Market Bubbles and Wasteful Avoidance: Tax and Regulatory Constraints on Short Sales
AbstractAlthough short sales make an important contribution to financial markets, this transaction faces legal constraints that do not govern long positions. In evaluating these constraints, other commentators, who are virtually all economists, have not focused rigorously enough on the precise contours of current law. Some short sale constraints are mischaracterized, while others are omitted entirely. Likewise, the existing literature neglects many strategies in which well advised investors circumvent these constraints; this avoidance may reduce the impact of short sale constraints on market prices, but may contribute to social waste in other ways. To fill these gaps in the literature, this paper offers a careful look at current law and draws three conclusions. First, short sales play a valuable role in the financial markets; while there may be plausible reasons to regulate short sales-- most notably, concerns about market manipulation and panics -- current law is very poorly tailored to these goals. Second, investor self-help can ease some of the harm from this poor tailoring, but at a cost. Third, relatively straightforward reforms can eliminate the need for self-help while accommodating legitimate regulatory goals. In making these points, we focus primarily on a burden that other commentators have neglected: profits from short sales generally are ineligible for the reduced tax rate on long-term capital gains, even if the short sale is in place for more than one year.
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Bibliographic InfoPaper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1413.
Length: 54 pages
Date of creation: Apr 2003
Date of revision:
Publication status: Published in Tax Law Review (Winter 2004), 57(2): 233-274
Note: CFP 1142.
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Other versions of this item:
- David M. Schizer & Michael R. Powers & Martin Shubik, 2003. "Market Bubbles and Wasteful Avoidance: Tax and Regulatory Constraints on Short Sales," Yale School of Management Working Papers ysm356, Yale School of Management.
- D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- K23 - Law and Economics - - Regulation and Business Law - - - Regulated Industries and Administrative Law
- K34 - Law and Economics - - Other Substantive Areas of Law - - - Tax Law
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-06-25 (All new papers)
- NEP-CFN-2003-06-25 (Corporate Finance)
- NEP-LAW-2003-06-25 (Law & Economics)
- NEP-RMG-2003-06-25 (Risk Management)
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