The Economy is Suffering from Uncertainty

Uncertainty impedes economic activity, but it’s notoriously difficult to quantify those effects. They’re just too complicated. In general, individuals and businesses cope with uncertainty by withholding investment, postponing hiring, and by holding more cash. If uncertainty gets really bad, like in a war, destruction of lives and assets is gambled on the chance of victory and a better future as refugees and wealth flee for safety. After the fact, it’s impossible to accurately measure how the economy would have behaved without the uncertainty. This year, Congress has heightened economic uncertainty in many ways, some necessary and some unnecessary. Here are the major ones.

Tax rate uncertainty — The 2001 and 2003 Bush tax cuts expire at midnight, December 31, 2010. There’s some chance a one or two-year extension will pass during December’s lame duck session, but, in my opinion, there’s a greater chance that a compromise won’t be reached until next February. The Secretary of Treasury can keep withholding rates on earned income and pensions from changing if he chooses, but the top tax rates on other forms of income would jump to 39.6% from 15% for capital gains and dividends and from 35% for other unearned income. The prospect of that tax hike on dividends has already launched a stampede by corporations to increase dividend payouts, robbing future investment. This is by far the most damaging and most unnecessary uncertainty foisted upon us by Congress.

Current budget uncertainty — Congress has not passed any appropriations bills this year, except the war supplemental. That means hundreds of billions of federal procurement dollars are in limbo. Fiscal 2010 ends at midnight next Thursday, and a continuing resolution will have to be enacted before then to keep the government from shutting down. We found out the hard way about the costs of shutting the government down in late 1995. Check out this CRS report on the consequences. I don’t expect a shutdown, but a series of short-term CRs will heighten the uncertainty over future federal spending.

Future budget uncertainty — Uncle Sam has racked up some huge debts, 62% of GDP and headed much higher. Everyone can see that sometime soon, hopefully after a stronger recovery next year, we’re going to have to cut spending and raise taxes or face much higher interest rates and inflation. This will be a very difficult and delicate policy adjustment. We will avoid it only by sacrificing the economic future of our children. I just heard this morning, that the President’s Fiscal Reponsibility and Reform Commission is making more headway behind the scenes than expected. I still can’t imagine the Commission finding 14 votes for any serious deficit reduction proposal, but we’ll see when they vote on December 1.

Health care uncertainty — The Patient Protection and Affordable Care Act is changing health care in massive ways, the effects of which are disputed by experts. There are a lot of tradeoffs here. I can’t fault Congress for moving ahead, but the effects, whatever they are, will take years to work through the economy.

Financial reform uncertainty — Our financial crisis cried out for reform. The Dodd-Frank Wall Street Reform and Consumer Protection Act will benefit us in the long-run, but for the next year or two, the uncertainty of how it will be implemented and of exactly how much additional cost it will impose on financial institutions has and will translate into less lending and less economic growth.

Housing finance uncertainty — Uncle Sam and a many financial institutions are still sitting on a lot of toxic housing finance assets. To dump them on the market for pennies on the dollar would make us worse off, but, at the same time, they are a big drag on the economy. A gradual workout is necessary and is underway. Early next year, President Obama will finally unveil his plan for dealing with Fannie Mae and Freddie Mac. Like health reform, this will be with us for a long time.

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About Pete Davis 99 Articles

Affiliation: Davis Capital Investment Ideas

Pete Davis advises Wall Street money managers on Washington policy developments that affect the financial markets. President of his own consulting firm since 1992, Davis Capital Investment Ideas, he draws on 11 years of experience as a Capitol Hill economist with the Joint Committee on Taxation (1974-1981), the Senate Budget Committee (1981-1983), and Senator Robert C. Byrd (1992). He worked in the House and Senate, and for Republicans and Democrats.

Davis brought the first computer policy model, the Treasury Individual Income Tax Model, to Capitol Hill in early 1974, when he became a revenue estimator on the Joint Committee on Taxation. He formulated the 1975 rebate, the earned income tax credit, the 1976 estate tax rates, the 1978 marginal tax rates, and the Roth-Kemp tax cut. He left Capitol Hill in 1983 for the Washington Research Office of Prudential-Bache Securities, where he advised investors for seven years.

Davis has long written a newsletter on the Washington-Wall Street connection for his clients; Capital Gains and Games is his first foray into the blogosphere.

Visit: Capital Gains and Games

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