Does Differential Taxation of Short-Term Relative to Long-Term Capital Gains Affect Long-Term Investment?

Pressure from short-horizon investors can hurt investments in innovative, long-run value increasing projects. We explore the efficacy of a commonly proposed tax-based policy tool to mitigate this problem: imposition of differentially greater taxes on short-term capital gains vis-a-vis long-term capital gains. Using a panel of 30 OECD countries and 21 capital gains tax shocks over 1991-2006, we find that rewarding longer-term ownership through lower capital gains taxes results in an increase in corporate innovation. The evidence should be of interest to lawmakers and regulators and also adds to our understanding of the real effects of taxation of investor trading activity.