- The Washington Times - Monday, December 21, 2009

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.

The Bush tax cuts also reduced the top marginal rate from 39.6 percent to 35 percent and the 36 percent rate to 33 percent. These are tax cuts that Mr. Obama wants to expire at the end of next year.

Mr. Bush also reduced the top capital-gains tax rate from 20 percent to 15 percent and the top dividend tax rate from 39.6 percent to 15 percent. During the 2008 campaign, Mr. Obama pledged to raise both of these taxes to 20 percent for high-income taxpayers. Finally, Mr. Obama would phase out personal exemptions and limit itemized deductions for high-income households.

Economists and budget analysts are divided over the advisability of raising taxes in an environment of double-digit unemployment.

“We need to send a signal to the financial markets that we are getting serious about our fiscal situation,” said Isabel Sawhill, an economist and budget expert at the Brookings Institution.

“However, it is not desirable to raise those taxes immediately. They could be phased in gradually as the recovery unfolded, perhaps triggering them to reductions in the unemployment rate,” Ms. Sawhill said.

“You’re going to need tax increases and spending cuts, but the question is when to implement them without choking off the recovery,” said Gus Faucher, director of macroeconomics at Moody’s Economy.com. He said it would be “a mistake” to raise these taxes in 2011. He agreed with Ms. Sawhill and recommended phasing in the tax hikes after 2011. “I’d be very surprised to see taxes return to the Clinton-era top rate of 39.6 effective Jan. 1, 2011,” he said.

“Increasing the capital-gains and dividend tax rates would be directed at the financial markets, and if they looked vulnerable, it would not be a good idea,” said Rudolph Penner of the Urban Institute. However, if the unemployment rate is 10 percent but economic prospects looked good, allowing the cuts in the top marginal tax rates to expire would probably not do much damage, he said.

“Most people would agree that you don’t want to raise taxes when the unemployment rate is high and rising or high and stagnant,” said Mark Vitner, senior economist at Wells Fargo. “But given how big the budget deficit is and how everybody is scrambling to find revenue, I have to believe that taxes will go up.”

However, Mr. Vitner warned that business’s appetite for risk has greatly diminished in anticipation of rising tax rates and increasing regulatory burdens (including the cap-and-trade policy to reduce greenhouse gas emissions) and due to the unresolved questions surrounding health care reform.

Even deficit watchdogs are somewhat hesitant.

“Any tax increase would be a bit risky because the economy will not be humming along by any means,” said Maya MacGuineas, a deficit hawk who is president of the bipartisan Committee for a Responsible Federal Budget.

“On the other hand, saying ‘no’ to a tax increase is losing an opportunity to make a down payment on long-term deficit reduction,” which is a fiscal necessity, she said.

On balance, Ms. MacGuineas said the tax increase would probably not remove too much of the economic stimulus that is expected to be injected throughout the economy over the next two years, including expansive monetary policy and trillion-dollar-plus budget deficits.

Most liberal economists agree that allowing the expiration of the Bush tax cuts for high-income households would not hurt the economy.

Chad Stone, chief economist for the Center on Budget and Policy Priorities, warmly recalled the Clinton-era experience with tax increases and economic growth. President Clinton lifted the top marginal tax rate from 31 percent to 39.6 percent in 1993 amid cries from Republicans that his tax increase would wreck the recovery, destroy small-business job creation and cause a recession, Mr. Stone recollected.

Instead of a recession, however, the economy grew by 4.2 percent during 1994, and nearly 4 million jobs were created, more than in any year (except 1984) during the last three decades. Beginning with 1993, moreover, the unemployment rate declined eight years in a row, and the nation’s fiscal situation improved every year Mr. Clinton was in office. Economic growth averaged 3.9 percent a year during the Clinton presidency, when nearly 21 million jobs were created in the private sector.

“We already have a history after the imposition of these upper-income tax rates, and we know that a 39.6 percent rate will not wreck the economy,” Mr. Stone said. “All signs are that economic growth will continue in 2011 even if taxes rise on high-income people,” Mr. Stone said.

“Our challenge is to raise revenue while increasing consumption and, therefore, demand,” said Christian Dorsey of the liberal Economic Policy Institute. “Allowing some Bush tax cuts to expire will raise the effective tax rates on the wealthy by insignificant margins. As experience shows us in the ‘90s, not enough to change their spending behavior or to cost us jobs.”

Liberal economists note that 20.8 million private-sector jobs were created during the Clinton administration after the top marginal tax rate increased from 31 percent to 39.6 percent. (In 1997, the top capital-gains tax rate was lowered to 20 percent from the Reagan-era level of 28 percent.)

By comparison, liberals point out, only 159,000 jobs were created in the private sector during the eight years of the Bush administration, which reduced the top marginal tax rate from 39.6 percent to 35 percent and slashed the tax rates on dividends and capital gains.

Moreover, liberals add, in November 2009, 23 months after the recession began at the end of the seventh year of the Bush administration, there were 2.1 million fewer jobs in the private sector than there were 10 years ago.

The question remains: Should the Bush tax cuts for high-income households be allowed to expire? At least one economist said it may not matter much because it may not be a big deal.

Mr. Penner of the Urban Institute, who opposes raising the capital-gains and dividend tax rates in January 2011 if the financial markets remain vulnerable, downplayed the overall economic impact of allowing the Bush tax cuts to expire for high-income households.

“We’re not talking about a lot of money,” said Mr. Penner, who estimated the “whole package” would amount to about $50 billion per year in a roughly $15 trillion economy. Indeed, for the 2011-2015 fiscal period, the White House estimates that an average of $48.7 billion per year would be generated by re-instating the top-two Clinton-era tax rates, limiting personal exemptions and itemized deductions for high-income taxpayers and raising the top capital-gains and dividend tax rate to 20 percent.

Meanwhile, congressional Democrats recently have been pushing for significantly higher taxes on upper-income households above and beyond Mr. Obama’s campaign pledges.

Effective Jan. 1, 2011, for example, the House health-care bill would add a 5.4 percent surtax to the top marginal tax rate of 39.6 percent. The surtax would also apply to the top capital-gains and dividend tax rate of 20 percent for individuals earning $500,000 and couples with incomes above $1 million.

House Appropriations Committee Chairman Rep. David R. Obey, Wisconsin Democrat, recently proposed adding a 5 percent Afghanistan war surtax to the highest income-tax bracket.

The combined effect of adding the two surtaxes to the Clinton-era top rate of 39.6 percent would raise the top marginal tax rate from today’s 35 percent to 50 percent for wages and salaries. That’s an increase of 43 percent.

Is Mr. Obama reconsidering raising taxes in the midst of double-digit unemployment? Neither the White House nor its Office of Management and Budget responded to numerous phone calls and e-mails seeking comment.

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