December 3, 2005

Jim Glassman Has the Language Down Right (“Huge Automatic Tax Increases”)–and the Impact

Filed under: Economy,Taxes & Government — Tom @ 11:17 am

The language–”Three huge automatic tax increases.”

The impact of dithering on preventing them from taking effect could end the current prosperity:

The increases — 133 percent for the rate on dividend income, 33 percent for the rate on capital gains and what amounts to an infinite increase in the coming rate on what you pass on to your heirs — comprise a ticking time bomb.

The dividend and capital gains rates were reduced to 15 percent in 2003. The estate (also called death or inheritance) tax got an overhaul in 2001, with gradual reductions over 10 years and complete elimination set for 2010.

But the dividend and capital gains cuts turn into pumpkins (reverting to their old top rates of 35 and 20 percent, respectively) at the end of 2008. And in 2011, the pre-2001 estate tax reappears. Since backers lacked 60 Senate votes, all three of the cuts were only temporary.

The estate-tax cut can wait a bit for an extension, but the dividend and capital gains tax cuts can’t. My guess is that, early in 2006, the prospect of the big increases will weigh on markets. Investors will start selling stocks and other assets to take advantage of the expiring 15 percent capital gains rate, driving down prices.

Academic research has found that the dividend cut, by increasing what America’s 57 million investing families can keep after taxes, boosted stock prices considerably. A paper for the prestigious National Bureau of Economic Research by Alan Auerbach and Kevin Hassett concluded that the cuts “had a significant impact on equity markets” — a broadly positive impact. Take the cuts away, and stocks will almost certainly head in the opposite direction.

As for the estate tax: It’s hard to say if the tiny changes so far have had an effect, but the elimination of all taxes at death certainly will. Surveys show the estate tax is the most broadly despised federal tax, hated even more than the income tax. Americans of both parties think it’s unfair to tax income once on receipt and again at death.

Heading off the automatic tax increases on dividends and capital gains is especially urgent. I believe the economy’s growth will fall back to 2% in the latter half of 2006 if Congress does not choose to extend the rates currently in effect–preferably indefinitely.


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