As the shock of the economic meltdown we felt so keenly in January 2009 has diminished, fundamental trends are under way that could create the perfect storm for further economic disaster, starting as early as 2011. They threaten an economic downturn far worse than we have already suffered.
As we begin 2010, news reports tell us that the economy is on the mend, in the early stages of a recovery, and indicators suggest the recession is ending. In many ways, things just seem better than at the beginning of 2009. The stock market has stabilized and rebounded. Fewer people are losing their jobs. US manufacturing posts modest gains. But is it really smooth sailing really ahead? Or time to batten down the hatches?
Although we have adjusted our expectations downward for the future and reduced our spending, four major trends are cresting that threaten to drown the chances of a real recovery:
First, taxes. Additional tax increases are expected to go into effect in 2011 to support the health care overhaul. Further, the Bush tax cuts will end at the start of 2011 under budget policies already adopted by the Obama administration. After these changes, the top income tax rate including state taxes would average 52% across America.
This top U.S. income tax rate would be higher than in France, Germany, Canada, and 23 other countries in the OECD. In five states dominated by Democrats --California, New York, New Jersey, Hawaii, and Oregon -- the total top tax rate will be higher than in socialist Sweden.
The top capital gains tax rate would soar by 66%, from 15% today to over 25%. The individual income tax on corporate dividends would also swell substantially. These increases will stifle investment, entrepreneurship, small business start-ups, business expansion, new jobs, wage and income growth, and overall economic recovery.
The second factor affecting the economy in 2011 is rebound unemployment as stimulus spending declines. Whether or not the stimulus has been effective in preserving and creating jobs, even the Obama administration says that the effects of the stimulus spending will have peaked by mid-2010. Worse, by 2011, stimulus spending will likely produce a negative feedback effect on the economy. Every dollar in Keynesian stimulus spending. according to many economists, takes an estimated $1.23 out of future GDP. Additional stimulus spending by Congress—like “Cash for Caulkers” --- may extend phantom job creation a bit longer, but as soon as it is spent out, negative effects roll in.
Once the stimulus money is used up, state and local governments that used the funds to plug holes in their general operating budgets will have to cut back jobs or substantially raise taxes. As most jurisdictions, however, used the money to support levels of spending that were too high to begin with -- rather than to build additional infrastructure or other job opportunities that would lead to growth rather than end when the infrastructure project was completed -- all that spending will not have increased American productivity much. We will still be paying the bill for today’s stimulus spending in the future, however, but with higher interest costs and a larger tax burden.
A similar effect will result from the Census Bureau hiring up to one million workers for the 2010 Census. When those same workers are laid off in 2011, however, expect the unemployment rate to go up another 3 or 4 tenths of a percent.
The third trend that will crest in 2011 is inflation—from a combination of our weak dollar policy and our huge deficits. The dollar’s decline reflects incredibly loose Fed monetary policy, as the Fed expanded the money supply while maintaining record-low, near-zero interest rates. Additionally, federal debt will exceed 100% of GDP by 2011, leaving us with the 7th highest government debt-to-GDP ratio in the world, in company with countries such as Zimbabwe, Jamaica, and Lebanon. This will produce further dollar declines, and further increasing inflation.
Lastly, the fourth and final cause of the perfect storm will occur if Congress passes any of the expensive legislation that it has been contemplating. The resulting costs of a Cap and Trade, possible Healthcare Reform, or, should it still be in play, pro-union legislation like “card check” would all result in huge expenditures and inefficiencies that the American people will be forced to bear--starting mostly in 2011. With cap and trade, especially, energy production will be sharply constricted, and energy costs will rise further, contributing to inflation while killing still more jobs and creating still more misery. The perfect storm in 2011 may bring us double digit inflation, soaring interest rates, record unemployment and a worsening recession. Prepare yourselves.