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Brooks Wilson's Economics Blog: Laffer Forecasts Economic Collapse

Friday, June 11, 2010

Laffer Forecasts Economic Collapse

Arthus Laffer, for whom the Laffer curve is named, offered a gloomy forecast for the economy in "Tax Hikes and the 2011 Economic Collapse" written for the Wall Street Journal.  He notes that people respond to tax incentives. 
People can change the volume, the location and the composition of their income, and they can do so in response to changes in government policies.
He provides examples of people responding to tax incentives.
According to a 2004 U.S. Treasury report, "high income taxpayers accelerated the receipt of wages and year-end bonuses from 1993 to 1992—over $15 billion—in order to avoid the effects of the anticipated increase in the top rate from 31% to 39.6%. At the end of 1993, taxpayers shifted wages and bonuses yet again to avoid the increase in Medicare taxes that went into effect beginning 1994."

Just remember what happened to auto sales when the cash for clunkers program ended. Or how about new housing sales when the $8,000 tax credit ended? It isn't rocket surgery, as the Ivy League professor said...

In 1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn't take effect until Jan. 1, 1983. Reagan's delayed tax cuts were the mirror image of President Barack Obama's delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%.

But at the tax boundary of Jan. 1, 1983 the economy took off like a rocket, with average real growth reaching 7.5% in 1983 and 5.5% in 1984.
Laffer describes the incentive, a broad range of increasing taxes.
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.
And he predicts the impact of the response to increasing taxes.
Consider corporate profits as a share of GDP. Today, corporate profits as a share of GDP are way too high given the state of the U.S. economy. These high profits reflect the shift in income into 2010 from 2011. These profits will tumble in 2011, preceded most likely by the stock market.

In 2010, without any prepayment penalties, people can cash in their Individual Retirement Accounts (IRAs), Keough deferred income accounts and 401(k) deferred income accounts. After paying their taxes, these deferred income accounts can be rolled into Roth IRAs that provide after-tax income to their owners into the future. Given what's going to happen to tax rates, this conversion seems like a no-brainer.

The result will be a crash in tax receipts once the surge is past. If you thought deficits and unemployment have been bad lately, you ain't seen nothing yet.
If you tax something you will get less of it. In this case, government at different levels will be taxing economic activity. I wonder how much of the response will be timing of cash flows and how much will be reduced economic activity.

1 comment:

  1. Suzanne Stricker21/6/10 5:01 PM

    In my opinion, some sort of legislation needs to be passed to prevent tax rates from rising. Why would the government increase taxes during a recession while many people are having trouble making ends meet even at the current tax rates? The government needs a means replenishing some of its defecit spending and the citizens who are actually working hard are the ones who are going to be penalized. How can our country promote integrity and hard work ethics when the people who sit around and collect free social welfare and do nothing to promote the wellbeing of our country benefit more than the people who truly work hard and earn opportunities for high paying jobs? It is social and economic injustice. If someone is truly working hard and trying their best and their job happens to pay a low wage then it is understandable for the government to provide a little bit of assistance during hard economic times. But in most instances this is not the case. People really do respond to incentives. People in our country are going to have no incentive to work hard and contribute to our economy if they can stay home or work the bare minimum and get money and food just handed to them from the government. By raising the tax rates, the government is going to prolong a vicious economic cycle that will substantially hurt our country's chances for true and undisguised economic stability.