Monday, January 18, 2010

Tax Hikes and Legislation - Ari Paul

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In this issue:
1. The Massive Deficit
2. Looming Personal and Corporate Tax Hikes
3. Other Taxes and Legislation
4. The New Tax Math
5. Implications of a Debt Spiral

The US deficit is projected to grow by about $10 trillion dollars over the next decade. I’ll examine the massive federal deficit and the new taxes coming that will help reduce it. I’ll also look at the biggest financial legislation currently being discussed and how it will impact the federal budget.

1. The Massive Debt
The Congressional Budget Office (CBO) estimates that the federal deficit will average $1.1 trillion per year for the next decade without tax hikes. This $1.1 trillion represents about 8% of GDP and assumes that the government’s borrowing rates remain low and that economic growth returns to historical trend. The CBO warns that this deficit may result in a death spiral of growing debt that would eventually require the US to effectively default. To make things worse, states had budgetary shortfalls of about $110 billion in 2009 and will likely face shortfalls of $150 billion each in 2010 and 2011. There’s also a roughly $1.5 trillion pension shortfall that may require a federal bailout.

2. Looming Personal and Corporate Tax Hikes
The Bush tax cuts expire at the end of 2010. This will cause marginal personal income tax rates to rise 3-5%. Obama’s budget also limits itemized deductions and includes other provisions that raise about $63 billion in new tax revenue per year.

Healthcare taxes: A “Cadillac Tax” on premium healthcare plans would bring in $15 billion a year and would affect about 25% of Americans, including 25% of union workers; it is opposed by many large unions and many not make it into the final healthcare bill.

New taxes on businesses starting in 2011 total about $35 billion a year and include excise taxes, repeal of subsidies to the energy industry, and a repeal of LIFO accounting.

3. Other Taxes and Legislation
The “Jobs Bill”: a new stimulus bill aimed at producing jobs may include a $250 payment to seniors, subsidies for transportation and green energy projects, and tax breaks for small businesses. Early estimates of the cost are $75 - $150 billion. The Senate will begin discussion on January 19th.

One-time bonus tax: Britain and France have imposed a 50% one-time tax on Bankers’ bonuses. Germany is pondering the idea but looks unlikely to follow. US Congressman Welch just introduced a similar bill in the US, but it looks unlikely to become law.

Financial Transactions tax: two versions are floating around, one in the Senate and one in the House. Bill 2927 was introduced late December by Senator Harkin and would impose a roughly $150 billion a year tax on securities transactions. Earlier in December, a bill titled “Let Wall Street Pay for the Restoration of Main Street Act of 2009” was introduced by Rep DeFazio. Both bills impose a tax on stock transactions of 0.25% and on futures and derivatives of 0.02%. Currently this seems unlikely to pass. I examined the effects of this kind of tax here:

Climate Legislation: We have no idea what this bill will look like if and when it eventually passes, nor how much it will cost. The burden is on the Senate and climate is currently low on their priority list. After “Angliagate” and the failure of the Copenhagen climate talks, the democrats may lack the political will to get involved in another messy legislative fight. Opponents believe any bill is likely to impose large costs on businesses.

Big Bank Tax: The Obama Administration is pushing for a $90 billion tax on the largest 50 banks. We don't know exactly what form this will take, but it will probably be spread out over a decade.

4. The New Tax Math
These new taxes total about $120 billion in revenue per year. Additionally, the CBO estimates that current healthcare legislation will reduce the deficit by $10 billion per year. There are many questionable assumptions built into these numbers; the Obama administration has discussed extending certain provisions of the 2001 and 2003 tax cuts and we don’t know what will happen with the Alternative Minimum Tax or what new fees will be imposed on banks; also, the estimates of health care costs have a giant margin of error. Under these assumptions, the new taxes (and healthcare deficit reduction) only reduce the annual deficit by about 8%. Also built into these numbers is an assumption of 3% annual real GDP growth over the next decade and 1% inflation. Weaker growth or higher borrowing costs would cause the deficit to rise even faster.

5. Implications of a Debt Spiral
Eventually, growing fiscal deficits become unsustainable and it appears the US may have already entered a debt spiral. Japan successfully maintained a debt to GDP ratio of 150% for over a decade, so it’s not obvious when a high sovereign debt level will lead to crisis. Japan was able to maintain such a high debt level for so long at least in part because the Yen was an international reserve currency and Japanese citizens maintained an extremely high savings rate (financing Japan’s debt at low interest rates). The US has an even stronger reserve currency, and if we enter recession again the savings rate may skyrocket. In other words, we may be able to survive in the debt spiral for quite a long time. However, eventually we will have to either sharply devalue our currency or find some other way to default on the unsustainable debt. The other option, raising taxes and decreasing expenditures, would require sacrifices so great they seem politically impossible.

The Yap live on a small collection of islands in the south pacific. As money, they use giant stone wheels called Rai (pictured above). Maybe after the US devalues the dollar into worthlessness we’ll all be using stone wheels as money. I can picture the commercials – giant stone wheels 4 gold!

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