Art Laffer: Economic TEOTWAWKI in 2011

Art Laffer is one of America’s greatest economist and it is from him we derive the idea of the Laffer Curve. His book The End of Prosperity accurately predicted the disastrous effects of Obama’s sovietization of the economy and his new book Return to Prosperity lays out a detailed plan (which America will not follow) for how to dig us out of the welfare state hole.

But even Laffer admits it’s basically too late. In this Wall Street Journal op-ed Laffer discusses the sunset of the Bush tax cuts and the resulting financial slowdown that will result. But more importantly he explains why the tax increases coming in 2011 are the only thing propping up the economy now:

On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush’s tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts.

Tax rates have been and will be raised on income earned from off-shore investments. Payroll taxes are already scheduled to rise in 2013 and the Alternative Minimum Tax (AMT) will be digging deeper and deeper into middle-income taxpayers. And there’s always the celebrated tax increase on Cadillac health care plans. State and local tax rates are also going up in 2011 as they did in 2010. Tax rate increases next year are everywhere.

Now, if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be.

Also, the prospect of rising prices, higher interest rates and more regulations next year will further entice demand and supply to be shifted from 2011 into 2010. In my view, this shift of income and demand is a major reason that the economy in 2010 has appeared as strong as it has. When we pass the tax boundary of Jan. 1, 2011, my best guess is that the train goes off the tracks and we get our worst nightmare of a severe “double dip” recession.

In 1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn’t take effect until Jan. 1, 1983. Reagan’s delayed tax cuts were the mirror image of President Barack Obama’s delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%.

But at the tax boundary of Jan. 1, 1983 the economy took off like a rocket, with average real growth reaching 7.5% in 1983 and 5.5% in 1984. It has always amazed me how tax cuts don’t work until they take effect. Mr. Obama’s experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011.

Which once it’s laid out is just common sense, no? If you’re involved in an economic activity that will be taxed heavier in the future you milk it now for all it’s worth before you pay more taxes. When payroll taxes increase the cost of hiring people will go up, so those increases depress hiring. Capital gains tax increases mean it pays off less to invest in stocks or bonds, so making money on these things prior to the 2011 sunset is likely what had pushed the stock market up and much of the slow bleed in the markets are probably people looking to cash out now. As Laffer explains:

Consider corporate profits as a share of GDP. Today, corporate profits as a share of GDP are way too high given the state of the U.S. economy. These high profits reflect the shift in income into 2010 from 2011. These profits will tumble in 2011, preceded most likely by the stock market.

And even with the “shift” in economic activity to 2010 we have 10% unemployment, 20% underemployment and a population used to living on credit quickly reaching a point where there is no credit to be had. The jig is up, and economic apocalypse of our own making is on the horizon and even adopting Art Laffer’s policies now can do nothing to stop it.