Lower Taxes,
Higher Markets
What the U.S. is doing right
by David Gardner (DavidG@fool.com)

ALEXANDRIA, VA (July 15, 1998) -- Two roads diverged in a yellow wood today, as the Nasdaq rang up a 1.33% gain even as the S&P 500 lost a quarter percent of value. We, we took the road less traveled by... by um... by winning stocks, that is... the less lucrative road. We pretty much duplicated the S&P 500's fractional loss. Two ways of thinking about that. First, given that AOL and Amazon both dropped, it's nice to see us staying even with the S&P 500. But second, we got whomped on by the Nasdaq! Rats.

So here we are, midway through 1998, and the S&P 500 is presently up 21.06%. The conventional wisdom at the beginning of 1997 was that the market was "due for a correction." The Wise were saying, "Never in the 20th century has the stock market ever risen 20% three years consecutively."

And now here we are midway through the fourth, already up more than 20% for a fourth consecutive year.

It had never happened before, right, dear Fools?

History is worth something, up to a point. It's useful to understand the lessons that history has to teach in order to better understand the world around us and where it might be going. I'm a history buff. But when we say that something has never happened before and then begin to use history to say that it can't ever happen, we will never walk on the moon, never map the human genome, and never have four years of 20%+ gains on the stock market. But we've done or are doing all these things. So please, don't overhistoricize (that is one of the worst words ever to appear in a Fool Portfolio recap!).

I think one major reason behind the stock market's gains over the past two years, which is often forgotten about, is the reduction in capital gains taxes. There was that initial argument -- when the reduction was first being contemplated -- that it would cause a market crash. Remember that? "As soon as you lower the capital gains rate, what's going to happen?" the argument went. "I'll tell you: a whole bunch of people who've been sitting on huge capital gains through this long bull market will sell their stock, and crash the market."

It's easy to see in retrospect how wrong that thinking was, but I'm happy to note that you didn't hear anyone arguing this at any time at The Motley Fool. We recognized early on that the more you reduce taxes on stock-market gains, the more attractive you make the stock market as an investment vehicle. Money will therefore flow into it, not away from it.

The reduction in long-term capital gains taxes from 28% to 20% represented a huge amount of savings for private investors, in gross dollar terms. And the administration has further sweetened this package in its recent initiative to reduce the holding period to get that 20% rate down to 12 months, from 18 months.

Henry Hazlitt, in his excellent Economics in One Lesson, paints his subject (yep, economics) in very simple and Foolish terms. The average person knows how to spend his own money more efficiently than his best friend would spend it in his stead, or his father, or his broker, or his government. The more money an economy leaves in the hands of its citizens, the stronger its economy will be.

This has been demonstrated over and over since his book first appeared in 1946 (it reads just as well today, by the way). Whether you want to look at the case study of West Germany against East Germany, or the NATO economies versus the Soviet economy, or Japan against China -- the list goes on and on. Less government spending -- less government control over the means of production -- leads to stronger economies and better stock markets (and no need to police your borders to stop your own citizens from trying to escape!).

When you siphon off large amounts of money in the form of taxes, you wind up having the government spend your money for you, and it will always be by definition in ways that are less efficient than the way you'd spend it yourself. The economy suffers in the long term.

"Ultimately, every dollar of government spending must be raised through a dollar of taxation," Hazlitt reminded us. "Once we look at the matter in this way, the supposed miracles of government spending will appear in another light."

Among large-scale economies, the United States enjoys the freeest markets in the world, and every time we reduce the capital gains tax, our markets and economy will benefit. A significant and often forgotten contributor to our economy's and stock market's success is the transfer in spending from the government back to the people that the government taxes -- you and me. The stock market has been made more attractive by the current administration's investor-friendly policies, and the United States will continue to benefit from such efforts.

Let that not be forgot.

About today -- 3Dfx (Nasdaq: TDFX) rose ahead of its earnings report that arrives after the market closes tomorrow. In its last conference call, 3Dfx shared that revenues should increase 15% to 20% this quarter and margins will decline slightly as average selling prices edge lower. Earnings of $0.48 per share are expected. Last quarter the company earned $0.50 per share, more than doubling the estimate, on revenue of $50 million. Tomorrow we'll also see results from Iomega (NYSE: IOM). This busy month we'll see earnings from Starbucks and Innovex, too, among others.

Finally, AT&T (NYSE: T) rose despite the government's approval of WorldCom's takeover of MCI. Following the merger, MCI will remain the number two guy in its industry behind AT&T. But wait -- there is one catch. The merger was only approved on the condition that MCI sell all the assets related to its Internet business. That might be good news for AT&T, but word that Time Warner could lease its cable television infrastructure to long distance companies is arguably what caused Ma Bell's jump for joy. Such a policy would theoretically allow AT&T to sell local phone services.

Fool on!

-- David Gardner, July 15, 1998

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07/15/98 Close

Stock Change Bid ---------------- AMZN - 3 112.38 AOL -1 3/8 118.50 T +2 3/16 59.56 DJT - 5/16 7.63 DD - 5/8 68.13 XON - 9/16 71.50 INVX + 7/8 15.44 IP - 3/8 42.94 IOM + 1/8 5.69 KLAC +1 5/8 27.00 LU +2 9/16 90.50 SBUX - 7/16 56.31 COMS + 13/16 29.50 TDFX +1 5/8 21.25
Day Month Year History Annualized FOOL -0.26% 7.52% 53.44% 414.93% 51.54% S&P: -0.24% 3.61% 21.06% 156.28% 26.96% NASDAQ: +1.33% 5.27% 27.01% 176.95% 29.48% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 118.50 3158.68% 9/9/97 580 Amazon.com 19.11 112.38 488.02% 5/17/95 1960 Iomega Cor 1.28 5.69 344.19% 10/1/96 84 LucentTech 23.81 90.50 280.12% 8/12/96 130 AT&T 39.58 59.56 50.49% 2/20/98 215 DuPont 59.83 68.13 13.86% 2/20/98 200 Exxon 64.09 71.50 11.56% 4/30/97 -1170*Trump* 8.47 7.63 9.96% 7/2/98 235 Starbucks 55.91 56.31 0.72% 2/20/98 270 Int'l Pape 47.69 42.94 -9.97% 1/8/98 425 3Dfx 25.67 21.25 -17.21% 8/13/96 250 3Com Corp. 46.86 29.50 -37.05% 8/24/95 130 KLA-Tencor 44.71 27.00 -39.61% 6/26/97 325 Innovex 27.71 15.44 -44.29% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 84135.00 $81553.13 9/9/97 580 Amazon.com 11084.24 65177.50 $54093.26 5/17/95 1960 Iomega Cor 2509.60 11147.50 $8637.90 10/1/96 84 LucentTech 1999.88 7602.00 $5602.12 8/12/96 130 AT&T 5145.11 7743.13 $2598.02 2/20/98 215 DuPont 12864.25 14646.88 $1782.63 2/20/98 200 Exxon 12818.00 14300.00 $1482.00 4/30/97 -1170*Trump* -9908.50 -8921.25 $987.25 7/2/98 235 Starbucks 13138.63 13233.44 $94.81 2/20/98 270 Int'l Pape 12876.75 11593.13 -$1283.63 1/8/98 425 3Dfx 10908.63 9031.25 -$1877.38 8/24/95 130 KLA-Tencor 5812.49 3510.00 -$2302.49 6/26/97 325 Innovex 9005.62 5017.19 -$3988.43 8/13/96 250 3Com Corp. 11715.99 7375.00 -$4340.99 CASH $11876.47 TOTAL $257467.22

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