New Study Shows Tax Increases Harm U.S. Economy and Provide No Relief on Deficits and Debt

(Washington, June 14, 2012) – A new study released today by the American Council for Capital Formation (ACCF) finds that failure to continue extensions on Bush-era and other tax cuts would result in significantly reduced economic activity, heavy jobs losses, and financial disarray that could propel the economy into another recessionary tailspin.  Dr. Allen Sinai, Chief Global Economist and President of Decision Economics, Inc. conducted the study and examined the potential effects of various scenarios where the legislated tax increases on income, dividends, capital gains and social security take place.

If Congress and the Administration take no action on the tax dimension of the Fiscal Cliff, i.e., all Bush-era tax cuts expire as tax increases—income, capital gains, dividends, AMT—and social security taxes rise, the economic and financial impacts are severe:

Economy:  Significant declines in real economic growth of 2.6, 3.3, and 0.5 percentage points over 2013 to 2015 compared with a Baseline—and up to $855 billion of lost output which could well take the economy into another recession.

Jobs Losses: Large declines in the numbers of persons working, over 1 million estimated for all of 2013 and in excess of 3 million for 2014.  The unemployment rate would be 0.4 percentage points higher in 2013 and increase by a very large 1.5 percentage points compared with the Baseline in each of 2014 and 2015.

Lower Consumption Spending and Reduced Capital Formation:  Consumption spending down about $1 trillion per year, on average, over 2013-17, beginning with a relatively small decline of $343 billion in 2013 but rising to $1.2 trillion in 2015 with a substantial hit to business capital spending, down $13.4 billion in 2013, $68.5 billion in 2014 and $95.2 billion in 2015.

Financial Markets Disarray:  A stock market that very likely would sell off on the prospect, nearly 18% a year over 2013 to 2017, with corporate profits down and expected to be down.  This would represent real losses in the retirement and pension accounts of ordinary Americans, and significant declines in household wealth and the state of the household balance sheet.

Deficits and Debt:  The intended aim of the tax increases to reduce federal budget deficits and debt relative-to-GDP would be overwhelmed by the declines of real GDP and much lower prices; after the first year, ex-post, higher deficits and higher debt-to-GDP ratios, not lower.

This program of “tax austerity,” like the now-discredited and failed approach of austerity in the Eurozone, would prove counterproductive just as it has there.  Rather than improve the federal budget position, after allowing for cyclical feedback, it would worsen, with the same “negative loop” of fiscal restraint depressing economic activity and lowering tax receipts more than originally expected against a declining nominal GDP as has occurred in the Eurozone, making reducing deficit- and debt-to-GDP ratios elusive and a will-of-the-wisp.

Banking System Fragility:  A recessionary economy would weaken the business of banking and financial markets’ disarray negatively impact asset prices, bringing a contraction of financial institution balance sheets, a need for more capital, and the potential for another U.S. banking crisis.

Non-U.S. Effects:  The negative effects of a U.S. downturn on non-U.S. economies and global financial institutions would be yet another distinct negative side effect, with “contagion” from the fundamental interconnections of the biggest economy in the world with other global economies.

While a Scenario of allowing all tax cut extensions to expire may be unlikely on Capitol Hill; even allowing for the expiration of some, such as lower tax rates on capital gains and dividends, would create negative consequences.

A return to a maximum 20% capital gains tax rate and taxing dividends at ordinary income tax rates (39.6% from the current 15%) would bring a reduction in real GDP of about 0.7 percentage points for the next few years and 561,000 fewer persons working by 2015 compared to the Baseline.  Savings would weaken considerably and higher taxes on capital gains and dividends would have large negative effects on the stock market, which, in turn, would raise the cost of capital for business.

“The policy implications are clear!” Allen Sinai said.  “Congress and the Administration, as soon as possible, should join together before the Presidential Election and change the current law that triggers all of these tax increases, focusing not on differences such as disagreements on whether to tax the “rich” but on commonalities in views which for both the Administration and the Congress, Republicans and Democrats, are sizeable, including holding-the-line on taxes for middle- and lower-income families, maintaining the capital gains tax rate and dividend tax rate at 15%, and perhaps extending for another year the social security tax reductions.”

Sinai and Dr. Margo Thorning of the ACCF recommend that the financing of these extensions should come from reductions in the growth of federal government outlays and those savings that can be relatively easily agreed upon, but not at this point the entitlements such as Social Security, Medicare and Medicaid.  Those tough issues should be dealt with after the Presidential Election in a considered and thoughtful fashion.  Other savings can occur from the growth stimulus of maintaining the lower taxes and the relief for businesses and financial markets over a reduction in the uncertainties created by the Fiscal Cliff.

Allen Sinai said, “The prudent course of action would be to extend all those tax reductions that both Republicans and Democrats already agree upon, similarly so for reductions in federal government outlays, leaving for the next President and Congress the daunting issues of dealing with whether, and which, higher-income families should be taxed and at what tax rates, reform and rationalization of the health care and entitlements programs, and moving toward the kind of tax reform suggested by the Bowles-Simpson Deficit Commission and the Domenici-Rivlin Task Force.”

Download The Full ACCF Report:

“Macroeconomic Effects of Coming Tax Increases: 2013-22”

 Founded in 1973, The American Council for Capital Formation (www.accf.org) is a nonprofit, nonpartisan organization advocating tax, energy, regulatory and environmental policies that facilitate saving and investment, economic growth and job creation.


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