Insights & Advice


Higher Taxes—not if, but when

It is with some anxiety that I prepare for the inevitable. Higher taxes are coming our way, maybe not this year, but probably next. It is inevitable, given America’s fiscal condition. I expect we will receive the bad news sometime after the November elections.

Let’s face it, thanks to the 2008 financial crisis and bail-out on top of two continuing wars in the Middle East, plus Congress’ refusal to curb spending other than in lip service, raising taxes is the only way out of our dilemma. It would have already happened, were it not for the recession and double digit unemployment. But as soon as the economic numbers start to perk up consistently and employment starts to rise, watch out.

If you have been reading the data, you know that the federal deficit hit $1.4 trillion in 2009, the highest since WW II (9.9% of GDP) and will be even higher than that this year. Economists are predicting that the nation’s debt will account for a whopping 10.6% of GDP in 2010.

Historically, large deficits are reduced to more manageable proportions (3% of GDP) fairly quickly once the economy begins to recover since tax collections rise as businesses return to profitability and our incomes rise. The problem this time around is that no one is predicting the usual robust growth experienced in past recoveries. Instead, economists are predicting sub-par growth for the next several quarters, if not years, as consumers repair their own balance sheets and the financial sector deleverages.

Just today President Obama signed an order to establish a bipartisan commission to find ways of reducing our burgeoning deficit. Last month, he attempted to convince Congress to do the same thing but they rejected the idea out of hand. Most members of Congress saw right through the president’s tactic and wanted nothing to do with it. Republicans calling it a Trojan horse and a ploy to enlist their party in acquiescing to a tax hike in an election year. Democrats, although usually labeled the “tax and spend: party,” are wise enough to know that if you plan to raise taxes you don’t do it in an election year.

The timing is also interesting since the recommendations, which are non-binding, won’t be released until the end of the year, well-after the November elections and won’t even be discussed until the new members of Congress are in place in 2011. By then, Congress, if they go along with the sure-to-be recommended tax hikes, will have two years to justify the increase before re-elections.

Clearly, the deficit is just too big. It would be unrealistic to hope that lawmakers will suddenly find religion and cut spending to the point where it would have a serious impact on our national debt. Sadly, there are just too many ‘sacred cows’ in the spending side of our national budget to rely on the spending route. Raising taxes is the easier, more expedient method, one that our country has always used to balance the budget. It will also be a risky maneuver, since taxes have a way of dampening economic growth. If the economists are correct in predicting a slower, more moderate recovery, raising taxes at the wrong time could short circuit the recovery. That would be a big negative for everyone involved.

Posted in Macroeconomics, The Retired Advisor