'Read My Lips...': Does the Tax Rhetoric of Presidential Candidates Affect Security Prices?

We investigate whether security prices reflect the tax rhetoric of opposing candidates during the 1992 U.S. Presidential campaign. We use daily data from the Iowa Political Stock Market to measure changes in the likelihood that the candidate advocating an increase in individual income tax rates would be elected. To isolate the effect of tax rhetoric, we examine the relations between changes in election likelihood and (a) changes in the implicit tax rate on tax-exempt bonds and (b) daily abnormal returns to dividend-yielding stocks. We find that the implicit tax rate on tax-exempt bonds increases as the election probability of the candidate advocating the tax rate increase rises. Consistent with this finding, we also report that abnormal returns for dividend-yielding stocks are negatively associated with changes in the election probability of the candidate advocating a tax increase. Moreover, this negative association decreases with the level of institutional stockholdings, a proxy for the likelihood that the marginal investor in a particular stock is not an individual. In sum, these findings suggest that security prices reflect the expected changes in future tax policy implicit in the tax rhetoric of presidential candidates as the political fortunes of the candidates change throughout the campaign.