Tax Hike Could Aid Economy, Analysts Say
But the type of levies raised hold the key, they add. REDUCING THE DEFICIT
NEW YORK — IN economics, as in much of life, timing is everything. So is this the right time for a tax increase?
Economists say the answer depends on the size and shape of any tax hike agreed to by budget negotiators who plan to start the process May 15.
If the tax increase is modest, it may only slow the economy down a smidgen. As Douglas Lee, chief economist for County NatWest in Washington, says, ``There won't be a net effect if it is managed properly.''
And what is the right way to manage a tax hike?
By keeping it small and focused. ``A tax increase of $15 to $20 billion will only make a small dent in a $5 trillion economy,'' Mr. Lee says.
Even an increase of $25 billion a year over the next four years will not drive the economy into a recession, says John Paulus, chief economist at Morgan Stanley & Co. ``Those people who claim deficit reduction will lead to recession are not being honest,'' Mr. Paulus says.
If the deficit reduction took place in one year, he admits the effect would be dangerous to the economy. But, Paulus says, ``It is a multiyear adjustment process.''
However, there is a risk if tax hikes get out of control. A large tax increase, or an increase that harms the national psychology can be dangerous, economists warn. (Property tax revision riles voters in Kansas, Page 9.)
Mickey Levy, chief economist at First Fidelity Bancorporation, says increased corporate taxes or an increase in the capital gains tax would cause him ``great concern'' because it would increase the cost of capital. And Lincoln Anderson, an economist at Bear Stearns & Co., a Wall Street broker, cautions that an increase in marginal tax rates on individuals would be a negative influence on United States growth prospects. Marginal tax rates are the highest rate an individual pays.
Raising taxes on the wealthy could actually hurt the economy, contends Alan Reynolds, director of research at the Hudson Institute, an Indianapolis think tank. For example, Democrats are eager to end the so-called ``bubble'' that allows the wealthiest to pay a 28 percent tax rate instead of a 33 percent rate. Yet, Mr. Reynolds notes this would raise the wealthiest taxpayers' rate by nearly 18 percent. ``This is a big hit, and it would cause a lot of stir and a bad economic effect,'' he says.
There is even an inflation risk to raising taxes, says Sung Won Sohn, chief economist at Norwest Corporation in Minneapolis. If the negotiators, for example, should decide on a tax on imported oil, or an addition to excise taxes on alcohol, cigarettes, and gasoline, this increased cost will show up in higher consumer prices.
But these higher prices won't last long, Reynolds says. ``There will be a temporary increase while the economy absorbs the higher level,'' he explains.
If the gasoline excise tax is raised, Reynolds points out it will mean manufacturing costs will rise. This makes the US less competitive. It also lowers real incomes as individuals dig deeper into their pockets to pay for gasoline. But Reynolds figures another dime increase in the gasoline tax ``is only modestly bad.''
For the most part, economists are cheered by the prospect of the budget deficit coming down by a revenue increase. They reason this will reduce pressure on the Federal Reserve Board. Whenever chairman Alan Greenspan testifies before Congress, he complains about the size of the deficit.
Gary Ciminero, chief economist at Fleet/Northstar Financial Group in Providence, R.I., says there is circumstantial evidence the Fed would ease interest rates if the deficit is reduced. ``It is what everyone says, and the Fed doesn't dispute that,'' he says.
A significant decline in the deficit, says Mr. Sohn, could reduce long-term interest rates by one to one and half percentage points. Thus, mortgage rates, currently close to 11 percent, could fall below 10 percent.
A drop in the budget deficit will also help the lagging national savings rate, says Bruce Davie, an economist at Arthur Andersen & Co. in Washington. The deficit is counted as consumption. Cutting the deficit means increasing the savings rate and ``making more available for bricks and mortar and other good things,'' he says.
Past tax increases have rarely forced the economy into a slide. In the 1930s, the marginal tax rates were high, prompting some economists to speculate the Great Depression lasted longer than necessary. And Reynolds believes the high rates of the '70s resulted in a period of stagnation. But it did not suck the economy into a recession - something budget negotiators will be aware of.