Thursday, June 17, 2010

What happens when Tax Cuts Expire in 2011?

Tax rates will rise sharply. Businesses are already planning for it now, and it will affect the state of the economy and the recovery. But how much so? Here are two perspectives:

Tax Hikes and the 2011 Economic Collapse
Today's corporate profits reflect an income shift into 2010. These profits will tumble next year, preceded most likely by the stock market.
[...] On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush's tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts.

Tax rates have been and will be raised on income earned from off-shore investments. Payroll taxes are already scheduled to rise in 2013 and the Alternative Minimum Tax (AMT) will be digging deeper and deeper into middle-income taxpayers. And there's always the celebrated tax increase on Cadillac health care plans. State and local tax rates are also going up in 2011 as they did in 2010. Tax rate increases next year are everywhere.

Now, if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be.

Also, the prospect of rising prices, higher interest rates and more regulations next year will further entice demand and supply to be shifted from 2011 into 2010. In my view, this shift of income and demand is a major reason that the economy in 2010 has appeared as strong as it has. When we pass the tax boundary of Jan. 1, 2011, my best guess is that the train goes off the tracks and we get our worst nightmare of a severe "double dip" recession. [...]

The article goes on to compare what is happening now, with what Ronald Reagan did in 1981, to pull us out of a recession. The current Administration is doing exactly the opposite, and the results will be exactly the opposite too. Many in this Administration have been claiming that "capitalism is dead"; and now it seems they are doing their best to make sure it happens.

Tax cuts actually increase tax revenue, because as businesses prosper, there are more businesses and employees paying taxes. The Democrat leadership knows this too, but it doesn't fit with their agenda of attacking the private sector and expanding government power and control. Many of them would even like to overburden and collapse our current system of government and economics, so they can then replace it with something else. And unfortunately, the Democrat's understanding of economics in general, tends to be very poor. We are seeing the proof of that now.

Even so, I don't want to be strictly partisan about this, I want to be realistic. Is the prediction of "economic collapse" in 2011 too grim? Or at least, too soon? Perhaps.

Will Higher Tax Rates in 2011 Cause an Economic Collapse?
[...] I am reluctant to endorse Art’s prediction that the “economy will collapse,” since even good economists are lousy forecasters. But we certainly will see a large degree of tax planning, which will lead to less revenue than expected next year. And the higher tax rates will inhibit growth, though it is impossible to predict whether this means 2.1 percent growth instead of 2.3 percent growth, for instance, or 0.5 percent growth instead of 0.6 percent growth. [...]

You don't need to be a rocket scientist to understand that if taxes rise sharply, businesses will make decisions based on that, and the cost of higher taxes will be passed on to the consumer in the form of higher prices.

In our own business, we are buying new equipment and making repairs and improvements this year, because we are anticipating the costs of these things to rise next year. Therefore, we won't be spending much next year. I would have to assume that other business people who are paying attention to what is happening are going to do the same.

Even if we elect a better congress in November, it will take time to reverse the many bad trends that have already been put into motion. I don't see a quick fix for any of this. We are going to have muddle through. If that is the best we can do, then we must do it. The situation is what it is, but it can be improved, even if it has to get worse for a time, before it can get better.

Also see:

Has US Currency already "collapsed"?

What would a U.S. currency collapse look like?



Anonymous said...

I am confused. If the Democrats' understanding of economics is so poor, why were we left with a surplus after the Clinton administration and why were we in the red after the Bush years?
Also, why were we losing 300,000 jobs a month when Bush left office while we are adding 60,000 twenty months into Obamas term?

Chas said...

I agree, you ARE confused. Let me see if I can clear it up for you.

We had a surplus under Clinton, because he had a Republican dominated congress who would not let him spend recklessly. He didn't overspend, because he couldn't.

But Clinton did manage to be reckless in other ways. He pushed through his Community Reinvestment Act in 1997, which was directly responsible for the subprime mortgages that caused the financial meltdown many years later. Some Republicans saw the meltdown coming and attempted to avert it by putting restrictions on Fannie Mae and Freddie Mac, but they were blocked by Democrats.

Before Clinton left office, he also turned his back on 67 years of proven financial regulation and signed a bill legitimating Hedge fund speculation, turning our economy into a casino. All this made the financial crisis inevitable.

Did the Republicans spend and create huge deficits? YES, undeniably. It was very irresponsible to cut taxes while increasing spending. I'm certain that's a large reason why they were kicked out of power. That's why it's so intolerable that the current Administration is continuing even more aggressively to spend money that we don't have. Since when do two wrongs make a right? We need to cut taxes AND spending.

As for jobs, unemployment now is higher than it was at any time during the Bush Administration. Even the NYT's published this yesterday:

“The United States economy has lost more jobs than it has added since the recovery began over a year ago. Yes, you read that correctly.”

I suspect that's the math that is going to matter the most come November.