TAX NEWS - June 2010

Voros: Expiring Bush tax cuts could trigger Recession II

Ten days ago, noted — and controversial — economist Arthur Laffer stirred up the financial and political community by screaming in a Wall Street Journal piece that the economic sky of this country would begin to fall Jan. 1

"If you thought deficits and unemployment have been bad lately, you ain't seen nothing yet," was the last line in the op-ed that quickly polarized the political left and right. Laffer's fear is that a string of Bush (W)-era tax cuts will expire at the first of year, wreaking havoc on a delicate economy.

Apparently not everyone is concerned. The conventional-wisdom reaction to Laffer is that Congress will extend this host of tax cuts that aid families and investors. However, there has been no formal action in Congress to do just that, and President Barack Obama's proposed budget for 2011 does not include them. Thus, Laffer is losing sleep.

Are you married? Do you have a child younger than 17? Will you have capital gains? Do you collect dividends off your stock investments? Does your company conduct business offshore? Does the estate tax mean anything to you?

These are just a few of the tax-sensitive areas about to be bopped over the head with tax increases beginning Jan. 1.

According to The Tax Foundation, the following tax cuts will go away in about six months:


- The two "marriage penalty elimination" provisions will expire, so that: The standard deduction for married couples will fall, no longer double what it is for single filers; and the ceiling of the 15 percent bracket for married couples will fall, no longer double what it is for single filers.

- The 10 percent tax bracket will expire, reverting to 15 percent.

- The child tax credit will fall from $1,000 to $500.

- The tax rate on long-term capital gains earned by middle- and upper-income people will rise from 15 percent to 20 percent.

- The tax rate on qualified dividends earned by middle- and upper-income people will rise from 15 percent to ordinary wage tax rates.

- The top tax rate will revert from 35 percent to 39.6 percent.

- The estate tax will be restored with an exemption level of $1 million and rates that top out at 55 percent.


That's just a few, not to mention tax increases that affect businesses that generate income offshore.

Laffer worries, for instance, that as we get closer to the end of the year, investors will start gaming the system by selling stock to beat the capital gains tax increase.

Better to be safe than sorry. But that is just the start of the incentive-fueled psychology, which he says has already happened.

"Now, if people know tax rates will be higher next year than they are this year, what will those people do this year?" Laffer wrote. "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."

It would seem like a no-brainer that in a weak economy you do not take disposable income from families, or give incentive to investors to sell or increase taxes on corporate income. But as it stands now, that's exactly what is going to happen.