TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, April 27, 2007

U.S. News: Dow 13,000 and the Bush Tax Cuts

Interesting article in today's U.S. News & World Report:  The Dow and the Bush Tax Cuts, by James Pethokoukis:

With the Dow industrials making new records every day of late–even cracking the 13,000 barrier to fascinate all the Wall Street numerologists out there–I thought it would be a real kick to see how the stock market has performed since Congress passed the 2003 Bush tax cuts on May 23, 2003. (The Jobs and Growth Tax Relief Reconciliation Act accelerated the 2001 tax cuts and cut taxes on capital gains and dividends.) Since then, the Dow is up 52%, the S&P 500 60%, and the Nasdaq 69%. (Overall, the stock market has created some $6.8 trillion in new wealth since then as the size of the economy has grown by some $2.8 trillion, not adjusted for inflation.)  ...

[O]ne could argue that the super stock market and declining deficit are somehow happening independently of the tax cuts. That is what the government's "static analysis" economic models do. They're the same ones, of course, that predict no negative economic effect from $2 trillion of tax hikes if the Bush tax cuts from 2001 and 2003 are left to expire at the end of 2010, as some in Congress and in the Democratic presidential race advocate. I wonder if investors will have the same benign analysis.

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I read Bull's Eye Investing by John Mauldin a couple of years ago. ISBN: 0471716928. It is about long term ("secular") trends in the stock market. I'll state up front that I'm not doing justice to his research and his findings in this post. The gist of it, however, is that historically when (a) interest rates and (b) taxes have ballooned, while (c) the market p/e ratio is low, the effect of cutting interest rates and lowering taxes creates an environment for sustained secular bull markets. Like I said, this is the gist of it, and I'm really not doing justice to Mauldin's extensive research.

Nevertheless, based on this, the bizarre thing about the market performance today is that historically speaking interest and tax rates have not ballooned to the historical highs that Mauldin described in his book. Thus, the appearance of a healthy market is both surprising and, more likely, misleading.

Consider the high interest and tax rates at the end of the 1970s. The period from 1980 until about 1999 is the most recent long term ("secular") bull market. Factors (a), (b), and (c) were all in place at the end of the 1970s, which created the environment for this long-term period of growth. Granted, there were corrections during this period, but generally the growth of the market was huge.

Contrast the period of 1980-1999 with the market performance from about 1964-1979. During the earlier period, factors (a), (b), and (c) were not in place and the market demonstrated all the characteristics of a secular bear.

I have referenced only two periods, but Mauldin's historical documentation is more extensive.

Based on Mauldin's writings, it seems to me that the environment today is more analogous to the 1964-1979 period. The tax cuts probably have helped, but they probably won't contribute to the sustained growth of a secular bull.

Posted by: anon | Apr 27, 2007 12:18:28 PM