Goldman Sachs Says Tax Rise May Erase U.S. First-Half Growth

Failure by Congress to extend Bush- era tax cuts even temporarily may erase U.S. economic growth in the first half of next year, according to Alec Phillips, an economist at Goldman Sachs Group Inc.

Gross domestic product would be cut by almost 2 percentage points if Congress fails to extend the tax cuts, due to expire Dec. 31, along with temporary tax credits under the 2009 stimulus bill as well as relief from the alternative minimum tax, Phillips calculates.

Even a temporary lapse in the tax provisions “would essentially wipe out most of the modest growth we expect in the first half of 2011,” Phillips wrote in a research note released yesterday. He said in a phone interview that a higher tax rate in the first two months of the year would have that effect.

Bank of America-Merrill Lynch’s global strategy group also issued an update yesterday predicting that “Congress will be gridlocked through year end.”

“Having consulted BofAML legislative advisers, it is now the view of U.S. Equity Strategy that Congress is unlikely to pass any tax package before the Bush tax cuts expire at 2011 start,” David Bianco, the firm’s chief U.S. equity strategist, wrote.

‘Fear of Tax Hikes’

“The fear of across-the-board tax hikes in 2011 is likely to constrain growth” in both household spending and business hiring and capital expenditures in the fourth quarter of 2010, Bianco said. He said the “The setback to confidence is likely to prevent” the Standard & Poor’s 500 Index from reaching a forecast target of 1,300 points.

President Barack Obama and most Democrats want tax cuts enacted under former President George W. Bush extended for individuals who earn less than $200,000 a year and couples earning less than $250,000. Republican leaders in Congress want the tax cuts extended for all income groups.

Democratic Senators Dick Durbin of Illinois and Tom Harkin of Iowa today expressed doubt the Senate will vote on extending the cuts before leaving to campaign for November elections.

“I see the value of a vote, but given the short time- frame, it may be difficult,” Durbin, the second-ranking Democrat, said in Washington. He said legislators are “so tightly wound up in this campaign” that a bipartisan agreement won’t be reached as the House may adjourn as early as next week.

Goldman Sachs’s Phillips predicts Congress will allow the tax cuts for the wealthiest Americans to expire while extending middle-class tax cuts, the “Making Work Pay” payroll-tax credit and relief from the alternative minimum tax.

‘Prospects Uncertain’

“However, with essentially no congressional action to date, the prospects for such an extension are uncertain,” Phillips wrote.

Goldman Sachs this month forecast economic growth at a 1.5 percent annual rate in the first quarter of 2011 and 2 percent in the second quarter, according to a Bloomberg News survey.

Delaying a vote on the tax cuts also may hurt confidence among business owners and consumers, said Ethan Harris, head of North American economics at Bank of America-Merrill Lynch in New York.

“It’s about psychology, and I think it’s already happening right now,” Harris said in an interview. “Why is the corporate sector unwilling to engage here? I think the answer is there are too many uncertainties.”

Most likely, Congress will wait “until the last minute” this year to reach an agreement, Harris said. If they delay into February, that would be “enough to put the economy easily into a recession in the first quarter,” he said.

Cuts Into GDP

Letting all of the roughly $270 billion in tax cuts lapse would subtract almost 10 percentage points from annualized disposable income growth in the first quarter of 2011, Phillips said in his note. That could reduce final demand by about 2 percentage points in the first half of 2011 and cut gross domestic product by almost the same amount.

Income tax rates now are at 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. If Congress doesn’t act, they’ll revert to 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent.

To contact the reporter on this story: Courtney Schlisserman in Washington cschlisserma@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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