Robert Couch and Dr. Mark Showalter, Economics

I completed my research project concerning the capital gains tax and stock market volume. I spent approximately one hundred hours uncovering previous research on this topic, gathering my own data, performing statistical regressions on this data, drawing conclusions from this data, and writing up my results with prose, charts, and tables.

It is a very difficult task to determine what effect changes in the capital gains tax have on the economy. Many have argued that lowering the tax would generate more stock market trading volume. The increase in this trading volume is argued to cause an increase in tax revenue large enough to offset the decrease in immediate revenue from the lower tax rate. An elasticity measure is very difficult to estimate, yet is key to determining how a tax change would affect tax revenue.

One approach has been to look at how trading volume on the major exchanges has been affected by changes in the tax rates. Recently, this type of study has produced perplexing results. In particular, researchers have noticed that trading volume increased after the 1986 tax increase this phenomenon contradicts theory.

In my paper, I propose that part of the reason for these perplexing results is that researchers have failed to account for the time trend in trading properly. Whereas previous researchers assume a linear time trend where trading volume increases linearly with time, I explore various nonlinear time trends. Technically, this involves modifying the regression model used. First I began by including a quadratic component to the time trend variable of my regression. This did not reconcile results with theory, so I tried adding to my regression variables such as shares outstanding, seats on the exchange, timelagged variables, and nonlinear tax-dummy specifications.

My most robust results were found when I divided my dependent trading volume variable by the number of shares outstanding. This seemed to account for the nonlinear time trend best6that is, without overshadowing the effect of tax rate changes. Admittedly, my criteria for determining the superiority of this specification is ad hoc. However, since the theory predicting lower trading volume with higher tax rates is widely accepted and there is little understanding concerning the time trend of trading volume, I feel it more appropriate to try several different time-trend specifications before rejecting the theory altogether.

I am very pleased with my research experience. I tackled a project that was very technically very challenging. My advisor (Mark Showalter) was very helpful in explaining questions in the difficult literature that I ran across. Although my results may not ever be published in a major journal, I feel that I generated relatively significant results. As an undergraduate, I didn’t expect to understand as much of the technical research already existing. However, I astounded myself by not only understanding the issue of capital gains taxation, but actually making a contribution, albeit small, to the debate. Most importantly, I learned a lot about research and regression applications and will be much better prepared for graduate school next year. I have decided to postpone my graduation date so I am planning to extend my research to discuss more about the technical issues of autocorrelation in my paper and submit it as an honors thesis. I am deeply grateful to the Office of Creative and Research Activities for the funding which allowed me to pay the bills by waiting tables fewer hours and spend more time doing research.