The Next 3-Year, $924 Billion Tax Increase Will Hurt Economy

Includes: DIA, SPY, TLT
by: Jason Tillberg

The Congressional Budget Office's estimates of the federal budget sees tax increases dwarfing spending cuts over the next 3 years.

Here are the estimates made by the Congressional Budget Office as of February 5th, 2012 of aggregate federal revenues and spending out to 2015:

(Click to enlarge)

I added the last two columns to show the percent change and dollar amount change from 2012 to 2015. Across the board, tax revenue is expected to go up quite substantially, especially corporate income taxes.

The aggregate dollar amount of expected tax revenue increase over the next 3 years is $924 billion, which would be a 37.7% increase over the tax revenue of 2012.

Here is what the CBO had to say about tax revenue estimates:

"Federal revenues will increase by roughly 25 percent between 2013 and 2015 under current law, CBO projects. That increase is expected to result from a rise in income because of the growing economy, from policy changes that are scheduled to take effect during that period, and from policy changes that have already taken effect but whose full impact on revenues will not be felt until after this year (such as the recent increase in tax rates on income above certain thresholds).

As a result of those factors, revenues are projected to grow from 15.8 percent of GDP in 2012 to 19.1 percent of GDP in 2015-compared with an average of 17.9 percent of GDP over the past 40 years. Under current law, revenues will remain at roughly 19 percent of GDP from 2015 through 2023, CBO estimates."

As for Federal expenditures, the mandatory spending, which includes personal current transfer payments, or social security, Medicaid and Medicare, is expected to rise 15.3% or $311 billion over the next 3 years.

Discretionary spending however is going to get cut into 2014 before rising again in 2015. Discretionary spending in 2015 is expected to be $96 billion less than what it was in 2012.

Here is what the CBO had to say about the spending forecasts:

"In CBO's baseline projections, federal spending rises over the next few years in dollar terms but falls relative to the size of the economy. During those years, the growth of spending will be restrained both by the strengthening economy (as spending for programs such as unemployment compensation drops) and by provisions of the Budget Control Act of 2011 (Public Law 112-25). Although outlays are projected to decline from 22.8 percent of GDP in 2012 to 21.5 percent by 2017, they will still exceed their 40-year average of 21.0 percent. (Outlays peaked at 25.2 percent of GDP in 2009 but have fallen relative to GDP in the past few years.)"

The total federal deficit, which was $1.089 trillion in 2012, is expected to decline to $430 billion by 2015.

It is quite clear, based on these estimates from the CBO that the take down of the deficit from $1.089 trillion to $430 billion will be on the backs of taxpayers.

Of course, these are all just estimates and subject to change but are based on the current laws that govern taxes and spending as of February 5th, 2013.

However, the CBO estimates that gross domestic product will grow in the following 3 years as follows:

  • 2013: Nominal 2.9% Real 1.4%
  • 2014: Nominal 4.4% Real 2.6%
  • 2015: Nominal 6.2% Real 4.1%

Herein lies the problem, I'm fearful those estimates simply don't come to be.

Economist and historian Martin Armstrong has a unique definition of a unique term.

"Asset-Class-Shift Deflation - takes place when one earns say $1,000 and that remains unchanged, however taxes rise diminishing the available funds for discretionary spending producing a decline in economic activity that is deflationary based on the reduction in disposable income. The higher taxes move, rents, healthcare, or other non-discretionary spending, the lower the economic growth in proportion to the decline of discretionary spending."

That's the money shot right there. These tax increases will put a large amount of stress on discretionary spending from eating out to sending your kids to summer camp or filling up your gas tank and visiting your grandkids.

While I can appreciate we need to be able to keep our debt holders, especially our foreign debt holders, both confident in holding Treasuries and more important, confident to continue to be buyers of our Treasuries, we need to be fiscally responsible. We need to show plans that we will be fiscally responsible. That's what the CBO just did.

Here is a chart of foreign and international holders of our federal debt:

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Another very important factor is the rate of interest bond holders are willing to accept on their Treasury holdings. Currently, the 10 year Treasury bond yields just 1.89% as of March 1st.

Here is a long term chart of the constant 10 year Treasury yield:

(Click to enlarge)

My observations are that the tax increases will prove deflationary, meaning prices will not rise and may even fall in some categories because aggregate demand should prove to be weak. This would prove bad for nominal growth of GDP and will likely put us in a recession, which the CBO does not anticipate in its forecasts.

This may well prove strong for the dollar during these next 3 years. Very weak aggregate demand will keep inflation low, so the pain of holding dollars earning zero interest in savings accounts may not be limited. At the same time, asset prices may fall across the board from the major U.S. equity averages like the S&P 500 (NYSEARCA:SPY) or the Dow Jones Industrial Average (NYSEARCA:DIA) during these next 3 years, providing long term investors far better buying opportunities.

As for bonds, we may begin to see some deterioration in confidence in U.S. Treasuries if tax revenue estimates come up short and that may well cause rates to reverse their long term down trend and start going higher. Higher interest rates would be bad for long term bonds like iShares Trust Barclays 20+ Year Treasury Bond Fund (NYSEARCA:TLT).

Cash and high quality durable good should be ok to park funds during these next 3 years while you can await better investment opportunities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.