PJ Media

The 2011 Tax Tsunami

The midterm elections are over, and the results can be summed up in one word: change. The Obama agenda has been rejected, as has government-run health care. Also turned back was any effort to fundamentally transform the United States. Americans witnessed a total rejection of fiscal recklessness and sent a clear message to Washington: handle our finances just like everyday Americans handle their own finances. Also big losers on November 2 were big government and the divisive two Americas approach — haves vs. have-nots, rich vs. poor, white vs. black. The American voter reminded the White House and the Democratic Party that we are all Americans.

A gain of more than 60 seats in the House represents the biggest such gain since 1948. Yet the gravest of dangers here is for Republicans to read the election tea leaves as a pat on the back for them. It wasn’t. November 2 was a simple bipartisan message sent by voters along a wide political spectrum: Stop spending and keep government out of our lives. Keep taxes low. Get government out of the way of job creation. Lest we forget, the election of 2008 spanked Republicans for precisely the same misdemeanor: spending money we don’t have. Budgets transcend politics; they either balance or they don’t.

Conservatives now have a daunting task ahead of them, and very few tools with which to accomplish it. With a Democrat-controlled Senate and a lame-duck president in the Oval Office, Republicans are heading to a knife fight wielding a spoon. In less than three months, the largest tax increases in U.S. history will take effect, and most people don’t even realize it. These massive tax increases will take effect on January 1, 2011, and the same folks who can’t understand why spending a trillion dollars on pork-laden government projects, union dole-outs, and ACORN doesn’t create private sector jobs are clueless as to the devastating effect these historic tax increases will have on our economy in 2011. Despite the midterm victories we enjoyed, the tax tsunami is coming.

Instead of freezing government employment, freezing growth in discretionary spending, vetoing every spending bill choked with earmarks, working to regain an effective line-item veto, and extinguishing wasteful government programs, the White House has the veto power and will undoubtedly use it. Our president’s strongly held political religion firmly believes that the new taxes and even more government spending is necessary to fix a $1.4 trillion deficit which the White House itself created and to reduce a national debt which the White House itself worsened.

We’ll undoubtedly be treated to more of the Bush blame game. Forget for a moment that Bush held average unemployment at 5.3%, saw the strongest productivity growth in four decades, and witnessed robust GDP growth. Set aside the fact that he oversaw this growth despite an inherited recession, 9/11, Hurricane Katrina, and wars in Afghanistan and Iraq. Focus instead on the simple fact that the last budget that a Republican Congress had control over had a deficit of approximately $162 billion dollars — a large number to be sure, but not so large that the Democrats and our “progressive” president couldn’t expand it in under two years by nearly a factor of ten. Under the Obama administration and with the Democrats in complete and total control, we have record debt, record deficits, record unemployment, record underemployed, record foreclosures, record bankruptcies, and soon, record tax increases.

Thinking Americans will recall that the Bush tax cuts of 2001 were in response to the recession of 2001 and helped pull the country out of its morass in only eight short months. The cuts now being blamed by our president for our predicament were George Bush’s version of Barack Obama’s stimulus plan, with one important distinction. Instead of creating a handful of temporary government jobs and subsidizing the expansion of unions and government, Bush slashed tax rates, boosted the child tax credit, increased the standard deduction for married couples, and increased contribution caps for a variety of savings programs. Thinking Americans will also recall that it was Democrats who made these tax cuts possible.

On May 26, 2001, Sen. Ben Nelson (D-NE) was one of a dozen Democrats to rally behind President George W. Bush’s Economic Growth and Tax Relief Reconciliation Act of 2001, the tax cut package that underscored the administration’s plans for job growth. It received the support of 58 senators. Without the Democrats who recognized the economic and revenue boost value of the tax cuts, the cuts would not have passed. Two short years later, Bush again cut taxes with the help of some of the same Democrats now trying to blame the cuts for our economic woes. The Jobs and Growth Tax Relief Reconciliation Act of 2003 passed with precisely the 50 votes it needed to become law (Vice President Dick Cheney cast the deciding vote). That too was passed with the help of Democrats.

The cause and effect phenomenon of tax cuts resulting in increased federal tax revenues is difficult to figure out only for those who have never run a business, met a payroll, or read a balance sheet. It was, in fact, one of the most famous Democrats in history who memorialized why this is. In the January 1963 Economic Report of the President, John F. Kennedy set into motion the “Soak-the-Rich Catch-22” currently frustrating the Obama regime when he said:

Tax reduction thus sets off a process that can bring gains for everyone, gains won by marshalling resources that would otherwise stand idle — workers without jobs and farm and factory capacity without markets. Yet many taxpayers seemed prepared to deny the nation the fruits of tax reduction because they question the financial soundness of reducing taxes when the federal budget is already in deficit. Let me make clear why, in today’s economy, fiscal prudence and responsibility call for tax reduction even if it temporarily enlarged the federal deficit — why reducing taxes is the best way open to us to increase revenues.

But the Democratic Party long ago stopped being the party of JFK, who today would be somewhere to the right of George W. Bush. Barring a Democratic epiphany, the largest tax hikes in the history of America will soon take effect courtesy of an unpopular president and a Congress with a 14% approval rating. They will hit a listing American economy in three tsunami-like waves beginning on January 1, 2011.

Americans for Tax Reform has summarized the Democrats’ scheduled tax hikes in three separate tidal waves, the first of which will hit shore on January 1, 2011:

First Wave

Bush Tax Cuts Expire. Congress didn’t even have the strength of character to stay and vote on extending the Bush tax cuts before running home to protect their professional political careers. These tax cuts all expire on January 1, 2011. Thereafter, the top income tax rate will rise from 35% to 39.6%, the same rate at which two-thirds of small business profits are taxed. The lowest rate will rise from 10% to 15%. All the rates in between will also rise. Somewhere I seem to recall a promise about tax cuts for 95% of “working families.”

Higher Taxes on Marriage and Family. The “marriage penalty” (narrower tax brackets for married couples) starting with the first dollar of individual income. The child tax credit will be cut in half from $1000 to $500 per child. The standard deduction will no longer be doubled for married couples relative to the single level. The dependent care and adoption tax credits will be cut.

Death Tax Returns. 2010 is a great year to die; there is no death tax. For those dying on or after January 1, 2011, however, there is a 55% top death tax rate on estates over $1 million. A person leaving behind a home and a 401k could easily pass along a death tax bill to their family.

Higher tax rates on savers and investors. The capital gains tax will rise from 15% this year to 20% in 2011. The dividends tax will rise from 15% this year to 39.6% in 2011. These rates will rise another 3.8% in 2013.

The second wave — summarized by Joan Pryde, senior tax editor for the Kiplinger letters — will follow closely on the heels of the first.

Second Wave

Obamacare will be the focus of congressional wrangling over the next two years, but it is unlikely to be repealed in that time. There are over 20 huge and completely new taxes contained within the new health care law which was hurried through Congress without being read and passed against the will of the American people. Several will first go into effect on January 1, 2011.

They include:

The “Medicine Cabinet Tax.” Under Obamacare, the ability to use pre-tax dollars from health savings accounts, flexible spending accounts, or health reimbursement accounts to purchase non-prescription, over-the-counter medicine will be a thing of the past.

The “Special Needs” Kids’ Tax. There will be a new cap on flexible spending accounts of $2500 where there currently is no limit. This will hit parents of special needs children particularly hard. Tens of thousands of parents with special needs kids currently use FSAs to pay for their kids’ educations — which can add up to tens of thousands of dollars per year.

The HAS Withdrawal Tax Hike. The health care bill Nancy Pelosi told us we’d have to pass to see what was in it increases the additional tax on non-medical early withdrawals from a health savings account from 10% to 20%, disadvantaging them relative to IRAs and other tax-advantaged accounts, which remain at 10%.

The third wave will ensnare an additional 28 million Americans and countless small businesses.

Third Wave

The Alternative Minimum Tax and Employer Tax Hikes. The AMT, which was originally intended simply to make sure that wealthy taxpayers didn’t use tax shelters and other tactics to avoid having to pay any taxes at all (a good start for an argument for a flat tax), affected nearly 4 million families last year. Starting in 2011, it will affect over 28 million families. According to the leftist Tax Policy Center, Congress’ ineptitude and failure to index the AMT will result in an explosion of AMT taxpaying families, each of which will have to calculate their tax burdens twice, and pay taxes at the higher level.

Small Business Expensing Is Slashed and 50% Expensing Disappears. Obama doesn’t understand that small businesses can normally expense (rather than slowly deduct, or “depreciate”) equipment purchases up to $250,000. This will be cut down to $25,000. Larger businesses can expense half of their purchases of equipment. In January of 2011, all of it will have to be “depreciated.” The effect is a huge tax and an additional expense to the businesses which create jobs.

Tax Benefits for Education and Teaching Slashed. The deduction for tuition and fees will no longer be available. Tax credits for education will be limited and teachers will no longer be able to deduct classroom expenses. Coverdell Education Savings Accounts will be cut, as will employer-provided educational assistance. The student loan interest deduction will be disallowed for hundreds of thousands of families.

Charitable Contributions From IRAs Disappear. Under current law, an IRA can contribute up to $100,000 per year directly to a charity without penalty. This contribution also counts toward an annual “required minimum distribution.” Not any more, thanks to a compassionate and ultra-liberal Congress.

The Health Care Tax That Wasn’t. Remember when your president told you straight-faced that when Americans are required to obtain health insurance or pay a penalty it wasn’t a tax? He lied. In defending the Obamacare mandate in court, Obama and his army of lawyers are now defending the requirement as an exercise of the government’s “power to lay and collect taxes.” How’s that hope and change working out for everybody? I thought everybody making less that everybody making less than $250,000 per year wouldn’t see an increase in their taxes.

The last thing our struggling economy needs is higher punitive taxes. Cutting taxes increases tax revenues — something most Democrats can’t seem to get their minds around. President Ronald Reagan crushed the recession of the early 1980s by strictly adhering to “supply-side economics” and reducing government spending, reducing income and capital gains marginal tax rates, reducing government regulation of the economy, and controlling the money supply to reduce inflation. Our president is doing just the opposite.

Arthur Laffer is a noted economist and the creator of the Laffer Curve — a graph depicting how federal tax income increases as tax rates decrease up to an optimum beyond which income declines. According to Laffer, 2011 will be the economic equivalent of 2012 in the recent movie of the same name. This tsunami of tax increases will devastate American businesses and will likely be followed by every economist’s nightmare, a double-dip recession — a recession followed by a short-lived recovery, followed by another recession. The promised recovery of 2010 will instead feature a return to recession, stripping mainstream economists of any remaining credibility and perhaps making 2011 the worst economy in U.S. history.

According to Laffer, “Tax rate increases next year are everywhere.” Laffer says the coming hikes — coupled with the prospect of rising prices, higher interest rates, and more regulations next year — are causing businesses to shift production and income from 2011 to 2010. In other words, 2010 income will be inflated above where it otherwise should be and 2011 income will be dramatically lower than it otherwise should be. Not surprisingly, the nine states without an income tax are “growing far faster and attracting more people and businesses than are the nine states with the highest income tax rates.”

History bears this out. A 2004 U.S. Treasury report reveals that many taxpayers took wages and bonuses early — to the tune of more than $15 billion — in order to avoid the ill effects of Bill Clinton’s massive 1993 tax increases. At the end of 1993, these same individuals re-shuffled wages and bonuses one more time to avoid the 1994 increase in Medicare taxes.

History also reveals similar behavior after Reagan’s delayed tax cuts — which were passed in 1981 but didn’t become effective until 1983 — caused a massive hiatus in economic growth in 1981 and 1982. The GDP flatlined and the unemployment rate climbed well over 10%. In 1983, when the tax breaks kicked in, the U.S. economy exploded, with real growth reaching 7.5% in 1983 and 5.5% in 1984. We will see exactly the opposite phenomenon in 2011.

Yet it isn’t just the tax increases that will kill jobs and small businesses. A survey from the National Association for the Self-Employed shows that businesses will experience a 1,250% increase in the amount of tax-related paperwork required of them in 2012 — kryptonite for small businesses.

The new conservative majority in the House of Representatives has a task of Herculean proportions staring them in the face. The fallout from the coming tax storm will be a crash in tax receipts of monumental proportions, even higher deficits, and more record unemployment. If you thought the Obama “recovery” of 2010 was bad, just wait until 2011.