How the High LTCG Tax negatively impact the Indian stock market?
Long-term capital gains tax (LTCG) is a tax that investors pay for holding stock or a mutual fund for more than 1 year. Here we will discuss how the high taxes on market affects its growth.
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Harsh Garg
9/12/20264 min read
LTCG stands for Long-Term Capital Gains. It is the profit made when you sell an investment (such as stocks, equity mutual funds, or real estate) after holding it for a long time. In India, if you keep listed equity shares or equity mutual funds for more than 12 months and subsequently sell at a profit, the profit is known as LTCG. Currently, LTCG over ₹1.25 lakh in a financial year is taxed at 12.5% (plus 4% cess). Gains up to ₹1.25 lakh per year are tax-free.
Why does the high LTGC hurt the stock market?
Discourages long-term investors
The basic goal of LTCG tax is to reward people who have held assets for a long time. However, a high tax rate makes even long-term investors feel disadvantaged. A 12.5% capital gains tax can drastically lower the final corpus over the course of 10 to 20 years. For instance, if someone earns ₹86 lakh over 20 years, LTCG tax at 12.5% can deduct more than ₹10 lakh. This is not due to poor investment, but rather to a taxation of patience.
When investors realise that a significant portion of their long-term profits will be taxed, they may:
Avoid equity and switch to real estate, gold, or fixed deposits.
Prefer assets with favourable tax treatment.
Reduce new investments in stocks and mutual funds.
Reduces market liquidity
The high LTCG tax produces a "lock-in effect". Investors delay selling stocks even when the fundamentals change in order to avoid paying taxes. This lowers trading volume and market liquidity. Brokers and market analysts have indicated that higher capital gains taxes, along with the high Securities Transaction Tax (STT), have reduced volumes by 30-40% in some categories.
Low liquidity means:
Increased gap between buying and selling prices (bid-ask spread).
Increased price volatility, particularly among midcap and smallcap companies.
Companies are finding it more difficult to attract new equity capital as the pool of active investors declines.
Hits compounding for retail investors
Compounding over decades generates equity wealth. Every rupee paid as tax cannot be reinvested. Over time, this minor leakage becomes a significant loss.
For a retail investor who has been using SIPs for 15-20 years:
Gains beyond ₹1.25 lakh annually are taxed at 12.5%.
This lowers the base on which future returns compound.
The final corpus may be much lower than it would be without LTCG tax.
Raises "hurdle rate" for equity returns
Investors always compare post-tax returns on stock to other options such as FDs, real estate, or gold. A high LTCG tax raises the "hurdle rate"—the minimal return required by an investor to justify taking on equity risk.
If after-tax equity returns appear less attractive:
Conservative investors remain away from stocks.
HNIs and family offices spend less on equity.
Foreign Portfolio Investors (FPIs) also see India as a high-tax, low-net-return market.
Creates the negative sentiment around the budget and policy changes
Every budget, the market closely monitors any changes in LTCG or STCG rates. Even the prospect of a rate hike can prompt selling. In 2024, when LTCG tax was hiked from 10% to 12.5% and STCG from 15% to 20%, indexes such as the Sensex and Nifty fell on Budget Day.
High and regularly shifting tax rules lead to:
Uncertainty about long-term planning
Equity investors are perceived to be "over-taxed" in comparison to other kinds.
Retail and HNI investors have lower confidence and risk appetite.
Slow capital formation and economic growth
On a macro level, stock markets operate to pump savings into businesses. When the tax on equity returns is high:
Savings are invested in traditional assets such as gold, real estate, or bank accounts.
Companies find it tougher and more expensive to raise equity capital.
New and developing companies receive less investment, which may hamper job creation and innovation.
Global compativeness issues
Many rival marketplaces offer long-term investors lower or no capital gains tax. For example:
Singapore and the UAE have 0% capital gains tax for individuals.
In the United States, many investors benefit from tax-advantaged retirement accounts and lower long-term capital gains rates.
Bottom line
A moderate LTCG tax can assist the government in collecting income while protecting investment. However, a high or poorly structured long-term capital gains tax:
Reduces long-term investment and compounding.
Lowers market liquidity and raises volatility.
Encourages tax-driven behaviour rather than fundamental investing.
Makes equity less appealing relative to other assets and countries.
In a market that relies on retail participation, SIPs, and long-term wealth accumulation, keeping LTCG tax at a fair level is critical for the overall health of the Indian stock market.
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