A Study Of Capital Gain Taxation For Securities In Taiwan

The government financial policy concerning the collection of Capital gain tax for securities has been a controversial issue within government officials, scholars, stock brokers and the mass majority of investors. The main focus of such controversy has been debated over the impact of such tax collection policies on the current stock market activities. The historical data has shown that the proposal of collecting capital gain tax for securities has a negative impact upon Taiwanese stock market activities. Such negative impact has been observed with series of events including dramatic fallen in stock index and trading volume and increase in stock volatility. Since such tax collection announcement proposal has been deemed as an unwelcome event by most investors. The result of opposing pressure against collection has obstructed and increased the execution difficulty for the government policy under the good intention of establishing a taxation reformation to increase taxation income and improving taxation fairness.This study shall apply qualitative research and quantitative research techniques to focus on the impacts of the two recent taxation reform proposal announcements of capital gain tax for securities in Taiwan(The 1988 Kou announcement and the 2012 Liu announcement). The qualitative research part of this study shall be done through the discussion of aspects regarding to the 2013 Taiwan Capital gain taxation for securities legislation and economical financial behavior. The purpose of such study is to illustrate how the design of capital gain taxation for securities and government policy impact on the market and economy. In the other empirical study approaches investigate the stock trading variation regarding to the market reaction to announcements of capital gain tax for securities. This study also adept an empirical study with GARCH(1,1) model and GJR model to evaluate the capital tax announcement impact on the stock trading pattern. This study also intends to find out whether or not the capital gain tax announcement will cause a lock-in effect in the stock market and resulting to reduction of securities transaction tax income and impacting on national economy. To exclude international influences, this study takes Taiwan stock market as an experiment group contrasting to Hong Kong stock market to analyze the long term and short term effect of capital gain tax announcement with a DID regression method. Then finally a conclusion is proposed through compared analysis of micro-economic and macro-economic data from one year prior and after the announcement of Taiwanese capital gain tax of year 2012. This study intends to discuss the causes of capital gain taxation for securities effect and provides possible improvement strategies through the qualitative research of tax neutrality principle analyzing the impact of capital gain taxation for securities on government policy and financial revenue.The expected contribution and innovation of this study intends to investigate the capital gain tax policy fairness and efficiency through legal aspect(legislation), market aspect(investor behavior) and taxation aspect(macro-economics and micro-economics) mainly base on tax neutrality principle. This paper will further conclude the taxation efficiency through quantitative research of the impact of capital gain tax for securities announcements on the market behavior of Taiwanese investors. This paper intends to research on tax neutrality principle on government policy and financial income influences and proposes improvement suggestions. This paper will analyze Taiwan stock market behavior pattern changes due to market investors reacting to taxation announcements as future reformation and innovation reference to legislation units. The contribution on co-operation of cross-strait economic aspect is to take taxation policy of both sides as a foundation to further research on capital gain taxation for securities. This will help us develop further understanding toward taxation policy of both side and how market investor behavior impact on economics and society with quantitative research on the taxation announcement influence.The conclusion of this paper is that the merit of the 2013 Taiwan capital gain taxation for securities has favor individual and cooperation that invest into long term investment by giving reduction of taxation duty and providing the rules of cancelation between earning and loses. However the qualitative and quantitative analysis suggestions shall be concluded through the legislation aspect, investor behavior aspect, capital market micro-economic and macroeconomic aspect to justify the fairness and efficiency of the taxation policy.The first part of this research would adept qualitative research in legislation aspect to offer three suggestions for design structure of 2013 Taiwan capital gain taxation for securities with “fairness” consideration.(1)The design of Taiwanese taxation for securities was too complicated which resulted into “unfairness” between the stock market investors and noninvestors. Those whom invested in the stock market must pay a 0.3% securities transaction tax and also required to pay income tax for the dividend income(including dividend and bounces). In addition the new health cares policy that a 2% health tax has been added to dividend income. Capital gain tax for securities is to be included in annual income tax. The overall taxation for securities was considered to be overload.(2)Stock investors might consider themselves double taxed by capital gain tax for securities since the received dividend has already been accounted within their annual income tax. Therefore this paper suggests that it would be more appropriate to reduce the dividend income tax rate in the annual general income taxation structure and adept separation taxation. This paper also suggests a reduction of the securities transaction tax to reduce investor taxation loading to compensate for capital gain taxing for securities.(3)The current capital gain tax for securities regulation has allowed “Foreign Institutional Investors(FINI)” whom has accounted for 25% of the total Taiwan stock market trading volume to be tax-free. Such regulation has been considered to be unfair to the local stock traders and inconsistent with the volume taxation principle.On the other hand, the current capital gain tax for securities regulation has four unfair contents regarding to the design.(1)The current capital gain tax for securities regulation mainly requires stock investors to pay tax. Which has disregards other capital gain incomes sources such as trading bonds, funds and future options. Such taxation has resulted into “substitution effect” and “lock-in effects” within stock trading market and encourages investors to seek for other trading tools such as oversea stock market investments and cause an investment capital shifting into tax-free or low-tax merchandise. Therefore this paper suggests that the taxation system should collect capital gain tax for securities evenly from all sources of investment.(2)The current taxation policy to tax individual investor whom possesses more than 10000 shares of IPO new stock has influenced the trading activity in IPO market. Therefore this paper suggests an expansion to the tax-free maximum IPO possession threshold to reduce market impact.(3)The current taxation regulation has been considered to be unfair to those individual investors whom would have reached an annually 1 billion(NTD) trading volume and to those local firms as well. Such design may encourage the establishment of dummy investors and dummy oversea cooperation to avoid further taxation.(4) The current taxation regulation has been considered to be unfair to the local firms. The new regulations has raised the minimum cooperation tax rate and reduced the tax-free deduction. Which has increased the taxation loading to the non-professional investing organizations and considered inconsistent with the taxation fairness principle and also failed to support the original taxation fairness principle since the taxation was focusing on stock capital gain only.The current capital gain tax for securities regulation has two inefficient aspects.(1)The taxation design has set up a 8500 point stock index threshold and causing a lock-in effect in Taiwan stock market deducing trading volume by 30%. The legislation has been amended twice within a year leading to an inefficient legislation process.(2)The taxation collection process has faced many practical difficulties such as investors may have distributed their investments into dummy investor accounts and dummy oversea investing accounts. According to the previous taxation failure experience practical taxation difficulty would cause collection inefficiency in the foreseeable future.The second part of this research would adept four quantitative study methods to analyze market investor behaviors. First, it has been done through event study analysis to understand the announcement effect of the two capital gain tax for securities announcements in Taiwan stock market(1988 and 2012 announcement). The result has shown that the 1988 Kou announcement has been over-reacted to cause a decline of stock index by 36%. The trading volume has also been eliminated during a 19-day period. The main reason of such irrational reactions by market investors could be summarized to the cause that such policy has not been openly discussed before the announcement. Therefore this paper suggests that such controversial policy ought to be fully discussed before execution to obtain the trust of market investors in order to calm the risk-phobia natural of investors and reducing possible market impact. The second part of the study has been done through the examination of the average changing of the market activity indicators. Second, T-test has been performed to understand the difference of market indicators before and after the event. The result has shown that Taiwanese stock market index, trading stock unit, trading volume, turnover rate indicators have significant negative difference during the observation period except for stock return rate. The reduction of trading volume has result a lock-in effect and influenced the market financial activities and also impacted on the profits of market brokers. The third part of the empirical study has adapted GARCH(1,1) model and GJR model to test on the influence of the capital gain tax for securities announcement event. Both of the announcement event samples have shown a negative impact on the short term stock market return rate since taxation has resulted investor to increase trading cost and reduced profit. Therefore this study concludes that an announcement of capital gain tax for securities will cause a negative impact on stock return rate regardless of the content of the announcement. However in a long term aspect that the investors realized the influence factors for long term stock return rate could not be decided by taxation. We could expect that investors will make rational decisions for long term investment arrangements. Therefore the capital gain tax for securities announcement has non-significant influence for long term stock return rate. The GJR model has shown the of capital gain tax for securities announcement event has significant negative influence and created a nonsymmetrical volatility to stock return rate. Which indicates that such announcement possess a threshold effect that bad news will trigger volatility for worse news. Finally, in the observation of short term lock-in effect that results obtained from regression method has found the Taiwan stock exchange volume has decreased 36.5% between the period from 28 th March 2012 to 30 th November 2012 which the contrast group of Hong Kong stock market has a reduction in trading volume of 21.1%. It could be explained that such period has been influenced by international economic crisis such as European bond risks and other events. After applying the DID method to exclude international factors that the cross examination result found the Taiwan stock exchange volume was still reduced by 11.5% indicating that capital gain tax announcement was a short negative and significant lock-in effect. A further analysis of long term lock-in effect with regression method has shown that during the period between 28 th March 2012 and 29 th September 2014 that the stock exchange volume of Taiwan has been still reduced by 28.1%. The contrast group of Hong Kong stock market has only been reduced by 7% after the extension of observation period has diluted international influence factors such as European bond crisis. The DID method has shown that Taiwan stock exchange volume remains to be reduced by 14.1% after DID cross examination which excluding international factors. The research results conclude that capital gain taxation for securities has a long term negative lock-in effect to Taiwan stock exchange volume.The third part of this research has adapted a quantitative method to analyze the impact of capital gain taxation for securities on the macro-economic and micro-economic level. The fourth part of this research will combine with the first part of the paper on legislation discussion and the second part of the paper on behavioral finance to apply financial quantitative analysis data. This study has mainly focus on the fairness and efficiency aspects of the 2013 Taiwan capital gain taxation for securities issue basing on “tax neutrality principle” for recommendation to Taiwan area and mainland China capital gain taxation for securities policy. Since “tax neutrality principle” was built on the assumption of “supply and demand elasticity” and the “external tax burden” are directly related. Therefore this paper concludes the suggestions of overall summary as follow.1. Take the experience of “fairness” and “efficiency” in the 2013 capital gain taxation for securities in Taiwan as a reference.(1)From the demand elasticity of stock investment aspects :The general investor(whom perform financial activities can be considered as general financial customer) would deem investing activity not to be a necessity. The structure of Taiwan stock market is mainly composed by professional investors about 32%~42% and general investors about 58%~68%. Therefore the majority of the general stock traders would possess greater demand elasticity in the stock market. Therefore the taxation collection would result greater “extra tax burden”. Which is most likely leading to greater “substitution effect” and “distort of resources” effects.(2)From the supply elasticity of stock investment aspects:For capital market is full of various investing tools including oversea investment products. Therefore the capital market consumer has greater demand elasticity contrasting to capital market producer supply elasticity which is relatively smaller. Capital market producer in Taiwan mainly composed by the regional company and financial securities organizations(including stock issuer, stock brokers and relevant subsidiary services organizations and employee). Therefore they are influenced by the trading volume reduction caused by capital gain tax for securities collection policy. The investor behavior changes have further caused major changes in macro-economics and micro-economics. It reveals the possible unfairness effect caused by the taxation policy.(3)From taxation policy adjustment of market structure aspects:The demand elasticity of stock investment was relatively flexible therefore the substitution effect was significant. Therefore the collection of capital gain tax for securities generated relatively greater additional tax burden. However from a market structure adjustment aspect that after taxation policy the cooperate investors of Taiwan stock market was originally 37.2% and increased to 41.3%(Foreign Institutional investors was the major beneficent enhancing from 21.8% to 25.1 %); general individual investors(including smaller and median traders who has no specific necessity for investment activity or daily operation) has been reduced from 62.7% to 58.7 %. From the above subjects that the market will adjust among with the taxation structure, it suggests that the stock market investor structure may be adjusted by the taxation policy through supply and demand elasticity of stock market with the taxation.(4)From the capital gain taxation for securities impact on investor psychology and behavioral effects : the quantitative and empirical analysis revealed that capital gain tax for securities announcement event would changes investor behavior and impact Taiwan stock market remarkably due to the market structure mainly composed by 60% to 70% individual investors. Therefore the trading volume and turnover rate of Taiwan stock market dropped significantly due to the announcement effect. Capital gain tax for securities announcement has impact on the trading volume producing lock-in effect and increased volatility. Which may be the result of 2013 Taiwan capital gain tax for securities application including individual investors and cooperation and adept practical taxation method impacting on mass individual investor privacy. If the taxation design failed to clarify the trading log privacy and rights protection issues that further impact may influence the stock market.(5)From the capital gain taxation for securities impact on the micro-economic and macroeconomic aspect : Taiwan stock market trading volume has been reduced by 25%~30% due to the lock-in effect resulted by the taxation announcement while Taiwanese trading oversea securities investment account has grown 37.2% during the announcement period. About 97.8 billion us dollar has been shifted to overseas market during Q2 of 2012 to Q2 of 2014. The annually shifted oversea securities investment amount is approximately equals to 8.5% of the year 2013 annual GDP of Taiwan. The stock market trading volume of nearby nations such as Hong Kong stock market has been increased during the announcement period. The shift of capital has hence that the government may have lost a proportion of taxation income due to such oversea capital movement and resulted into unnecessary financial loses. The direct impact of the securities transaction tax for securities in the two-year observation period after taxation announcement has resulted into a 44.7 billion(NTD) taxation reduction. Comparing to the annual income of securities transaction tax originally around 100 billion(NTD) per year(approximately 5%~6% of the overall taxation revenue). The capital gain tax for securities has resulted into a 22 billion(NTD) lost per year in securities transaction tax revenue which is a reduction of approximately 20%. Based on the forecast of government units that 10 billion(NTD) for individual capital gain tax of securities and 4 billion(NTD) for enterprises may be collected by the new taxation form. The capital gain tax for securities is expected to contribute 1% of the Taiwan overall annual income. It may seem to unworthy regarding to the loss of other taxation income due to reformation. The lock-in effect and the taxation design has caused the activity of IPO market to decline and further influence the future IPO capitalization ability. The lock-in effect has also affected the security exchange agency business and mostly likely to be one of the reasons for the reduction of 2013 Taiwan cooperation tax reduction by 16.6 billion(NTD) which is approximately 4.51%. Form the “capital distribution distortion” aspect that the 2013 annual land value increment tax has increased by 22.2 billion(NTD)(27% increase) and may be deemed as one of the substitution effect created by the capital gain tax for securities. The increase of land value increment also indicates the possibility of launching asset bubble and capital distribution distortion disfavoring social welfare redistribution. The taxation policy may cause impact on the employment and securities financial industry has a reduction of active brokers by 2300 people after taxation announcement. On the other side such taxation policy has caused society instability and cost of taxation to increase which require further notice.2. The suggestion of Taiwan area and mainland China capital gain taxation for securities implement.First, empirical result of capital gain taxation for securities in Taiwan regarding to the “fairness and efficiency” issue that this study suggests government should take in the individual investor capital gain tax for securities to be a “sub-optimal state” and paused individual investor capital gain tax collection or re-modify taxation design before perfecting the securities taxation system. Although the fairness principle is important to taxation and all income shall be taxed, however that practical taxation may cause a “butterfly effect” and influence market investor confidence and behavior through taxation announcement and resulting into micro-economic and macro-economic impacts. Therefore this study suggests government authority ought to understand market investor structure and behavior before applying new taxation policy. Then to focus on the tax neutrality principle to analyze demand and supply flexibility of capital market in order to systematically improve the capital market taxation structure such as to reduce investor dividend tax or securities transaction tax. Further clearance and protection of investor privacy concerns and rights issue before a formal taxation must be done. From the stock trading elastic point of view that individual investors have greater demand elasticity. Therefore the substitution effect and lock-in effect caused by capital gain tax has caused massive impact to stock market and further impact on micro-economics and macro-economics. To the overall economics and society that the cost of tax collection(cost of society and the collection itself) will out weight the benefit of tax collection(actual taxation income) if counting the highly collection difficulty brought by dummy traders and disguised oversea investors. This paper has already adept the quantitative and qualitative empirical aspects and finding that capital gain tax for securities announcement has already effected Taiwan capital market as well as society. The suggestions may require further discussion and the cross-strait market difference must be taken into consideration, however may serve as a highly systemically and critical view point for the future reference.Second, under the aspect of taxation revenue or taxation adjustment capital market that the law marker ought to consider a “simplified version of the taxation design” combining fairness and efficiency factors in order to create a win-win situation between the government and the investors. The suggestions of this paper are:(1)To the ability theory of taxation aspect, suggest to learn from Hong Kong area and Singapore’s capital gain tax system designed. Capital gain tax shall collect priority on stock investment demand elasticity relatively smaller and professional individuals or business investors whom are more likely to earn profit from investing activity.(2)In order to consist with the fairness and social justice principle of the capital gain tax for securities. The overall capital market taxation structure ought to be reviewed and adjusted to lower investor loading on the aspect of dividend tax and securities transaction tax.(3)In order to balance the investor lost and gain then balance capital market development structure that this paper suggest an extend recognition of capital lost and reward long term stock holder with a premium taxation policy.(4)On the prospect of stock investor capital gain collection policy that this paper suggests the taxation authority to cooperate with security agency and build up electronic system to evaluate investor practical income. When capital gain of investors is happened the system will adept pre-tax separation taxation and only returned when the investor suffered a capital lost in that trading annual. The practical tax collection by government is to be only done when the investor has applied an account clearance and calculate through security agency. Such collection policy is thought to be more consistent to the spirit of capital gain taxation despite the collection technical difficulties.(5)Under the consideration of taxation efficiency and adjust market structure by capital market taxation, this study suggests the policy maker to adept a “flexible taxation module” instead of a single mainframe regulation. The securities transaction tax should be deduced when the market trading volume was low in order to encourage the market activity and reduce investor taxation loading. While the stock market is over-heated or reaching the edge of the bubble that “the alternative securities transaction tax which equals to the concept of capital gain tax for securities” may be implement in the capital market when the investor received certain trading profit or certain indicators of the stock market over-heated. This view point may require further discussion but hope to serve as an innovation toward future government policy making.Efficiency will affect the fairness, and fairness will once again affect the efficiency. Under the framework of the cycle of economics and cycle of social development that taxation policy makers shall keep “tax neutrality principle” in mind, strengthens taxation functions and government function. This study suggests government authority to apply a general principle “to do the right thing priority than to do the thing right” before establish taxation policy. All government policy shall intend to achieve both fairness and efficiency in order to maximize social welfare economy in the aspect of “Pareto efficiency(Pareto Optimality) ”.