Why does taxing stock trade result in price decrease?

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z1235 replied on Fri, Oct 28 2011 6:50 PM

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The stock trade tax is a transaction tax, which lowers the incentive to trade, which lowers trading volume, which lowers liquidity, which lowers the incentive to hold a less liquid asset. So stock prices -- ceteris paribus -- should fall, or rise less than they otherwise would without the tax.

The real estate tax is an asset tax, which increases the cost of owning the asset, which lowers the incentive to hold a more costly asset. So RE prices -- ceteris paribus -- should fall, or rise less than they otherwise would without the tax. 

Prices should fall in both cases relative to a no-tax scenario. The fact that, in absolute terms, they fell in the first case, and they kept rising in the second, is only a reflection of the strength of the underlying price trends in each market. 

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lyly replied on Fri, Oct 28 2011 8:19 PM

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Thank you for your answer. 

I am sorry if I did not make it clear. The real estate tax I'm talking about is a transaction cost: you pay taxes when you buy a house. But it seems irrelevent to the question anyway. 

I am a bit confused about price fall. If the government tax automobile or tobaccos, will their prices fall? What's the difference?

Also, by underlying strength, are you suggesting that there may be bubbles in the stock market while the real estate market has much solid demands?

Thank you. 

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z1235 replied on Fri, Oct 28 2011 8:49 PM

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You are right. The argument remains the same when the RE tax is a transaction one, as well. 

In general, transaction taxes on X are discouraging transactions in X, which decreases market liquidity in X, which hurts the market in X. But liquidity is not the only factor that determines the price of X. If people need cars, they'll own them, as renting them long-term is prohibitively expensive. Less people may be able to afford them (hence there'd be less cars sold) but the ones who could afford them would still pay the tax and the higher price. If people need tobacco, like every nicotine addict does, they'll pay whatever high price which is still low enough to keep them stay addicted. Not so with houses, as one could rent if ownership becomes too expensive or risky due to taxation. (Would you buy X if there was a 100% transaction tax on X?) Not so with stocks either, as one could live without trading stocks if/when doing so becomes too expensive due to taxation. 

As for your last question, there could be bubbles in both Chinese stocks and real estate but each at a different stage and/or intensity depending on government policies.