Cataldo, Anthony J., II

Curatola, Anthony P.

Savage, Arline

English

Digital Commons @ West Chester University

West Chester UniversityDigital Commons @ West Chester UniversityAccounting Faculty Publications Accounting8-2000Tax Payments and the Stock Market 'Crash'Anthony P. CuratolaAnthony J. Cataldo IIWest Chester University of Pennsylvania, acataldo@wcupa.eduArline SavageFollow this and additional works at: http://digitalcommons.wcupa.edu/acc_facpubPart of the Taxation CommonsThis Article is brought to you for free and open access by the Accounting at Digital Commons @ West Chester University. It has been accepted forinclusion in Accounting Faculty Publications by an authorized administrator of Digital Commons @ West Chester University. For more information,please contact wcressler@wcupa.edu.Recommended CitationCuratola, A. P., Cataldo, A. J., & Savage, A. (2000). Tax Payments and the Stock Market 'Crash'. Strategic Finance, 17-18. Retrievedfrom http://digitalcommons.wcupa.edu/acc_facpub/121 6 S T R AT E G I C  F I N A N C E  | A u g u s t  2 0 0 0OAnthony P. Curatola, EditorTax Payments and the Stock Market ‘Crash’ON FRIDAY, APRIL 14, THERE WAS A STOCKmarket “crash.” The close-to-close decline in the NAS-DAQ was 9.7% (25.3% for the week); the Dow Jones In-dustrial Average (DJIA) fell 6.6% (7.8% for the week);and the broad-based Standard and Poor’s 500 Compositeindex declined 6.9% (10.9% for the week). Widespreadpanic, anticipation, and individual investor needs for liq-uidity only exacerbated these declines.The primary cause of this decline was the surprising“bad news” of high inflation, which fueled fears of a Fed-eral Reserve increase in inter-est rates to cool the economy.In general, bad news tends tocause investor overreac-tions. Adding to the de-cline, CNBC’s market ex-perts suggested, were actual oranticipated (continuing) stockmarket margin calls and the April 17federal income tax return filing dateand related tax payments.The April 17 filing date actuallyrepresented a potential “doublehit.” Not only was it the day oftax payment for the balance of1999 calendar year taxes, but italso represented the due date for the first quarterly esti-mated tax payment of 2000. And to the extent that tax-payers were surprised by higher 1999 calendar year taxbills, they were also surprised by higher first-quarter esti-mated tax payments. Both payments require liquidity,and marketable equity securities represent a current assetthat is relatively easily—though not always profitably—liquidated.The “tax (estimated tax) payment effect” has been pres-ent and statistically detectable, intermittently, throughoutthe entire history of individual taxation. But these histor-ical instances weren’t economically significant. This is thecase with most stock market “seasonals” (for example,“holiday effects” and the highly publicized and tax lossselling-related “January effect”). This year’s tax paymenteffect was probably, for the first time, both statisticallyand economically significant.Tax payment effects on stock values were easilyidentified during the 1917 and 1918 “War Tax” peri-od, when individual federal income taxrates rose significantly to financeWorld War I. For a more contempo-rary example, tax payment effectswere easily detected during muchof the post-World War II peri-od. During and after WorldWar II the U.S. (1) movedfrom a “class tax” to a“mass tax,” (2) imposedself-employment taxes(1951), (3) increased self-employment tax rates,and (4) increased wagebases to which self-employment taxeswere applied. During the 1980s, self-employed taxpayerswere frequently “caught by surprise” by increasing self-employment taxes and related increasing tax payments.Therefore, the self-employed represented an easily identi-fiable (and statistically testable) group likely to experiencethis need for cash.Tax payment effects are a function of John MaynardKeynes’ theory of individual investor liquidity prefer-TaxesILLUSTRATION: ARTVILLE/LISA MANNINGences and, in particular, the in-vestor’s need for cash. This effect iseasily detected during periods of ris-ing tax rates or, simply, rising taxesdue to a robust economy (for exam-ple, realized capital gains for the1999 calendar year).Generally, contemporary tax pay-ment effects on the stock markethave followed a three-day decline-correction sequence. As noted byCataldo and Savage:1 “…thestrongest effect [is] for the com-bined April estimated tax paymentand final payment/return filingmonth.”How much of the April 14 de-cline was due to tax payment ef-fects? We don’t know. It takes two tothree years for the Internal RevenueService’s Statistics of Income Divi-sion to release individual taxpayerdata. But once this data is releasedto the public it will be possible toapproximate the combined impactof the April 17 tax return payments.Based on prior research, we suspectthat the April 2000 crash will beboth statistically and economicallysignificant.Will economically significant taxpayment effects recur in April 2001?Probably not, or at least not to thesame degree. First, overreactions toeconomic bad news were probablythe primary and most significantcause of the decline. Second, for in-vestors to be caught by surprise withhigher tax bills, the stock market in-creases experienced during 1999would have to reoccur during 2000.Finally, the memory of this year’s“crash” is likely to be publicized innext year’s financial press. As is thecase with all stock market seasonals,publicity tends to reduce the magni-tude of their effects. Anthony P. Curatola is Joseph P.Ford Professor of Accounting atDrexel University, Philadelphia,Pa. He can be reached at curatola@worldnet.att.net.A.J. Cataldo is an assistant professorof accounting at the Haworth Collegeof Business, Western Michigan Uni-versity, Kalamazoo, Mich. He can bereached at aj.cataldo@wmich.edu.Arline Savage is an assistant professorof accounting at the School of BusinessAdministration, Oakland University,Rochester Hills, Mich. She can bereached at savage@oakland.edu.1A.J. Cataldo and A.A. Savage, “TheJanuary Effect and Other SeasonalAnomalies: A Common TheoreticalFramework,” in Studies in Manage-rial and Financial Accounting, Vol.9, Marc J. Epstein, ed., JAI PressInc., Stamford, Conn., 2000.1 8 S T R AT E G I C  F I N A N C E  | A u g u s t  2 0 0 0

Tax Payments and the Stock Market \u27Crash\u27

https://digitalcommons.wcupa.edu/cgi/viewcontent.cgi?article=1006&amp;context=acc_facpub

Tax Payments and the Stock Market \u27Crash\u27

Abstract

Similar works

Full text

Available Versions

Digital Commons @ West Chester University