One Man’s Opinion: Will Tax Hikes Push The US Economy Back Into Recession?

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Friday’s better-than-anticipated jobs number makes it a little bit easier for President Obama to hike taxes on the wealthy, says Barry Knapp, Head of Equity Strategy at Barclays Capital.

However, on close examination, you’ll see earnings-growth has been very tepid and total hours worked has remained flat.  In other words, every one-tenth of that total hours worked is worth 300,000 jobs in terms of income. That means income growth has been slow, but the unemployment rate coming down and a headline number stronger than expected does strengthen the President’s hand, Barry said.

Barclays is worried about getting a bad mix when the final deal is struck, he noted. The more you try to tax your way out of it, much like the Italians and the Spanish have done, the bigger the impact is on the macro-economy and on investors in particular, because obviously we are talking about capital gains rates and dividend rates. So, the latest report probably strengthens his hand and moves us a little bit toward an outcome that increases tax at the expense of really cutting entitlements, getting our long-term debt under control, Barry observed.

Asked to explain what’s better for the overall situation in the fiscal cliff debate and how markets are going to view a deal if its either predominantly geared towards entitlement spending cuts or predominantly geared towards tax hikes, Barry said the focus always seems to be on the timing on the deal but the bigger issue is if it’s a good deal or not.

If you look at Italy a year ago at this time, Mario Monti, the technocrat, gets named the Prime Minister and he comes out with a EUR 40 billion package. It’s two thirds tax hikes and one third spending cuts. Household debt-to-GDP is quiet low in Italy (In other words, private wealth to GDP is quite high, i.e. – it’s a wealthy population on a relative basis).

However, consumer spending fell four and a quarter percent on an annualized basis in the first half while government spending actually went up and the economy plunged into a recession, he observed.

So, we try to tax our way out of it, and we think it’s holy and effective, and if we look at the position of consumers in the US, the confidence is high because of the housing market recovery. But the savings rate has been drawn down to a level below the equilibrium level given the amount of wealth destruction that’s still taking place while income growth is slow. So we are not in a position to sustain a big tax hike, he opined.

Asked if the stock markets are factoring in a “no-deal” situation and going over the fiscal cliff in 2013, Barry replied in the negative. Measures of risk look quite low, nothing like they did a year ago this time.

A number of people look at consumer confidence readings and feel they are okay because consumers are deleveraged. But if we go over the cliff in January and those negotiations prove problematic, then there will be a macroeconomic effect that markets will wake up to.

The markets don’t have a great history of anticipating recessions anyway and do a much better job in picking up the bottoms of a recession, he noted. But sometimes it gets hit right between the eyes without expecting it, and we do think it’s likely the first move for the markets in 2013 will be down, Barry concluded. You can watch the video here.

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