The U.S. economy shrank for the second quarter in a row this year, signaling the start of a recession. But what kind of recession is this? And how would a slowdown affect taxes?
In fact, it’s a “technical recession,” said Viraj Patel, the New York-based managing director and head of asset allocation at Fiduciary Trust International. By “technical,” he says that GDP might have fallen off for two consecutive quarters, but not every part of the economy is shrinking. In fact, the six variables used by the National Bureau of Economic Research to make a recession determination have been positive rather than negative since December.
“There are many variant perceptions here,” Patel said, “as traditional indicators such as unemployment, output, income and so on are still fine and not indicating a recession.”
Much of the economic turmoil has to do with lingering distortions from the Covid-19 pandemic, including problems related to trade, inventories and housing.
No matter how it shakes out, however, whether it’s a downturn or recession, taxes are going to be affected, since governments turn to either tax cuts or tax increases to deal with the fallout from economic problems.
“Many people believe … that recessions occur because of insufficient taxation or that government can or should tax us out of them,” said Peter C. Earle, economist at the American Institute for Economic Research. “In fact, recessions are when taxes should be either lowered or removed to let markets function and kick-start both production and consumption.
“When production and consumption drop, as occurs in a recession, taxes based upon consumption—sales taxes, mostly—fall,” Earle added. “Officials are likely to try to find ways to make up for the shortfall by raising various taxes and fees—at the worst possible time.”
He specifically noted the current Inflation Reduction Act—now working its way through Congress and recently approved by the U.S. Senate—as a good example. The legislation has some major tax provisions, such as a 15% minimum tax on the book income of companies.
Businesses carrying too much debt may find their deduction for the interest expense associated with this debt curtailed because of the legislation.
“The limitation to deduct interest is modified for 2022 and will make it more difficult to deduct the full amount of the interest incurred,” said Jim Brandenburg, a Milwaukee-based tax partner at the professional services firm Sikich.