Taxes- what's in store

We're going to have a trillion dollar deficit in 2009 (even before Obama's huge spending plans). Federal spending has been out of control since 1998 and appears poised to move from excess to insanity, using the financial crisis as cover.  We know we're all going to have to pay.  Here is what I expect to see in the next Congress' first term:

 1) Federal gasoline tax hike in 2009 (assuming gas stays below $3/gallon into early '09).  I expect to see 20-50 cents added to the current tax.  Obama will sell this as a conservation measure and a way to fund his planned investments in "green" energy.   The far left has always favored higher gasoline taxes and the Blue Dog Dems will be looking for ways to pay for some of Obama's new initiatives.  The Dems will look to substitute a broader carbon tax for the gasoline tax once the economy recovers.

 2) Windfall tax on oil companies.  While this is a stupid idea (see also: Carter) and hurts US companies at the expense of foreign producers, it is red meat to the Dem base and may be used to help sell the gas tax ("you the motorist will be paying more at the pump for 'investment' and conservation, but don't worry- the oil companies will be paying, too").  

 3) Eliminating the income cap on social security for the employer portion.  Obama will likely apply the 6.2% employer tax to all income over $200,000.   For a high-earning employed person this means no direct tax hikes- instead your employer pays more (meaning over the long run they will find ways to pay you less).  This will probably be sold as a way to punish companies for excessive executive pay.  This will be extremely painful to traditional self-employed small business people, but generally they aren't Obama supporters.  The LLC lawyer/hedge fund/private equity crowd that Obama depends on for campaign cash will have ways around it (by converting salary income to capital gains).  I don't see Obama going after carried interest in his first term.

 4) Capital gains/dividend tax hikes-  certainly back to 20%, likely to 28% for high earners.  In order to cushion the impact on the market these hikes may be phased in over several years.  Increased ability to deduct capital losses from income in 2009 may be thrown in as a sweetener.  Capital gains revenues will be tiny in 2009 (who has gains?), but by raising tax rates in 2010/2011 the government will be poised to collect big on the inevitable market rebound.

 5) Income tax hikes.  Back in 2000, Clinton's last year, the 39.6% bracket started at $288k for a couple.  Due to inflation indexing the top bracket for a couple in 2008 began at $358k with a Bush tax cut rate of 35%.  Obama is talking about reinstating the 39.6% rate at somewhere at or below $250k in joint income.  After inflation, this is the equivalent of lowering the threshold for Clinton's 2000 top bracket to about $200k for a couple.  Clearly, Obama is not just talking about a repeal of Bush's upper income tax cuts but new tax hikes that go further than Clinton's did.   A more interesting question is the fate of the 33% bracket (which was the 36% bracket under Clinton).  Back in 2000, this bracket started at $161k or a couple, and currently starts at $200k.  However, as Obama's new top bracket ($250k) comes in below Clinton's old (non inflation adjusted) number of $288k, I expect that we could see the 36% bracket come in somewhere at or below the old Clinton threshold of $161k for a couple.  Could this have been what Joe Biden was talking about when he let $150k slip as the new definition of rich?

 6) Targeted corporate tax hikes (elimination of subsidies for Republican-associated industries to be replaced with subsidies and credits for Dem-favored industries and activities).  I expect the net revenue contribution here to be negative.

The scary part is that all of the above plus a $100 billion cut in annual defense spending (assuming we quickly scale back in Iraq) wouldn't even balance the 2008 budget, let alone pay for any of Obama's new initiatives.  I suspect that Obama and Pelosi are comfortable with the idea of $300-400 billion deficits once the economy recovers and the defense budget normalizes (say in 2011).   I believe that plan will be to finance the current level of spending through the above tax hikes and defense cuts and then spend $300 billion on top of that (in today's dollars). Refundable tax credits (or social security tax "refunds" for lower income workers), infrastructure boondoggles, healthcare and aid for unionized industry and "green" industry will all be high on the spending agenda, though these will have to compete with spending requests from individual US States, many facing bankruptcy as tax revenues fall while a decade of spending at twice the pace of inflation needs to be funded.  States will be looking for at least $100 billion of budgetary assistance in 2009, and a wholesale bailout of states and the muni bond market would dwarf the recent Wall Street rescue.

Eventually, the $300 billion or so in new annual spending will have to paid for, as well as the 2 trillion or so in new national debt we'll accumulate in 2009/2010 as well as the debt accumulated during the Bush administration.  This will require not only regressive consumption-based taxes (higher gasoline/carbon taxes, VAT) but also dramatically higher taxes on middle income earners.  At the end of the day, European-style Social Democratic spending levels require European-style taxes.  If a social democratic paradise could be built off the backs of the rich alone then some country would be doing it somewhere.   It seems we need to re-learn the lessons of the 1970s.  There is no such thing as a free lunch, and "change you don't have to pay for" is an empty promise.