The Bush Tax Cuts Are Expiring. Will The 2011 Tax Hikes Bring On A Double Dip Recession?

At the end of the 2010 there will be a tax increase for all taxpayers, if something isn’t done.  Back in 2001 the Bush administration helped to get an across the board tax cut passed that effectively lowered the marginal tax rates for all people paying taxes.   (If you didn’t pay taxes, it doesn’t matter too much does it?).  Now those cuts are expiring and on January 1st, 2011 the new marginal tax rates will go into effect unless extended by legislation.

Thankfully for many of us the Obama administration has decided that they will push to renew the tax cuts for all taxpayers making less than $250,000 a year.

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Obama wants tax breaks proposed by President George W. Bush to expire this year. His budget would eliminate tax breaks on those making more than $250,000 a year, a move almost certain to be opposed by Republicans and perhaps some Democrats as the economy crawls out of the recession.

“We extend middle-class tax cuts in this budget,” Obama said Monday at the White House, but “we will not continue costly tax cuts for oil companies, investment fund managers, and those making over $250,000 a year.”

So only those taxpayers making more than $250,000 a year (joint) will see an actual increase in their tax rates.  The rest of this (hopefully) will see an extension of the Bush tax cut.

For more of a look of what your tax rate would be if the cuts were to expire, check out this article:  Tax Rates If Bush Tax Cut Expires

Will Tax Hikes On Higher Income Taxpayers Bring On A Double Dip Recession?

There is no consensus as to what effect tax increases will have on the economy, but there are some pretty strong opinions on both sides.    Democrats are saying the tax increases are needed to help close the deficit and Republicans counter by saying that tax increases would cripple our economy in this tough environment.  I suspect the truth lies somewhere in between.

Today I read an editorial by prominent economist Arthur Laffer where he argues a tax increase for higher income individuals could have a crippling effect on our economy, and could bring on a 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.

Now, if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be.

Also, the 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.

Joel Slemrod, a professor of economics at the University of Michigan argues that increases on the wealthy are painful but necessary:

Obama’s approach of raising taxes only on the wealthy is probably the safest bet. While acknowledging that the economy will remain shaky next year, Slemrod said “not raising any taxes in the face of this fiscal imbalance also has economic effects.’’

“We start to play out a scenario where interest rates go up,’’ Slemrod said. “So it’s not as if increasing taxes has certain adverse impacts, but not raising taxes do not.’’

One thing that most agree on is that the coming year has some shaky prospects regardless of the tax cuts are extended or not. The economy has taken a pretty severe blow these past 2-3 years, and who knows what effect tax increases or the lack thereof will have.

What do you think? Will a tax increase on higher earners have a negative effect on the economy? Are tax increases necessary – or an extremely bad idea? Tell us your thoughts in the comments!

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Last Edited: 17th June 2010

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  1. says

    The possibility of a double dip from the expiration of the tax cuts will be a de facto tax increase–not what we need with the ecomomy on wobbly legs.

    Even with mortgage rates below five percent the economy is still looking too anemic to absorb another shock, which the tax increase will certainly be.

    Are these “interesting times” or what???

      • says

        “isn’t it interesting that the answer is never to cut spending”

        That’s because government power comes from spending! To cut spending is to cut your own power. Voters vote for candidates who promise spending to “help” with “problem X”, not those who cut spending.

        Conservative voters don’t get this when they vote for self declared conservative politicians–even they don’t cut spending when they get into office. The proof of this is in the growth of the fed budget during the largely Republican controlled eight years of GW Bush.

        Republicans can’t claim to be fiscal conservatives! They’re aren’t any–we didn’t get a debt this large only since January 2009. It’s become our way of life…that’s the bigger problem no one wants to talk about.

        What ever the problem, whoever the party and whoever the politician, the answer is always more spending. And here we sit…

  2. says

    you can bet Tax-it-all Obama and the democrats are waiting to jack up taxes and steal more from hard working Americans who are already struggling to make ends meet. After all, it’s how the federal government is funded.

  3. says

    I think it will be a horrible idea to let the tax cuts expire – for the “rich” or any other group. It will crush the economy by heavily taxing the very people who do 75% of the hiring in this country.

    Instead of trying to increase revenue, they should focus on decreasing spending.

  4. Ronsense says

    Dave, How do you propose for us to get out of this defecit. Tax cuts certainly won’t do it and Sweeping Democrats won’t work as well. Bush initiated these cuts in the first place maybe he should have not done that and we wouldn’t have been this mess we are in now. I think some Republicans should be sweep out of office faster than a lighting strike in Oklahoma!

    • says

      I don’t think the problem is not enough taxes – it’s government spending being out of control. There needs to be something put in place so that spending can only be a certain percentage of GDP, or something along those lines. Massive spending programs, especially in down economies like we have now – is awfully irresponsible. As far as Republicans being swept out of office, I can’t imagine that’s very likely.

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