Question

For example, suppose that you own 100 shares of a

company. Over the course of a year (the stock must be held for this period of time in order to get the preferred rate) the value of this portfolio

rises from $1,000 to $1,500. The gain in value of $500 is taxed at about 15%. By contrast, a dollar of wage income is typically taxed at a much

higher rate.

Now suppose that the government raises the tax on capital gains. Based on the Tobin money demand model it follows that:

Answer 1

According to the Tobin's demand for money model, it follows that the desired money holdings will rise.

This will be the response as individuals might want to hold their money in the form of cash since investing money would result into a greater amount of charged cost (Taxes on capital gains) than the interest income. Subsequently, individuals would like to keep their cash in the most fluid structure with themselves. Then as a result there will be a fall in the investment rate.