Economy Shrank Fourth Quarter as New Taxes Loomed

0penniesAccording to a CNBC article the economy has posted a “stunning drop” in GDP, which the article describes as a “surprise” for the fourth quarter. Are you surprised? I’m not surprised. The “expected” Gross Domestic Product growth during the fourth quarter of 2012 was about 1%, however the GDP actually contracted by .1%. Although it is a small contraction, it is the first time the economy has shrank since the recession ended.

The article says that it could be some one time factors which are effecting the economy, such as the “biggest cut in defense spending in 40 years, fewer exports and sluggish growth in company stockpiles”.

And those volatile categories [government spending cuts and slow inventory growth] offset faster growth in consumer spending, business investment and housing — the economy’s core drivers of growth.

While these factors almost certainly contributed to the economic slowdown during the fourth quarter, they cannot completely explain away the GDP’s shrinking. We may be seeing the beginning of another recession.

This is because tax increases took effect at the beginning of January. Since the payroll tax has increased, families are taking home an average of 2% less income each year. And growth in consumer spending for the fourth quarter might not be as good as it sounds… the fourth quarter includes Christmas. Consumer spending will be a tough category to grow, based on the fact that consumers have 2% less money to spend due to the payroll tax hikes. The article claims that the growth rate could stay weak as people “come to grips” with the payroll tax increase, however even if the public comes to grips with the tax increase, there will still be less money for consumers to spend. And any money that may have been saved is almost sure to remain tucked away, as the tax increase has also led to a sharp decline in consumer confidence.

In regards to another one of “the economy’s core drivers of growth”, business investment may have little reason to grow in the months moving forward. Many businesses have reduced their inventories, such as Caterpillar, Inc. which “said this week that it reduced its inventories by $2 billion in the fourth quarter as global sales declined from a year earlier”. Inventory reduction is also seen as a sign of weak sales to come, and suggests a slowdown in factory production.

Adding fuel to the fire is the fact that capital gains and dividend taxes increased on January 1 for high income earners, from 15% to 23.8%. I would love to hear an explanation for how increasing the taxes paid on investment will spur business investment. In reality, it will harm business investment, because there is less to be gained from investing. This means less economic expansion, fewer new companies, and fewer new jobs.

The contraction in fourth quarter GDP growth for 2012 is more likely an omen of what is to come, rather than being caused by “one time factors”. As businesses and individuals accepted the fact that Obama’s reelection would mean tax increases, their behavior reflected the realization. Companies can’t hire because the costs associated with new employees are high, and growth in company sales are uncertain. It will be harder to find investors for innovation or expansion because of the increased taxation on investment income. Consumers will spend less as they take home less money, and become increasingly skeptical that the economy will bounce back. I believe these factors are what contributed to a fourth quarter economic slump. It is simply impossible to tax an economy out of a recession.

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