Taxmageddon
Have you heard about Taxmageddon?
That's the rather quirky name some have given to the approaching expiration of the current tax rates at the end of the year coupled with the deep spending cuts that also loom in current law.
A recent report by the Congressional Budget Office (CBO) sheds some light on what effect Taxmageddon might have on the nation's economy and U.S. debt levels.
The report looks at what would happen under current law, i.e., the expiration in December of the so called Bush tax cuts and the alternative minimum tax (AMT) not being adjusted as it has been now for several years, and compares that with what has been recent policy, i.e., one that assumes those tax rates will be extended and the AMT will be patched.
The CBO report concludes that if the tax cuts are allowed to expire, and the AMT isn't patched to keep it from affecting potentially millions more taxpayers, the U.S. federal debt will gradually go down over the next 25 years.
The actual numbers are that the debt will decline from an estimated 73% of gross domestic product (GDP) this year to 61% by 2022 and 53% by 2037. By contrast, tax revenues would climb to 24% of GDP by 2037, an amount much higher than normal, and would continue to grow after that.
The report further postulates that because of the scheduled spending cuts set to take place under current law, government spending at all levels will go down to the lowest percentage of GDP since pre-WW II days. This is with the notable exception of spending in interest, Social Security and health care.
The problem is there is ever growing pressure on members of both major political parties to extend the tax cuts, since jobs reports of late have not exactly been stellar and there are signs of a slowing economic engine.
Because of this, there are legitimate concerns that allowing a tax rate increase would have devastating economic effect and could lead to a recession. However, there is certainly no agreement on exactly how to pay for extending the tax rates as they are now, or on whether it should be done for all taxpayers or just those at certain income levels.
And I wouldn't look for an agreement anytime soon, with elections approaching and very few willing to put their political necks on the line with tough decisions.
On the other hand, while an extension of the tax rates may help the economy now, the longer we put off dealing with the budget deficits, the worse things will get, at least according to the CBO.
Under the assumption that current tax rates do get extended, or at least most of them, and that the AMT is once again patched to keep it from spreading, the CBO paints a picture of the long-term fiscal health of our beloved country that is quite bleak.
To illustrate, federal debt is projected to exceed 90% of GDP by 2022. That's only 10 years away people! Further, it would keep growing according to the CBO, hitting perhaps 200% of GDP by 2037. By comparison, the historical high is 109%.
And what is the significance of that really?
A recent paper released by the National Bureau of Economic Research (NBER) took a look at advanced economies going back to 1800 that had debt levels above 90% of GDP. What it found was startling.
First, as expected there was a direct correlation between high debt levels (i.e., levels over 90% of GDP) and low economic growth. It also found that the average period of high debt and low growth was an astounding 23 years. Further, over that 23 year period, there was a cumulative reduction of GDP of 24% over comparable periods with lower debt levels.
In other words, persistent high debt causes major economic decline that lasts for years!
The authors of the study were quick to point out, however, that the paper wasn't meant as a call "for rapid public debt deleveraging in an environment of extremely weak growth and high unemployment." So as you can see, even among researchers, what to do is a quandary.
Going back to the CBO report, the findings of NBER are consistent. CBO says such crushing debt levels will lead to higher interest rates, more foreign borrowing and less investment here at home. These factors lead to lower income growth here in the U.S. and a reduction in gross national product.
The CBO also called out other negative consequences, such as higher interest payments on the public debt that would eventually require higher taxes, a reduction in government services or both.
It goes on to implore decision makers to do something quick about the excessive levels of public debt, while at the same time noting the difficult trade-offs no matter which way they go.
Needless to say, a situation filled with such uncertainty makes planning for the future, both on a personal and business level, a very difficult thing to do, and it will remain so until more certain policy decisions are made.
