Empirical Studies - Public Finance

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The project assembles new data and provides significant new results on some of the most timely and important issues in U.S. tax policy. The first part determines how transaction taxes and other costs of trading affect stock market performance. The second part uses the "natural experiment" provided by the U.S. time series data, particularly the 1981 and 1986 tax reforms, as well as comparisons between U.S. and Canadian experience, to test competing theories of how tax subsidies affect the markets for rental and owner-occupied housing. The questions about transaction costs and stock market performance attracted substantial policy interest in the aftermath of the October 1987 market break. Plans to grant capital gains tax relief for long-run investments, as well as suggestions to tax all securities transactions regardless of gain or loss, are examples of such fiscal initiatives. Unfortunately, there is virtually no empirical basis for evaluating these proposals. This part of the project develops a data set consisting of time series on the transactions taxes and commission rates for each of the major stock exchanges in world equity markets; uses these data and other information on market characteristics to study the links between trading costs and equity turnover rates, market volatility, the size of the market decline in October 1987, and serial correlation properties of stock returns; and conducts an in-depth study of several nations which have changed their transaction tax rates or their commission structures during the last decade. The influence of taxation on housing markets is also essential to evaluating recent tax changes. For example, the 1986 Tax Reform Act may ultimately increase real rents by twenty percent. For most low-income households, the welfare effects of this change in the real cost of an item which may account for 35% of the household budget is far larger than the direct effects of changes in tax payments. This project uses time series data from the United States and Canada (a "control" with similar demographic and financial conditions but divergent tax policies) to study the housing effects of tax reform. There has been relatively little empirical work using the variation in U.S. tax policies in the last five years to determine which models or assumptions best described the observed effects.