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Large Tax Increases in 2011 Will Tip Us Into Recession

Taxes

I am on record as saying I think there is a 50-50 chance we slip back into recession in 2011, as I think the economy will soften in the latter half of the year and a large tax increase in 2011 (from the expiring Bush tax cuts) will tip us into recession.

Words: 841

Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com, provides below further reformatted and edited [..] excerpts from the John Mauldin’s (http://www.frontlinethoughts.com) original article* for the sake of clarity and brevity to ensure a fast and easy read. Mauldin goes on to say:

Tax Increases Matter!
Research shows that tax cuts or tax increases have as much as a 3-times multiplier effect on the economy. If you cut taxes by 1% of GDP then you get as much as a 3% boost in the economy. The reverse is true for tax increases. as such, if the economy is growing at less than 2% by the end of the year, then a tax increase of more than 1% of GDP could and probably would be the tipping point. Add in an almost equal amount of state and local tax increases (and spending cuts) and you have the recipe for a full-blown recession – at least the way I see it.

The uber-Keynesians that are in control of our economic policy clearly do not think that large tax increases matter, or if they do think so they are not speaking out about them. They are conducting an experiment on our economic body without benefit of anesthesia. Here’s a prediction about which I can feel confident: if we do slip back into recession, they will blame some factor other than the tax increase and call for massive stimulus. In fact, they will probably say that the lack of stimulus was the problem in the first place. Paul Krugman will be the head cheerleader.

It’s Different This Time!
While I think the chances are better than even that we have a recession in 2011 I do acknowledge that double-dip recessions are very rare. The last (and only) one we had was because Volker was stamping on the brakes trying to bring inflation under control in the ’80s. this time, however, we are not coming out of a normal business-cycle recession. We went through a debt crisis and a balance-sheet, deleveraging recession…It wasn’t just a bubble in housing, it was a bubble in debt and now we are reducing that debt. We are coming to the end of the Debt Supercycle (a term coined long ago by … Bank Credit Analyst).

We now have a bubble in government debt that is getting ready to burst in one country after another. What is indeed a very rare thing (a double-dip recession) is a very real possibility. Since we don’t have the yield curve to guide us, let’s look at what we do have.

The Leading Indicators Are Starting to Turn
a) The Economic Cycle Research Institute’s (ECRI) Index of Weekly Leading Economic Indicators has turned down of late with the 13-week annualized rate of change i.e. shorter-term momentum, clearly indicating that we are in for a recession in short order.

b) EMphase Finance, based in Montreal, “have discovered a new leading indicator to forecast U.S. Real GDP Y/Y, and it is simply the U.S. Terms of Trade (TOT). It is defined as the export price / import price ratio. TOT is suggesting a decline of U.S. Real GDP Y/Y to nearly 0% within the next 12 months…Will this lead to a double-dip recession? We believe the odds of a double-dip recession within the next 9-12 months are minimal, but odds may increase to 50-50 in 2011, depending on the evolution of variables we follow in the upcoming months.”

c) David Rosenberg of Gluskin Sheff, based in Toronto, is of the opinion that “the ECRI leading index (growth rate) [data suggests] either a 2002-style growth relapse or an outright double-dip recession – pick your poison.”

My Opinion
Unless something changes, we are going to enact the largest tax increase in U.S. history and that will be matched by equally large tax increases and spending cuts by state and local jurisdictions. We are going to do it at a time when the above research suggests that growth may be in the 1% range and unemployment will still be in the 9-10% range. Extended unemployment benefits will be long gone for many people. Housing will still be in the doldrums and housing prices are likely to fall from here.

Given the above, I think we have to increase the odds of a 2011 recession to 60%, and those odds will rise and fall based on the economic performance of the next two quarters.

Do tax increases matter? We are about to find out!

*http://www.frontlinethoughts.com/gateway.asp?ref=reprint

Editor’s Note:
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
Permission to reprint in whole or in part is gladly granted, provided full credit is given.

View the original article at Veterans Today

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