Business, Politics, Economics, Leadership

Third in a series of posts examining the Ten Tyrants of Uncertainty – ten factors causing US business to sit on the economic sidelines and contributing to the extended ‘jobless recovery’.

2011 is set to see the largest across-the-board tax hikes in US history, when the so-called ‘Bush tax cuts’ expire and rates return to their previous levels. Personal and corporate income tax, capital gains tax, dividend tax and estate tax are all set for substantial hikes.  Maybe.  Or maybe, after the mid-term elections next week with a different political climate  and a new Republican House majority in Washington, D.C., the Bush tax cuts will be continued for another 12 or 24 months, either selectively or in aggregate.  We will not know until late November or early December, when we find out how much backbone the newly elected ‘fiscally conservative’ Republicans actually have, whether any kind of bipartisan spirit emerges, and what the Lame Duck Democratic House majority decides to do with its expired mandate (see my earlier post “Business Worries about the ‘Lame Duck’ Session“).

There are two separate problems with the uncertainty regarding Federal tax rates for 2011 and beyond: one is that uncertainty, specially when the divergence between the two scenarios is as drastic as it is in the current situation, makes it very hard to plan – and when it is hard to plan, business and investors usually become hyper-cautious and consumers defer spending and save rather than borrow; and the second is that, if the Bush tax cuts are reversed or, even worse, additional increases are layered on top of a return to pre-Bush tax rates, consumer demand (which is already on life support) will collapse and any meaningful recovery in the US will be further delayed, with dire consequences for many businesses.  The reality, though, is that uncertainty has the same short term impact as an actual tax rate hike.  Consumers are not spending, business is not investing, and jobs are not being created at anything like the rate needed to pull the economy out of the ditch and get it nose-up again. If this behavior continues long enough, it will become institutionalized – savings will replace credit and cost management will replace growth capital as the new consumer and corporate norms – and we will be set for an extended recession with the risk of it deepening into a true depression.

Another consequence of the current, uncertainty-reduceded level of economic activity is that the gross tax take at every level in government will continue at its current reduced levels, or potentially decline even further, driving demand for additional borrowings to sustain spending commitments and making it harder to service (let alone reduce) our national debt…  Of course, as a fiscal conservative it is my own view that, if the uncertainty is resolved in favor of higher tax rates the net effect will be to reduce the gross tax take anyway, as economic out-performers respond to the perverse incentive by emulating John Galt.

The Bottom Line: Until the uncertainty surrounding the future Federal tax rates is resolved, it will remain yet another factor conspiring to keep businesses sitting in the economic sidelines, waiting for clear signals before committing capital to growth – and, the uncertainty had better be resolved in favor of sustaining the current rates rather than increasing them, if we hope to see an end to the ‘jobless recovery’ and any kind of broad-based improvement in consumer economic circumstances any time soon.