Obama Tax Deal Presents Confusing Picture for the Economy

Barack Obama’s watered down attempt to extend the Bush tax cuts may have some in Washington anticipating a boon to the American economy, however, a deeper look at the picture it presents ends up revealing an image unlikely to please anyone.
Amid the continuing debate about the proposed extension of the Bush tax cuts remain two salient, but largely overlooked points: First, this debate is not about tax cuts, but rather about tax increases; and second, the wider implications presented by a tax agreement that does little to alleviate the business communities’ concerns over tax stability and free cash flow. Within these and other concerns, Members of Congress on both ends of the ideological spectrum have found cause for concern.

House and Senate Democrats have objected to the “low” increase in estate tax rates, under current proposals set to jump to 35% on estates valued over $5 million. Many within the Democratic party seek a restoration of rates in excess of half an estate’s value exceeding $1 million.

Democrats further object to the maintenance of a tax regime they see as beneficial to the wealthy. Apparently the fact that many small business owners incorporate their taxable business income into their personal tax returns has little sway on a Democratic party more concerned with demagoguery and class warfare than in fostering an economic and fiscal climate conducive to growth.

On the other end of the spectrum, Republican concerns focus more on the time frame upon which this “tax-hike delay” will be extended. Further GOP objections include a large increase to the nation’s budget deficit that will result from the proposed extension of unemployment benefits and other such “stimulative” spending provisions.

To be clear, irrespective of the disagreements many have regarding the various points within both Democratic and Republican proposals, a failure to prevent the impending tax increases set to manifest in 2011 would be deleterious to the nation’s fragile economic recovery.

While failing to prevent a massive tax increase would be unconscionable at a time when nascent economic growth is sputtering along, the tax deal winding its way through congress is far from perfect. The lack of stability this deal provides for American businesses contemplating hiring and capital investment decisions undermines the degree to which it will spur economic growth.

On these issues I spoke to Paul Matthews, a Texas-licensed CPA and former hedge fund manager. “First of all let me say that if this tax cut measure is passed, it will do little to nothing to bolster economic activity or economic growth,” Matthews lamented.

“When a business is evaluating whether or not to employ capital into a new project, the business is concerned about the free cash flow that the project will create. By increasing taxes, you decrease a project’s free cash flow, and by definition will reduce the number of projects a business is willing to considering investing in.”

Matthews continued, “When tax uncertainty enters the picture, you complicate the mathematics implicit in the free cash flow calculation, and thus marginal projects get shelved because they may not be profitable in a higher tax environment.”

As the tax deal moves nearer to reality, legislators must recognize that this imperfect compromise will likely only have a marginal effect on economic activity. Not increasing one’s taxes is far different than lowering one’s taxes, and that reality does not portend well for the anticipated economic growth sought through this legislation.

The added uncertainty found in a tax compromise set to expire two years hence will not likely assuage the business communities’ reluctance to hire more employees and expand their businesses. An opportunity to make permanent the Bush tax cuts, and by extension provide a true stimulus to the economy, one predicated on a climate of economic stability, has fallen by the wayside.

Scott Erickson has worked in the field of law enforcement for the past decade and holds both his B.S. and M.S. in Criminal Justice Studies. He is a contributor to The Daily Caller and writes on myriad political, national security, and counterterrorism issues. His blog can be found at www.scottgerickson.com

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