Market Bubbles and Wasteful Avoidance: Tax and Regulatory Constraints on Short Sales

Michael Powers (), David M. Schizer and Martin Shubik
Additional contact information
David M. Schizer: Columbia University

No 1413, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: Although 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.

Keywords: Short sales; Momentum traders; Value investors (search for similar items in EconPapers)
JEL-codes: D43 G12 K23 K34 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2003-04
New Economics Papers: this item is included in nep-cfn, nep-law and nep-rmg
Note: CFP 1142.
References: View references in EconPapers View complete reference list from CitEc
Citations:

Published in Tax Law Review (Winter 2004), 57(2): 233-274

Downloads: (external link)
https://cowles.yale.edu/sites/default/files/files/pub/d14/d1413.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found

Related works:
Working Paper: Market Bubbles and Wasteful Avoidance: Tax and Regulatory Constraints on Short Sales (2003)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cwl:cwldpp:1413

Ordering information: This working paper can be ordered from
Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA
The price is None.

Access Statistics for this paper

More papers in Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University Yale University, Box 208281, New Haven, CT 06520-8281 USA. Contact information at EDIRC.
Bibliographic data for series maintained by Brittany Ladd ().