Kristian Rydqvist, Joshua Spizman, and Ilya Strebulaev
Government policy and ownership of equity securities
Journal of Financial Economics | Volume 111, Issue 1 (Jan 2014), 70–85

Since the end of World War II, direct stock (also referred to as equity) ownership has declined. In the United States, households held 90% of equity directly just following World War II. By 2010, the amount of direct equity held by households declined to under 30%. Equity ownership migrated to financial institutions, who own almost 50% of U.S. stocks in 2010. Where historical data is available, this pattern is similar worldwide. Between 2005 and 2010, the average direct household ownership of equities is approximately 17%. We show that tax policy was a major factor in causing this worldwide shift in equity ownership.

The Tax Benefits of Pension Funds

Governments around the world allow retirement savings to be favored by the tax system. For example, the United States defined benefit pension funds and 401(k) accounts both provide tax incentives to contribute to them. For brevity, we refer to all of these plans as pension plans. Investment returns from assets held inside a pension plan accrue tax free. When holding stocks directly (outside of a pension plan), both dividends and capital gains are subject to personal income tax. This difference is the first tax benefit of contributing to a pension plan. A second tax benefit of pension plans is that employers and employees contribute pre-tax income. Therefore, households can reduce their marginal tax rates while working by shifting taxable income into lower-income retirement years.

The Evolution of Stock Ownership

Figure 4f show the evolution of stock ownership for the eight countries (Canada, Finland, France, Germany, Japan, Sweden, United Kingdom, and United State) in our sample from 1945-2010. The solid diamonds and lines represent direct household ownership of stocks and the open diamonds and dashed line represent tax-preferred institutional holdings (pension funds, investment funds, and insurance companies). There are several important observations. First, the decline in direct household ownership was large across all countries, with the average decline being 40%. The second observation is that household direct ownership of stock was largely replaced by financial institutions, which increased by 24%. Finally, there was significant variation both across time and across countries in the shifts in stock ownership. The decline was larger for most countries in the 1970s and 1980s and varied across countries in all time periods.

4: The evolution of stock ownership: US
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This and subsequent figures show how stock ownership has evolved over time. The sample period is from 1945 to 2010. Solid diamonds and lines represent direct household ownership of stocks while open diamonds and the dashed line represent tax-preferred institutional holdings (defined as pension funds, investment funds, and insurance companies). Interpretation: Households have shifted from holding stock directly to indirectly in tax-preferred accounts across the world.
5: The evolution of stock ownership: Canada
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6: The evolution of stock ownership: Japan
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7: The evolution of stock ownership: Germany
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8: The evolution of stock ownership: UK
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9: The evolution of stock ownership: Sweden
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10: The evolution of stock ownership: France
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11: The evolution of stock ownership: Finland
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The Tax Explanation: The United States

We argue that tax policy is a major factor in explaining the shifting ownership structure. The development of the United States pension and mutual fund industries provides an example of how government tax policy helped shape the structure of institutional ownership. Figures 12f report the evolution of the U.S. pension fund and mutual fund industries. They show pension fund and mutual fund holdings of stocks and bonds. The figures show that since the 1940s, pension funds ownership of both stocks and bonds has grown; and by the 1980s, pension funds owned a large fraction of both stocks and bonds. Interestingly, mutual funds owned an insignificant portion of these assets during this time period. However, mutual funds began to grow in the 1980s, replacing pension funds as the dominant form of equity savings. This phenomenon can be explained by government tax policy.

12: Pension fund stock holdings in the US
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This and subsequent figures show how institutional holdings of stocks and bonds in pension and mutual funds has evolved over time in the United States. The sample period is from 1945 to 2010. Interpretation: Institutional holdings of stocks and bonds in the United States grew depending on tax incentives.
13: Pension fund bond holdings in the US
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14: Mutual fund stock holdings in the US
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15: Mutual fund bond holdings in the US
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During the 1940-1980 time periods, pension funds have a tax advantage that mutual funds do not have, due to the Revenue Act of 1921. In 1978, the new 401(k) legislation allows for adoption of defined-contribution plans. However, it is not until the Economic Recovery Tax Act of 1981 where defined contribution plans became operational, by specifying contribution limits. The combination of the 1978 and 1981 reforms create a new demand for defined contribution plans that are managed by mutual funds. Dickson, Shoven, and Sialm (NTJ 2000) show that roughly half of equity mutual funds are held inside a tax-deferred account. Obviously, taxes are not the only reason for the growth of the mutual fund industry and, while this evidence is telling, we must provide systematic evidence relating the ownership of financial asset to government tax policy, using our panel of eight countries.

The Tax Explanation: Worldwide Evidence

We construct two proxies to capture the tax incentives from holding stock inside a pension plan for all eight countries in our study. GAP measures the difference in investment returns between holding stocks inside a pension plan versus outside a pension plan. SMOOTH measures the benefit of shifting taxable income from higher income work years into lower-income retirement years. Meaningful measures of both GAP and SMOOTH rely on understanding details of how dividend, capital gains, and ordinary income are taxed. We use a married-filing jointly income of five times GDP per capita to construct all tax related variables.

1: Effect of tax incentives on direct household stock ownership
Direct Household Stock Ownership
Constant –0.73** –0.19
GAP5 –32.3**
SMOOTH5 0.5
N 396 396
R2 0.000 0.027
This table reports the results of regressing the annual change in households' annual, direct stock ownership on GAP, which measures the rate of return difference between saving inside and outside a pension plan and SMOOTH, which measures the tax benefit of income smoothing. The sample period is from 1945 to 2010. Interpretation: A three percentage point difference between saving inside and outside the pension plan associates with an annual decline in the fraction of household direct equity ownership of about one percentage point.

We test whether or not tax incentives (GAP and SMOOTH) affect the change in direct household stock ownership. Table 1 reports our regression results. Specification (1) reports only the average annual change in household ownership across the eight countries (0.73%). When we add our tax incentive variables, the coefficient on GAP is significantly different from zero, while the coefficient on SMOOTH is not. Most importantly, the intercept term is no longer statistically significant. From an economic standpoint, our results mean a three percentage point difference between saving inside and outside a pension plan results in an annual decline in the fraction of household direct equity ownership by about one percentage point.

2: Effect of tax incentives on direct household stock ownership
1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2010
Constant 1.03 0.59 0.21 0.46 –0.84 2.65**
GAP5 –19.4 –39.4** –22.1 –41.9** –31.7 –147.6
SMOOTH5 –94.9 –31.8 –21.4 –13.2 28.2 –35.3
N 37 68 72 80 80 53
R2 0.098 0.132 0.083 0.101 0.002 0.050
This table reports the results of regressing the annual change in households' annual, direct stock ownership on proxy variables for the tax benefits of saving inside a pension plan on a decade-by-decade basis. The coefficient on GAP is generally negative. Our statistical results are driven by the cross-sectional variation in tax policy across our eight countries.

Table 2 explores the time-series impact by estimating our model on a decade by decade basis. The coefficient on GAP is generally negative and of similar economic magnitude to the full panel estimates of Table 1. Statistical significance varies because the number of observations in each decade is small.

In conclusion, we show that government tax policy has an important impact on the evolution of stock ownership. Over time, households moved from holding stock directly to holding it indirectly inside a pension fund or mutual fund.


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