Tax Reform And The Future Of GDP

Economists who specialize in the effects of taxes on GDP had often made a simple and rational forecast. Tax rates would rise in 2011 because individuals and businesses assumed that tax cuts implemented during the Bush presidency would expire. That would move economic activity into the last quarter of 2010 as people and enterprises planned to take advantage of the better tax rates while they are still in effect.

Those theories are in doubt because it seems that some tax cuts will stay in effect and that the Obama administration may offer the nation’s big businesses incentives for certain kinds of expenditures and R&D programs.

Now, fourth quarter GDP may not be aided by a rush avoid rising taxes. The first quarter of 2011 may be a just as good time for taxable events. The shift in the behavior of those taxed may not change from one year to the next at all.

Those pieces of news may be very good. Experts feared that a double-dip recession could appear in early 2011 because of the taxable transactions done late this year. They would pull GDP improvement into the final months of 2010 and leave early 2011 vulnerable to a sharp swift slowdown in economic activity.

The debate over taxes has become a political one. Republicans largely want to keep the Bush tax programs. That would be popular with anyone who faces a rising levy in 2011, particularly the rich. Democrats want taxes higher in 2011, on the basis that these higher taxes would help close the deficit. It may not have occurred to them that higher taxes often means less consumer spending. The debate could go on until October or even longer.

The President and Congress may want to carefully consider the behavior of consumers. Pulling economic activity into the fourth quarter due to tax policy will give politicians a false security as fourth quarter’s GDP surges. That could affect policy decisions base on an optimism that the economy has rallied. That rally will die in early 2011 if those who are taxed believe that their situations will be worse in 2011 than in 2010.

Douglas A. McIntyre