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Tax Policy and Stock Prices

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  • Thomas Downs
  • Patric H. Hendershott

Abstract

Windfall profits and losses accrue to investors only when expected after-tax returns or discount rates change, and major tax policy shifts are likely to alter these variables. This study introduces a cashflow valuation model for estimating the windfalls to owners of U.S. nonfinancial corporations caused by the enactment of tax changes. The model is illustrated by analysis of two reform packages, the Treasury Proposal of November 1984 and the Tax Reform Act of 1986. We find that the original Treasury plan would have boosted stock prices by 20 to 30 percent; an increase of 10 to 12 percent is computed for the Tax Reform Act of 1986. This anomalous result -- a $125 to $140 billion dollar corporate tax increase (over five years) raising stock prices -- occurs because the tax increase is on new capital, not old capital. The stock market largely values expected returns on the existing capital stock, and these returns benefit from the adverse treatment of new investment.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2094.

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Date of creation: Dec 1986
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Publication status: published as Downs, Thomas and Patric H. Hendershott. "Tax Policy and Stock Prices," National Tax Journal, Vol. XL, No. 2, (June 1987), pp. 183-190.
Handle: RePEc:nbr:nberwo:2094

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  1. Martin Feldstein & Lawrence Summers, 1978. "Inflation, Tax Rules, and the Long Term-Interest Rate," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 9(1), pages 61-110.
  2. Brainard, William C. & Shoven, John B., 1980. "The financial valuation of the return to capital," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue 4, pages 43-104.
  3. Alan J. Auerbach & James R. Hines Jr., 1986. "Anticipated Tax Changes and the Timing of Investment," NBER Working Papers 1886, National Bureau of Economic Research, Inc.
  4. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, American Finance Association, vol. 32(2), pages 261-75, May.
  5. William C. Brainard & John B. Shoven & Laurence Weiss, 1980. "The Financial Valuation of the Return to Capital," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(2), pages 453-512.
  6. Patric H. Hendershott, 1985. "Tax reform and financial markets," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, Federal Reserve Bank of Boston, vol. 29, pages 153-186.
  7. Alan J. Auerbach & Laurence J. Kotlikoff, 1982. "Investment versus Savings Incentives: The Size of the Bang for the Buck and the Potential for Self-Financing Business Tax Cuts," NBER Working Papers 1027, National Bureau of Economic Research, Inc.
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Cited by:
  1. Andrew B. Lyon, 1988. "The Effect Of The Investment Tax Credit On The Value Of The Firm," NBER Working Papers 2537, National Bureau of Economic Research, Inc.
  2. Patric H. Hendershott, 1988. "The Tax Reform Act Of 1986 And Economic Growth," NBER Working Papers 2553, National Bureau of Economic Research, Inc.

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