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Lower Tax Collections Are Bullish for Stocks at Trader’s Narrative

The stock market can seem a bit schizophrenic to untrained observers. A lot of people can’t understand for example, how deeply negative consumer sentiment corresponds to higher stock prices in the future.

Another contrarian indicator is the amount of money collected by Uncle Sam. Obviously, when we have an economic slowdown, the government collects less taxes from corporations and individuals. So why would this be a positive development for stock prices?

The recent economic malaise is so serious that it has reduced the total government tax receipts relative to GDP to levels not seen since the 1950’s:

tax receipts compared to stock market McClellan Apr 2010
Source: McClellan

What is bad news for the US budget, may actually be good news for the stock market. As Tom McClellan writes:

…whenever total revenues get down to below 17% of GDP, the years which follow tend to be really good ones for stock prices. Conversely, seeing federal revenues at 18% or higher tends to have a depressing effect on stock prices.

…the federal government has been doing a lot of deficit spending to try and revive the economy, so a lot more of GDP lately has been government spending. The net result is that a lot more money is staying in the economy, allowing it to be put toward the task of lifting stock prices. In every case when federal revenues drop to a very low percentage of GDP, it is bullish for stock prices in the years that follow.

Peter Orszag estimates that the ratio will rise to 19% by 2014. If that estimate is borne out then it would be the 4th time in US history. The first was after World War II (not shown in the above chart), the second in 1982 and the third from 1998 to 2001.

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2 Responses to “Lower Tax Collections Are Bullish for Stocks”  

  1. 1 thunderbird

    Sure… so why do government tax receipts go down after market crashes? Maybe it’s because more people are unemployed, paying no income tax. And businesses are broke. Meanwhile, tax receipts trend higher when the economy’s doing swimmingly. It seems you’re confusing correlation with causation.

    The Republican suggestion that extremely unsustainable deficit spending (because of lower taxation) makes the economy run better is what’s bankrupted your poor country. And driving entire races and states into a multi-generational cycle of poverty by cutting spending at the wrong end (support for the poor) doesn’t do much for your productivity level, either.

  2. 2 GreenAB

    i see absolutely no relation here, other than that a drop in tax receipts mirrors a slowing economy which will be attacked by lowering interest rates, the real liquidity driver behind market moves.

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