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Chester Arthur, Grover Cleveland'Does it really impact the GDP? | ||
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By DAVID MOON, Moon Capital
Management It became evident in the weeks just before the recent election that Democrats would make substantial gains in both houses of Congress. With analysts correctly anticipating that the Republicans would lose control of at least the House of Representatives, most U.S. domestic stock-market indices reached five- and six-year highs. The Dow Jones Industrial Average reached an all-time high.
Coincidence? Not if you ask a Democrat.
Since the election, we've had some horrible days on Wall Street. Just this past week, the Dow declined 205 points on the two trading days straddling Thanksgiving ' typically, slow, uneventful days on Wall Street. These declines coincided with endless television appearances by the new Democrat House Speaker-to-be and talk of a return to 1992's failed health-care reform effort by New York's junior Democrat senator and former First Lady.
Coincidence? Not if you ask a Republican.
In the big scheme of things, it doesn't much matter which party is in power. Sure, I expect the Democrats to try to raise taxes on 'the rich,' which probably includes most people who read the second page of the Business section of the News Sentinel ' no matter how middle class you feel.
And I'm certainly not looking forward to a possible increase in capital-gains taxes. The current 15 percent top rate lets investors make capital-allocation decisions based more on economic factors than on artificial tax considerations.
This phenomenon is known as not letting the tax tail wag the economic dog. With high capital-gains taxes, investors will often continue to hold stocks of companies that are mismanaged or overpriced, simply to avoid paying taxes.
This can reward poorly run companies while depriving deserving companies of needed capital.
In the short term, anything can affect stock prices, and that certainly includes political shenanigans. But in the long term, stock prices are a function of earnings and cash flow, and politicians just don't think or act long-term. For politicians, the economy is much like the weather: they all talk about it, but don't really do anything about it.
Two exceptions come to mind, however.
If you change the structure of the economy, you can impact corporate earnings. Lyndon Johnson and Richard Nixon did that by creating massive government programs and departments. Once created, each new entity acts like economic kudzu, constantly expanding, out of control. This bureaucratic weed drains nutrients from the rest of the economy, slowing economic growth and depressing earnings.
By contrast, in the 1980s Ronald Reagan's tax-code changes caused a positive structural shift in the way investors allocated capital. Prior to 1986, many investment decisions were based on tax considerations, causing people to pour money into overpriced or otherwise undeserving investments.
Although politicians have tinkered with taxes since then, lower rates and fewer brackets remain with us today and continue to pay positive dividends for the economy and for investors. David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).
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