Tax Policy and Stock Prices

21 Pages Posted: 25 Jul 2007 Last revised: 24 Mar 2021

See all articles by Thomas Downs

Thomas Downs

Boston College - Carroll School of Management

Patric H. Hendershott

University of Aberdeen - Centre for Property Research; National Bureau of Economic Research (NBER)

Date Written: December 1986

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.

Suggested Citation

Downs, Thomas and Hendershott, Patric H., Tax Policy and Stock Prices (December 1986). NBER Working Paper No. w2094, Available at SSRN: https://ssrn.com/abstract=344864

Thomas Downs (Contact Author)

Boston College - Carroll School of Management

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Patric H. Hendershott

University of Aberdeen - Centre for Property Research ( email )

Aberdeen AB24 2UF
Scotland

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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