Wednesday, September 5, 2012

US : EXPIRING TAX CUTS

All the Bush-Era tax cuts are set to expire at the end of this year, meaning Obama needs to act, and act fast if he wants to avoid raising taxes across the board. Or is there something else in his mind? B&E catches up with the US Congressional Budget Office, Moody’s and others for an intensive analysis.

Another alternative is to limit the extension to individuals making less than $200,000 and married couples earning less than $250,000 (which makes 97% of the US population). In fact, this is what President Obama wants. But here the numbers backfire. Top tax rates in US are already at around 40% and an increase above that would prove counterproductive. Even if it happens, the revenue generated will not be enough to repay the $13.8 trillion debt. Further “the option would cost $2.3 trillion in the next decade and without any offsets this proposal could inflate the national debt to 78% of GDP by 2020,” says a report from PEW, an economic policy group based in US. Finally, there is the option of allowing the cuts to expire as scheduled. But that too comes with a huge price tag. If the tax cuts are allowed to expire at the end of 2010, chances are that the US economy might slip back into recession. Further, considering that the US recovery has already lost momentum (GDP is growing at a paltry 1.5% annualised rate, down from 3% pace a year ago) and the job growth is weak (after ticking 9.6% in August, the unemployment rate is likely to drift back into double digits in the coming months) this should be the last resort.

Even Douglas W. Elmendorf, Director, CBO in a presentation made on September 16, 2010 agrees to the fact that “If taxes were cut permanently or spendings were increased permanently, that would worsen the fiscal outlook.” According to him, even if changes were temporary, the additional debt would weigh on the budget and the economy in the future. US Congressional Budget Office told B&E through a communiqué, “If the 2001 and 2003 tax cuts were extended, the individual alternative minimum tax was indexed for inflation, and future annual appropriations remained the share of GDP that they are this year, the deficit in 2020 would equal about 8% of GDP, and debt held by the public would reach nearly 100% of GDP.” So, is there a way out for US policymakers?

One move that perhaps can solve the problem is the implementation of a nationwide value-added tax (VAT). As VAT has a broad base, it could generate enough revenue to deflate the ballooning deficit while simplifying the tax code. In fact, a Congressional Research Service report suggests that each 1% of VAT has the potential to generate $50 billion. Thus, even if it’s started at a low level, say 5-10%, it can generate big money. But, thanks to political enthusiasm and mid term elections due in November, it doesn’t seem to be happening anytime soon.

Another way out could be a combination, where tax cuts are extended for short term (say two years) and spending is cut. Though this would widen the deficit now, it will definitely reduce it relative to current baseline projections after a few years. However, developing such a combination would not be easy. Mark Zandi, the US based Chief Economist of Moody’s Economy.com tells B&E, “A misstep by the Fed could put a high hurdle in the recovery’s path. Yet the need for more monetary easing is increasingly evident given the high and rising unemployment rate, very low inflation, and weakening inflation expectations.”

But then, the US policymakers don’t have any other option. The clock has almost finished ticking and it’s time that they decide, and decide soon. After all, US can’t afford a laid-back attitude at the moment!


Source : IIPM Editorial, 2012.
 
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