Sunday, June 27, 2010

Coming soon: 2011 - An Obama induced economic disaster... Unfortunately it's not a movie!

By all accounts it appears as if we are finally coming out of the recession. We’ve had three quarters of positive economic growth, corporate profits have taken off like a rocket ship, job losses have been stemmed and the stock market is up 20% in the last 12 months. Despite all of the carping about the progressive Barack Obama and his seemingly anti-capitalist administration, things actually look pretty good.

There is a word for that rosy image... it’s called a mirage. While ostensibly all of the above is true, they bear very little relevance to what is actually going on in the real economy, or more importantly, in the real lives of Americans. If you thought 2009 was a tough year, just wait until 2011 arrives. Next year is going to make last year look like a cakewalk.

Why? It’s rather simple actually. Despite the obvious exception of their putting Barack Obama in the White House, Americans are generally rational people. Rational people react to incentives. When Cash for Clunkers offered consumers $4,500 to trade in their old cars on something new, sales took off. ( reports that the true cost of the program to taxpayers was $24,000 per car!) This year when the government offered an $8,000 tax credit for buying a home, not surprisingly, home sales leapt.

If we were to leave things there then there would be no problem. (Assuming we skip the fundamental problem of government taking from some taxpayers to incentivize others to do its bidding…) The problem arises when we look at what happened after those programs ended. In September 2009, the first month after Cash For Clunkers ended, auto sales collapsed by 42%. In May of this year, the first month after the homebuyer tax credit expired, home sales dropped 2.2% and new home sales plunged to their lowest level since 1963. The decline would have been greater but buyers were busy closing on the homes bought under the program.

Now, imagine that chaos across the economy… That is exactly what we are headed for in 2011. Why? Again the answer is rather simple: Government. This time it’s taxes with a little regulation mixed in. Next year the United States is going to see a confluence of tax and regulatory increases that are going to deliver a body blow to the economy. Businesses large and small, are going to be hammered, and given that most jobs emanate from businesses, that will translate into fewer jobs. Here is a quick snapshot, and these are just the federal taxes, we’re not even talking about state here…

The Bush tax cuts are going to be allowed to expire, and the resulting top income tax rate will increase to 39.6%, up from 35%; dividend tax rates will soar to 39.6% from 15% while the capital gains tax rate will jump from 15% to 20%. For families of small business owners insolent enough to die in 2011 rather than 2010, the estate tax will take 55% of the estate, up from 0% today. Not only does death provide no reprieve from taxes, but apparently neither does paying taxes to foreign governments, as the administration is seeking to eliminate the foreign income tax credit, which would subject income taxed overseas to additional US taxes.

The impact of these taxes will be far wider than the administration would lead you to believe. They tout the fact that these tax increases will only impact individuals making over $200,000 a year or families making over $250,000. The first point they don’t mention is that corporations simply turn around and pass any tax increases on to their customers. From auto companies to toothpaste manufacturers to retailers, corporations get their tax dollars from their customers. Fundamentally taxes are paid by people, not corporations, and the more taxes they pay the fewer dollars they have to spend in businesses that employ people to provide goods and services. Secondly, the administration doesn't tell you that most small businesses in the United States, where more than 80% of all new jobs are created, are owned by people in that $250,000 - $1,000,000 per year tax bracket and they file their company’s taxes on their individual returns. To the degree that higher taxes make it more difficult to start, maintain or grow their businesses profitably, they will be hiring and employing fewer workers. Again, the impact is felt far beyond the “rich” the administration loves to vilify.

Those coming tax increases explain the positive economic news that started this piece. Corporations are like individuals in that they typically act rationally as well… again, with some obvious exceptions such as their support for ObamaCare and stimulus spending. Nonetheless, in an effort to escape the higher 2011 tax bite, companies have been doing whatever they can to accelerate their income into 2010. From slashing costs to repatriating foreign earnings to manipulating sales cycles, the growth and profits we are seeing now are the result of corporations acting as consumers did with Cash For Clunkers and the homebuyer tax credit.

At the end of the day, (or year in this case...) the combination of these tax hikes with the new regulations associated with ObamaCare (2,000 pages), financial reform (1,900 pages) and whatever else the administration can muscle through before they lose Congress in November will be nothing short of devastating. If unemployment is sitting at almost 10% when companies are actually spending money, building inventory and generating revenue from a trillion dollars in federal stimulus spending, what will it be when they pull step back as a result of these taxes and red tape? From outsourcing jobs to moving corporate headquarters to low tax domiciles to demanding increased productivity out of their current employees – resulting in decreased hiring – companies of all sizes react to incentives, particularly tax and regulatory increases. Don’t be surprised if 2010 turns out to be just the eye of the storm.

If you think the Obama administration made a mess of the Gulf oil spill, wait until the country gets hit with the coming Category 5 economic storm they are creating. One wonders if enough time will have passed that they will feel sufficiently abashed about blaming George Bush. Don’t count on it.

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