Intertemporal Tax Discontinuities

This paper defines an intertemporal tax discontinuity (ITD) as a circumstance in which different tax rates are applied to gains and losses realized at one point in time versus some other point in time, and studies the effects of ITDs on market behaviors at the time of disclosures of firm performance. The results show that ITDs either depress or amplify trading volume at the time of disclosure, depending upon whether the disclosure is 'good news' or 'bad news,' repectively, and lead to 'overreactions' in price changes independent of the 'news.' We propose empirical tests of one intertemporal tax discontinuity, the spread between short-term capital gains tax rates and long-term capital gains tax rates. We predict that stock responses to disclosures, such as quarterly earnings announcements, increase in the difference between short- term and long-term capital gains tax rates.