Tax hikes helped the U.S. economy go from downturn to depression in 1932.Throughout the mid-30s there were glimmers of economic recovery until taxes were raised again in 1937, helping send the economy into another recession. So, why would it be smart to raise taxes now during such a fragile economic recovery?
Art Laffer, once a member of President Reagan’s Economic Policy Advisory Board, explains why tax hikes in 2011 are going to depress output, production and reported income. The result, he says: a dreaded double-dip recession.
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.
Consequently, to the extent that we are having a genuine recovery, much of it is the result of future income realizations, production and demand being shifted from 2011 into 2010. Why? Because it’s cheaper. Economic incentives work. Just take a look at “Cash for Clunkers.”
We argued at the time that despite its popularity the program is likely doing little for the economy or for American consumers. Rather than creating new demand, the program may actually just be causing consumers to make purchases a few months earlier than they otherwise would have.
Sure enough, the month after the program ended the Washington Post noted: “General Motors’ sales plunged 36 percent in September compared with August. Ford plummeted 37 percent. Chrysler dove 33 percent.”
The same shifting effect will result from the Bush tax cut expirations.
[T]he 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.”
A real economic recovery involves returning certainty to the marketplace. The way to do that is to make it easier for businesses to plan ahead. If job creation is the number one concern, adding future tax increases to business’s worries is not a way to do so. However, extending the Bush tax cuts is the surest way to prevent further job loss.