U.S. Economy Undermined by Uncertainty

By Gary Palmer

Kevin Hassett, a senior fellow at the American Enterprise Institute, predicts that uncertainty about taxes and fiscal policy is likely to skyrocket by the end of this year. Hassett says the expiration of several tax cuts will result in significant pessimism about the American economy in the second half of 2012. This includes the tax cuts enacted during the Bush Administration, which are scheduled to expire December 31st.

From an individual/household perspective, allowing the cuts to expire will result in a tax increase of $494 billion in 2013, an unprecedented increase for one year. The average household tax bill will go up by $3,800 and will impact all income groups with middle- and low-income families hit the hardest. According to Curtis Dubay, a senior policy analyst with The Heritage Foundation, 70 percent of the increase will fall on middle- and low-income families. Dubay said, “That’s because 60 percent of the Bush tax cuts were for middle- and low-income taxpayers.”

The Washington Post called the looming tax increase “Taxmageddon,” and Federal Reserve Chairman Ben Bernanke described it as a “massive fiscal cliff.” Jim Capretta, a former official with the White House Office of Management and Budget, predicts that the tax increase will result in an economy that is “… about one to two percentage points smaller than it otherwise would have been, and unemployment that’s a full percentage point higher than it otherwise would have been.”

While there still is time for Congress to take action to prevent this massive tax increase, it is looking increasingly unlikely that it will. With the uncertainty almost $500 billion in new taxes, individuals and businesses are reluctant to make major purchases or investments. Thus, the fear of “Taxmageddon” is already having a negative impact on our economy as families and businesses wait to see what Congress is going to do.

Members of Congress surely know that uncertainty has a negative effect on the economy. If businesses can’t predict next year’s tax rate, they are unlikely to invest in new equipment or expansion or to hire more workers. Individuals and families are less likely to spend as much for the same reasons.

Adding to the uncertainty is the explosion of new federal regulations on American businesses. Since January 2009, federal agencies have issued 106 major regulations that cost $46 billion per year. In 2009 and 2010 alone, federal agencies issued 7,076 rules. The Small Business Administration estimates that the regulatory burden on the U.S. economy is now at $1.75 trillion, more than twice the amount of individual income taxes paid by American households.

Three economists, Scott R. Baker and Nicholas Bloom of Stanford University and Steve Davis of the University of Chicago, produced an index of policy-related economic uncertainty and estimated its relationship to economic activity including investment and employment. This uncertainty index surges around major federal elections; events such as 9/11, the war on terror, the Lehman bankruptcy, and the TARP bailout; and the debt ceiling dispute that foreshadowed declines in private investment, industrial production, and employment. Interestingly, the index also spiked during the debate over the stimulus package.

Since 2000, policy uncertainty has been higher, on average, than in the previous 15 years. The spikes caused last summer by the contentious battle over raising the debt ceiling and Standard & Poor’s downgrade of the U.S. bond rating created uncertainty that the creators of the index believe helps explain the slower growth of the U.S. economy.

With the $494 billion tax increase on the horizon, economy-draining new federal regulations forthcoming, another debt limit vote set for the end of this year, and the most consequential election in decades, the uncertainty index will spike again. When the index spikes, the economy will suffer and for good reason … people and businesses don’t risk their money when the government works against their interests.

Gary Palmer is president of the Alabama Policy Institute, a non-partisan, non-profit research and education organization dedicated to the preservation of free markets, limited government and strong families, which are indispensable to a prosperous society.

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