Barry Ritholtz: Why Markets Love Trump's Tax Cuts

Ted

FYI:Here we go again.

It has barely been a month since the Tax Cuts and Jobs Act of 2017 passed. Despite a volley of criticism over the bill, Mr. Market has voted with his feet. The U.S. equity rally since then has been substantial -- so much so that many market observers seem fixated on negative issues such as valuation, the speed of the run-up, and why a bad ending is inevitable.
Regards,
Ted
https://www.bloomberg.com/view/articles/2018-01-29/why-markets-love-trump-s-tax-cuts

LewisBraham

Ritholtz may be right that tax cuts are good for the stock market, but is wrong or intentionally misleading about their impact on the overall economy. It is disingenuous to call corporate tax cuts Keynesian fiscal stimulus in any traditional sense as that wasn't really what Keynes had in mind, but rather government spending on things like infrastructure to create jobs. The idea that these tax cuts will filter down throughout the economy to benefit everyone is the old trickle down lie. At best the evidence for it helping the average person in the economy is weak. Only one kind of tax cut specifically tied to creating new jobs--if you hire X people, you get Y tax cut--seems to work well. Here's an excerpt from Politifact comparing the impact of different kinds of stimulus:
politifact.com/truth-o-meter/statements/2010/aug/12/rachel-maddow/maddow-claims-spending-more-stimulative-tax-cuts/

As Greg Mankiw, a Harvard economics professor, explains in a summer 2010 edition of National Affairs magazine, Keynes believed that "extreme and sustained unemployment during a recession" is fundamentally the result of "a decline in overall (or aggregate) demand in the economy." The government can "help restore normalcy" by increasing demand through spending, writes Mankiw. "And because the influx of government spending drives businesses to hire and consumers to spend, its impact is multiplied."

According to classic Keynesian theory, government spending increases have a higher "multiplier" than tax cuts, because individuals might choose to save the money from tax cuts, rather than spend it.

Is there data to back up Keynes' -- and, by extension, Rachel Maddow's -- argument?

Yes, but there's also data that certain types of tax cuts can have a similar impact.

To start out, we turned to testimony by Mark Zandi before the Senate Finance Committee on April 14, 2010. Zandi is the chief economist for Moody's Economy.com and a former adviser to Republican Sen. John McCain during his 2008 presidential campaign. Page 5 of the testimony contains a table that summarizes Zandi's calculated "bang for the buck" for various fiscal stimulus programs. Spending $1 on unemployment insurance benefits, for example, increases the GDP -- the value of goods and services that the economy produces -- by $1.61 a year later, according to Zandi. (We found some counter-arguments in a previous Truth-O-Meter item checking New Hampshire Sen. Jeanne Shaheen's use of Zandi's data.) A temporary increase in food stamps has the biggest stimulative effect. For each dollar spent, GDP grows by $1.74 one year later. For spending increases as a whole, the "bang for the buck" ranges from $1.13 for the Low-Income Home Energy Assistance Program to $1.74 for food stamps.

The former economist for the GOP presidential candidate also looked at the stimulative effect of tax cuts. Making the Bush income tax cuts permanent has a multiplier of 0.32, which means that for every dollar the government cuts in taxes, GDP grows by $0.32. Cutting the corporate tax rate also has a multiplier of $0.32. According to the chart, the most stimulative tax cut initiative would be a job tax credit, which has a multiplier of $1.30.

So based on Zandi's research, Maddow is on solid ground. All but one of the spending programs that Zandi analyzed have a multiplier significantly higher than one. The highest multiplier for tax cuts is $1.30.

All of that said, Ritholtz is probably right that corporate tax cuts should benefit the stock market. Corporations and wealthy stock holders are precisely who the cuts are designed to help. The fact that the cuts are working in that regard shouldn't come as a surprise. They increase corporate profits after taxes by default. Yet whether the rally from the cuts is overdone at this point is another question entirely. Valuations matter too. And conflating the stock market's performance with the health of the overall economy is a gross distortion of the truth.