Incentives, Consumer Spending and an Inevitable Double-Dip?

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Macroeconomics

A famous phrase in consulting goes something like this: you get the behavior that you incentivize people to get. If bonuses get tied to the reduction of defects per million, you will see quality improvements. If the purchasing group receives a bonus for reducing PPV, it will focus on reducing PPV. If first time homebuyers receive an $8000 credit to buy a new home, more first time home buyers will enter the market than otherwise. The same applies to stimulus programs such as Cash For Clunkers. So why should anyone be surprised when the economy double dips in 2011 as the Obama Administration raises the federal personal income tax rate from 35% to 39.6%, while the capital gains tax rate increases from 15% to 20% and the top federal dividend tax rate increases from 15% to 39.6%? What incentives do increased tax rates create? They forces people to move income and spending to 2010 instead of deferring it to 2011, according to economist Arthur Laffer in a recent Wall Street Journal op-ed piece.

History suggests that Laffer is correct in his analysis. Laffer examines the policies Reagan deployed during the 1981-1982 recession in which he, like Obama, pursued deficit fiscal policies aimed at stimulating growth but instead of enacting [delaying] tax hikes (as Obama has chosen), Reagan implemented tax cuts effective January 1, 1983 as part of the Economic Recovery Tax Act (ERTA) (which ironically passed with bipartisan support according to Laffer). Now take a look at GDP numbers in context of those tax cuts:

Graphic Courtesy of the Wall Street Journal and Laffer Associates

Now I’m not a gambling kind of gal mind you but I am an observer of human behavior. And though we may all buy into the notion of “doing the right thing and acting in the “greater good the reality is that we’re all going to behave exactly as we are incentivized to. This household has pushed forward expenditures to 2010. I dare say 2011 does not bode well from a consumer-spending standpoint as we have been reporting. The tax rate increases won’t help the situation either.

–Lisa Reisman

Comment (1)

  1. MyAIC says:

    The Effect of a Dividend Tax Hike

    The tax rate on dividends will likely rise from 15% to 39.6% next year (a 164% increase). That hike will affect average Americans of all stripes – in 2007, 65% of taxpayers reporting dividends had incomes less than $100,000, and dividend-paying stocks have long been considered “safe enough for widows and orphans.”

    The hike could also affect the ability of utilities to attract the investors they need to finance important infrastructure projects – new power plants and transmission lines, renewable energy projects, upgrades to water and wastewater facilities.

    http://www.arizonaic.org/blog/250-dividend-tax-hike-effect

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