The Tax Time Bomb Is Ticking

01/15/2009 3:05 pm EST


Howard Gold

Founder & President, GoldenEgg Investing

Some time in the next couple of years, you are likely to pay higher taxes-and it's not for the reason you think.

Sure, the Bush tax cuts will almost certainly expire in 2011, virtually guaranteeing higher marginal tax rates for top earners. Speaker of the House Nancy Pelosi (D-Calif.) is pushing to end them even sooner. And tax rates on capital gains and dividends may move up as well.

But incoming President Obama, faced with the biggest financial and economic crisis since the Great Depression, has pledged to go slowly on tax hikes, which he fears would take consumer demand off life support and put it in the morgue. In fact, he has made some tax cuts a cornerstone of an economic-stimulus package Congress will debate in coming weeks.

No, the real danger to your wallets comes much closer to home-from cash-strapped states and municipalities, which are in their worst shape fiscally in decades.

Though they may resist at first, governors and state legislatures may be forced to raise income taxes, sales taxes, state university tuitions, transit fees, and whatever else will help pay the freight.

That may vitiate the impact of any federal stimulus package, because if one government takes while another gives, you'll still have less money to spend at the mall.

The situation is dire. The recession and the housing crash have landed body blows to local governments, severely reducing tax revenues. The National Governors Association (NGA) projects fiscal 2009 budget shortfalls may reach $60 billion, and fiscal 2010 deficits (mostly from the middle of this year to the middle of next) could top $80 billion.

And the Center on Budget and Policy Priorities (COBPP), a Washington, DC-based liberal think tank that focuses on state and local finances, says: "Combined budget gaps for the remainder of the fiscal year and state fiscal years 2010 and 2011 are estimated to total more than $350 billion."

Maybe we shouldn't spend the second half of the $700-billion Troubled Asset Relief Program (TARP) so quickly.

Indeed, the NGA says that states "may experience negative spending growth" this year for the first time since 1983 "and states may take up to several years after a recession is over to fully recover."

Until then, it's time to batten down the hatches.

From New Jersey to Nevada, desperate state governments already have begun to slash spending.

California has imposed furloughs on state workers and may cut funding of K-12 education by $5 billion amid a mind-bogging $42-billion budget gap by the middle of next year. Teachers in South Carolina face salary freezes. Nevada has increased premiums on children's health care. Florida, with an elderly population that tops four million, is considering cuts in Medicaid reimbursements to nursing homes.

And where budget cuts come, tax hikes are sure to follow.

Truth is, the hole is just too big to fill by budget cuts alone-without decimating services that the voting public has come to rely on. President Obama's proposed stimulus package can provide some relief, but it won't cover the whole shortfall.

And if the economy remains as weak for as long as I expect, tax revenues could slip even further while states face greater demand for services from the newly unemployed and the working poor.

Plus, state pension funds have racked up an estimated $865 billion in losses because of the stock market crash, and they could require taxpayer funding.

So, it's no surprise we've seen some tax hikes bandied about already. California Governor Arnold Schwarzenegger has proposed boosting and expanding the state's sales tax for three years, while Democratic legislators want to impose a "temporary" income-tax surcharge of 2.5%.

In New York, Governor David Paterson has requested 137 new tax and fee increases, including extending state sales taxes and imposing a new tax on iTunes songs and non-diet sodas. So, if you want to have a Coke while you're downloading the latest from Jay-Z or Radiohead, it'll cost you.

Across the country, politicians are figuring out how to nickel and dime the public with fees and nuisance taxes while holding the ultimate weapon-higher state income taxes-in reserve.

But some groups already are beating the drums for that.

The liberal COBPP, mentioned earlier, favorably quotes a pro-tax-increase report from Nobel Prize-winning economist Joseph Stiglitz and Peter Orszag, whom the new Obama Administration has tapped to run the Office of Management and the Budget.
The two economists state flatly: "Tax increases on higher-income families are the least damaging mechanism for closing state deficits in the short run." Their reasoning: Since lower-income families spend all their money, cuts in services or payments to poorer people will hurt the economy more than tax increases to "wealthier" folks, who at least save some of their discretionary income.

This is what wins Nobel Prizes these days?

Truth is, even "wealthy" people are tightening their belts as their home values and portfolios shrink and the spectre of unemployment looms.

"The affluent consumer, unfortunately, doesn't need anything," Neiman Marcus Group's chief executive officer Burt Tansky recently lamented. "They can-and are-shopping in their closets and bragging about it to me."

Already residents of the ten highest-taxed states (including New Jersey, New York, Connecticut, Maryland, Hawaii, and California) pay out more than 10% of their income in state taxes, including income, property, and sales taxes. The national average is 9.7%, according to the conservative Tax Foundation.

Let's say the Bush tax cuts expire in 2011 and top rates revert to the 39.6% at which they stood in the Clinton Administration. Then, increases in state or local taxes could easily push the tax burden on top earners well above 50%.

Now, I believe everybody should pay their fair share of taxes-with an emphasis on the word "fair." And certainly governments are under great strains to provide really essential services as more and more people fall through the safety net.

But there comes a point where even high earners lose the incentive to produce the wealth that pays for everything else.

In an economy like this, do we really want to try to get blood from a stone?  

Howard R. Gold is executive editor of The opinions expressed here are his alone and do not necessarily reflect the views of InterShow or

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