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Necessary Conditions for Share Prices to be Affected by Taxes When an investor sells a share of stock, the United States taxes the difference between the sales price and its tax basis, which is usually the purchase price.
Except for the period 1988-90, individual investors have been rewarded with a reduced tax rate if they hold the stock for a minimum period, which has ranged from six to 18 months.
Thus, it becomes difficult to explain why so many capital gains taxes are paid without resorting to incompleteness in the capital markets.
Finally, inelasticities in the supply of capital must prevent immediate readjustment throughout the economy following the tax rate change.All of these conditions must hold for a change in the long-term capital gains tax rate to affect prices (other than through indirect macroeconomic shifts).Similar conditions must hold for other changes in the taxation of capital gains to affect share prices.As if this complication is not enough, individuals who inherit stock assume a tax basis equal to the fair market value of the shares at the date of death.Therefore, a bequest can be sold immediately without incurring any capital gains taxes.
Under these conditions, share prices would never change and the company's value at liquidation would equal the shareholder's original capital contribution.