Predicting Stock Price Responses to Tax Policy Changes

A model for estimating windfalls resulting from tax policy changes is developed and tested. The effect on fundamental equity value of the policy changes enacted with the Economic Recovery Tax Act (ERTA) of 1981 is simulated, and the results are used as predictions about stock price windfalls. The fundamental equity value is computed for the US nonfinancial corporate (NFC) sector and 3 manufacturing industries. The ratio of year-end 1980 financial market value to fundamental value equaled 0.81 for the NFC, 0.98 in the food products industry, 1.09 in paper and allied product industry, and 0.75 in stone, clay, and glass. Fundamental value changed because of the enactment of ERTA. The greatest effect was from the accelerated cost recovery system because new capital received preferential treatment and old capital lost value. The stock market at-large is estimated to have suffered a 6.1% windfall loss; in the different industries, predicted losses range from 1.8% less to 2.6% more than market.