Making The Recession Last Forever

The latest edition of Forbes Magazine has an interesting cover story by Janet Novack and Brian Wingfield. They assert that, as soon as the economy begins improving, Washington will institute new measures to knock business back down a few pegs. That potentially includes higher corporate taxes, cap and trade, health care play-or-pay provisions, etc. Their argument is compelling. If they're right, Congress could fall into the same trap that kept us from exiting the Great Depression sooner.

The article says:

When Washington was putting trillions in bailouts and stimulus on Uncle Sam's credit card, many business leaders applauded (or at least stuck out their hands for the cash). Now, with the economy seemingly back from the brink, the cheering has stopped and the defensive game is on. Someone, after all, must pay for all that emergency deficit spending; for the $46 trillion (net present value) of Medicare and Social Security benefits already promised but not funded under current law; for renewing some of the expiring Bush tax cuts and containing the growth of the dreaded alternative minimum tax. Moreover, someone must pay for the Democrats' expensive shopping list: covering 46 million Americans without health insurance; mandating paid sick leave; moving to a low-carbon economy; and adopting tougher consumer, worker and investor protections.

Their logic is pretty simple. As soon as the power residing in Washington realizes that the well isn't dry, they'll try to fill up their bucket. The problem, however, is that if there's only a bucket's worth of water available when they do it, that won't fare well for the rest of the economy.

If they're right, then I see a few consequences that will result. The first is that markets are likely to anticipate Washington's actions. That means political risk will be historically high for quite some time. As a result, investment will be stunted, stock prices will trend lower and the private sector will have an even harder time clawing its way out of the hole.

Yet, at this time, the article indicates that the market has failed to realize its fate:

The stock market, now trading at 134 times trailing earnings, can be justified only with the presumption that profits will snap back to pre-2008 levels as soon as the recession ends. That may be a naive presumption. No sooner will there be a recovery in corporate profits than Congress will find ways to snatch them away.

That could make for a market crash in a year or so if Washington follows the path this article predicts.

If Congress raises corporate taxes, either through the tax code, or through back-door taxes like cap-and-trade, then the revenue that would have been reinvested to produce new growth won't be there. Companies won't be able to hire new workers and unemployment will remain high, or go back up if it began to modestly decrease.

I'm sure someone will disagree with me when I blame tax hikes, like the Revenue Act of 1932 for having been one of the factors that prolonged the Great Depression. That's a debate for another time. But if you accept that tax hikes hurt an economy, then it's pretty easy to see the possibility of history repeating itself.