You might have noticed that the stock market is very excited about the possibility of a Republican tax cut. It soared last week after the Senate and House passed a Republican budget plan authorizing future budget cuts to pay for a $1.5 trillion reduction in taxes. Last week, October 16-20, the Dow Jones (30 largest companies) rose 160 points, and the S&P 500 (the 500 largest companies) and the NASDAC (primarily technology stocks) rose to new highs as well.
A look at previous big tax cuts shows why the excitement. In 1981, new President Ronald Reagan convinced Congress to enact an across the board cut of 25% in tax rates – 5% in 1981, 10% in 1982, and 10% in 1983 along with a 30% cut in the estate tax. The federal budget deficit exploded, going from $79 billion in FY 1981 to $221 billion in FY 1986.
Households making $300,000 or more in 1982 (the top 1%) pocketed an extra $21,500 or more each year from the tax cuts. Many put their windfall into the stock market, especially as it began moving up in the fall of 1982. On August 12, 1982, the Dow Jones Average closed at a low of just 777. Before the end of that year, the index had moved past 1,000, and in 1987 it peaked at 2,722. A household investing $21,000 in August of 1982 had stocks worth $73,500 in 1987.
Wall Street also profited. In the 1980s, wealthy individuals almost always invested through banking firms like Goldman Sach, Morgan Stanley, and Merrill Lynch. They received large fees for their work and reinvested it into speculative activities like leveraged buyouts and derivatives – speculation that was wildly profitable until the crash of 1987. Big fortunes were made for five years and then, on October 19, 1987, the market fell 23% in one day – the equivalent to the market falling 6,000 points in 2017.
In 1997, President Clinton worked with Speaker of the House Newt Gingrich to pass a bill lowering capital gains taxes by more than 33%, lowering the estate tax, and paying for it with budget cuts of $50 billion per year. Since the top 10% of families in the U.S. own 80% of the value of stocks, most of this tax cut went to the wealthy. Between February 13, 1997, when investors saw clearly that a cut in the capital gains tax was coming, and May 6, 1998, the market rose over 2,000 points – a jump of 28.6% in just 15 months. This fueled the dot.com boom, which crashed in the spring of 2001, with the stock market losing one-third of its value in two years.
In 2001, President George Bush convinced Congress to pass a large cut in individual tax rates and followed up with another cut in the capital gains tax in 2003. The federal budget went from a surplus of $172 billion in 2001 to a deficit of $524 billion in 2004. Once again, the wealthy poured their tax savings into the stock market, snapping up mortgage bond securities and all types of derivatives. The stock market rose 60% between 2003 and 2007 and speculation in housing was off the charts. The housing boom ended in 2007 and, in September of 2008, the financial system fell apart, requiring huge bank bailouts as the stock market fell by 65% in just two years.
So hold onto your hats. Each giant tax cut touched off a speculative boom that ended in a crash that triggered a long recession – 1989 to 1994, 2001 to 2003, and 2009 to 2014.