

This is good for explaining the data. But could we live in a better world? A CGT seems to help, but what is the *right* level?
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OP(II). Under some conditions, the optimal tax counteracts the deviations of subjective expectations (beta) from its reasonable value (beta*).

Then, taxes ensure a reasonable capital market price so that markets can allocate resources efficiently.
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OP(III). OP can be implemented through a CGT = 100% + subsidy to the physical capital rents (productivity).

Why? CGT=100% eliminates the influence of beta on prices, preventing the feedback loop. But depress the price a bit. A subsidy restores the efficient price (RE).
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Final comment. Since Keynes and Tobin, many have proposed the use of Transaction Taxes to prevent financial turbulence. Recent evidence questioned this idea.

This paper suggests that a CGT can be the tax instrument they were looking for.

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