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Prof. Oliver Zhen Li
Professor of Accounting
NUS Business School
National University of Singapore

A reduction in tax rate can potentially increase market friction. A widening of the capital gains tax intertemporal discontinuity, the differential between short-term and long-term capital gains tax rates, is equivalent to a Tobin’s tax on short-term trading, discouraging informed arbitrage. Sell-minus-buy order imbalance among institutional traders reduced after the enactment of TRA1997 which widened tax discontinuity due to a long-term rate cut. Stock price synchronicity increases in tax discontinuity. This effect enhances in tax-sensitive institutional ownership with short-term gains. We conclude that the capital gains tax intertemporal discontinuity can be an impediment to informed arbitrage and compromises information efficiency.