Tax impact could be crucial to recovery

More economists across the political spectrum are now worrying that the economy will still be quite weak at the end of next year, when the Bush tax cuts are scheduled to expire for high-income households.

The White House confronts a jobless rate (10 percent today) that will likely remain in double digits through the end of next year, according to many private economic forecasts.

The expiration of the Bush tax cuts would result in a de facto tax increase when the U.S. economy, judged by its likely unemployment rate, will be much weaker than President Obama anticipated during his run for the White House.

Throughout the 2008 presidential campaign, as the economy plunged into the deepest recession since the Great Depression, Republicans pilloried Mr. Obama for his promise to allow the tax cuts to expire for individuals earning more than $200,000 and for couples with incomes above $250,000.

Mr. Obama and his economic advisers replied that the resulting tax increases would not take effect until January 2011, when the economy would likely be in the midst of a sustainable recovery.

With the economy expanding at an annual rate of 2.8 percent in the third quarter, the recession probably ended sometime this past summer. But employers still shed an average of 199,000 jobs per month in the July-September period. The unemployment rate reached double digits during the first two months of the fourth quarter, although the pace of job loss eased to a monthly average of 61,000 for October and November.

Many private forecasters, as well as the Federal Reserve, are now projecting that the jobless rate will remain highly elevated throughout next year and beyond.

Compared to average unemployment rates of 4.6 percent in 2007 and 5.8 percent in 2008, the jobless rate recently surpassed 10 percent for the first time since 1983. And that could be just the beginning of its foray into double-digit territory.

Moody’s Economy.com projects that the unemployment rate will be 10.6 percent in next year’s fourth quarter and average 9.6 percent throughout 2011. IHS Global Insight, another private forecaster, expects the unemployment rate to be 9.9 percent in next year’s fourth quarter and average 9.4 percent in 2011. The forecast by Wells Fargo projects the jobless rate will remain 10.8 percent from July 2010 through April 2011.

Even the Obama administration, in its economic forecast released with its August budget review, projected the unemployment rate will be 9.7 percent during next year’s fourth quarter.

Amid an unprecedented sea of postwar red ink, the White House is now preparing its budget for fiscal 2011, which begins Oct. 1, 2010. Tripling the red ink recorded in 2008, the 2009 budget deficit soared to $1.4 trillion, its highest postwar level in both dollar terms and as a percentage (9.9 percent) of total economic output.

The deficit explosion won’t abate anytime soon. In August, the administration projected that the 2010 deficit would exceed $1.5 trillion and the 2011 deficit would surpass $1.1 trillion.

The administration has come under pressure to address the massive fiscal imbalances, and raising taxes on high-income households has been a major ingredient in its strategy.

The Bush-era tax cuts, enacted in 2001 and 2003, are scheduled to expire at the end 2010.

Mr. Obama is committed to extending the tax cuts for individuals earning less than $200,000 and couples with income below $250,000. Those cuts include the new 10-percent tax bracket; a big reduction in the marriage penalty for middle-class households; the increase in the child tax credit from $500 to $1,000; and a reduction in middle- and upper-middle-income marginal tax rates from 31 percent and 28 percent to 28 percent and 25 percent, respectively.

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