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Tax bills help push markets into abyss

April 20, 2000


On March 30, consultant Jude Wanniski warned his clients of more falling stock prices over the next two weeks. After markets closed following the plunge of April 14, he sent another message suggesting that the next Monday might be a good time to buy. He proved correct on both counts based on something other analysts ignored: brutal federal taxation of investment.

According to Wanniski, taxpayers who had profited from the runaway bull market of 1999 before Dec. 31 had found "they owe Uncle Sam and must sell equities" to pay massive capital gains taxes--or else incur severe penalties. Hence, black Friday, convincing Wanniski that the crash was tax-related. "Which means," he said, "we've hit bottom, as there is no way taxpayers can sell stock on Monday to meet 1999 liabilities, even with extensions on filings." Hence, recovery Monday, with shares sharply higher.

A tax-induced crash would have profound effects on government policy. On the morning after the crash, the lead New York Times editorial correctly noted: "A good chunk of the current surplus has been supplied by a boom in tax revenues from capital gains." But instead of drawing the conclusion that this heavy taxation adversely impacted markets, the Times advised George W. Bush to beware of tax cuts.

Wanniski's conclusion is closer to reality. Instead of worrying about whether Federal Reserve Chairman Alan Greenspan still will raise interest rates after the fall, "much better if our `leaders' understand the noxious effects of capgains taxation." But not even Bush, much less Vice President Al Gore, proposes any needed modification in this tax.

What gives credence to Wanniski's theory is the nature of the sell-off--not institutions but individual investors (including many neophytes) all racing for the door at once as they realized their tax predicament. After Wanniski's March 30 warning, a client reply confirming this position came from Catherine Wood of Tupelo Capital (a New York-based asset management firm).

"I think that you're absolutely right," Wood responded the same day. "For the past three days, our trader has been saying that the institutions aren't playing, that the volume is suspiciously light for such big down days, and that the downdraft must be a function of retail selling. You've given us the explanation."

While Wall Street insiders speculated endlessly in print and on television about the source of the crash, the need to pay taxes and avoid stiff penalties from the IRS eluded them. A rare connection of the dots between taxes and stock prices was drawn by columnist Beth Piskora in the April 11 New York Post.

Writing on a Monday, Piskora attributed the big April 10 sell-off to people spending the weekend "filling in their 1040 forms and realizing they owe Uncle Sam a big payment." She quoted investment banker Peter Cohan: "Americans are using their brokerage accounts as their savings accounts, and many of them don't have the money just lying around to pay the tax bill."

Analytical support for the tax theory was provided by Wanniski's Polyconomics firm in tracking emerging-markets debt. During past declines of the Nasdaq high-tech stocks, Russia, China and Third World countries also suffered. This time, there was no negative impact. If either fear of recession or excessive tightening by the Fed caused the crash, Michael Churchill of Polyconomics concluded, "emerging-markets debt would be getting crushed."

Monday's recovery hardly compensates for massive loss of wealth, and may prove temporary. Market confidence would be restored by a serious move in Congress to eliminate or significantly reduce the capital gains rate. More achievable might be a reduction down to three months of the 12-month holding period of stocks to qualify for the lower tax rate on long-term capital gains. That would be a tonic for markets, considering the havoc wrought on Nasdaq by the short-term capgains rates.

But who will do it? Bush's flawed tax plan ignores capital gains. Sen. John McCain's imitation of Democratic rhetoric in condemning "tax cuts for the rich" has had a deadening effect on Republicans. The first step for them now is to understand what really happened in the markets the last month.

Robert Novak's new book is Completing the Revolution: A Vision for Victory in 2000. Novak appears on CNN's "Capital Gang" at 6 p.m. Saturday and "Evans, Novak, Hunt and Shields" at 4:30 p.m. Saturday and 10 a.m. Sunday.

-- - (, May 11, 2000


Another good reason for a "national sales tax" to replace the income tax. If people paid a tax when they BUY a stock, we wouldn't have this problem. <:)=

-- Sysman (, May 11, 2000.

So does this mean that this week's losses were retail players selling to pay the rest of their tax bills? Light volume, markets dropping, mostly the same features...

Methinks Mssrs. Novak and Wanniski have a "tax ax" to grind and that they're trying to use some negative market events to support their position. I've heard quite credible arguments that a lot of those April sales were Robertson and Soros/Druckenmiller unwinding positions as they went to cash to close out their big hedge funds. Could have been a lot of factors combining to create the April swoon.

Taxes happen same time every year and folks made good money in 1998 (under the same tax laws), but we didn't see anything like that April 2000 sell-off in April 1999.

-- DeeEmBee (, May 12, 2000.

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