We don’t yet know what, if any, forthcoming tax proposals will become law. However, one potential idea that might be included in such a plan could be to encourage businesses to invest more in their property, plant, equipment, and technologies. After all, in the long run, that would likely help the economy, as it may boost productivity – an essential ingredient in the potential growth rate of the economy. And in the short term, the very investment itself is a direct addition to GDP.
But, as with many things in life, it really isn’t so simple to magically make money appear by legislation. There are complicated side effects and interactions. So, let’s take a walk through the data and connect some of the dots along the way to see how (or if) this could actually negatively impact consumer spending.
So, this much might make intuitive sense. But it comes with a huge caveat: there are many other factors besides the stock market that can influence consumer spending and saving. Indeed, there have been times when consumer spending has fallen along with the value of the market – just as consumer spending had also risen after sharp drops in the market. The October 1987 stock market crash did nothing to stop the 1980s economic expansion. It’s hard to pin down the relationship of one variable to just one other variable.
Our main point, though, is not to make a forecast of the direction of the market or the levels of consumer spending or saving. Instead, this discussion is intended to illustrate just how complex the economy is. It rarely responds to just one factor, like tax incentives or the level of the stock market. In our example above, we’ve walked through unintended side effects of just one pathway. Multiply this by hundreds of other variables, and you can see where it is far from a slam-dunk case that one lever – tax policy – can influence markedly the economy or the market as a whole.
Indeed, former president Ronald Reagan cut taxes, and the market went up and the economy expanded in the 1980s. Former president Bill Clinton raised taxes, and the market again rose while the economy grew in the 1990s.
The bottom line is that investors would be wise to consider many more factors when investing than a single variable. Often, staying the course instead of responding to either fear or euphoria might be a better course of action. Recognizing the tendency of investors to respond to just one variable and the historical examples of why this hasn’t yielded results is proof of the economy’s complicated nature. Avoid the temptation to have selective attention.
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