11/17/2010 05:31 pm ET Updated May 25, 2011

If Tax Cuts Expire, Sayonara Obama

In Hamlet, it's to be or not to be.

On Wall Street and in Washington, no Shakespeare -- just extend or not to extend, that is the Bush tax cuts, which expire at year end.

That's what's on the mind of many concerned market watchers, who worry such an expiration, including the higher-income bracket ($200,000 and up), would further damage a weak economy and pummel the market.

David Wyss, the chief economist of Standard & Poor's, takes it one step further. "No extension and we'll slip back into a recession and the stock market will take a big hit," he tells me.

But such worries at the moment seem for naught. Wyss, for example, is convinced, along with many of his peers, that imminent expiration of the tax cuts is all but out of the question. He expects a compromise and predicts there'll be a two to three year temporary expansion across the board for all income brackets.

There were actually two tax bills enacted during the presidency of George Bush Jr. The first, which took place in 2001 and was designed to lower tax brackets across the board, managed to increase aggregate income by approximately 4% between July 2003 and July 2004. The second one, enacted in 2003, was designed to lower taxes on capital gains and dividends to encourage saving and investment.

The growing view of a number of investment pros is that some kind of an extension of the tax cuts, perhaps one excluding the rich, is pretty much of a sure thing.

London money manager Marcus Raab of Raab Associates is one of those who holds such a view, arguing that the initiation of higher taxes during the U.S.'s faltering economy would be equivalent to Obama saying farewell to the presidency in 2012.

Madeline Schnapp, the economics chief of West Coast liquidity tracker TrimTabs Research, also sees an extension, contending that raising taxes in this environment would be equivalent to political suicide. The implications of no extension would be ominous, she observes, pointing among them, to such harmful ramifications as:

--The creation of a $500 billion tax hike in 2011, with some estimates running as high as $750 billion.

--A much higher budget deficit, which would stay at around its current $1.35 trillion instead of dropping to around $900 billion.

--GDP growth next year of only about 1.5%, versus a generally expected 2.5%.

On the plus side, says Schnapp, if the cuts are extended, look for wages and salaries to go up a bit, lending standards to be eased somewhat and the case for positive economic growth reinforced.

As a result, Schnapp figures the Administration will likely kick the tax can down the road by about a year.

What, you may wonder, are the effects of the tax cuts expiring for the rich? A study conducted by Christina Romer, one of Obama's top economic advisers, shows that if taxes rise by $100 billion to $200 billion, which is 0.6% to 1.4% of GDP, then real GDP would be lowered by $300 billion to $600 billion.

Since GDP is currently 14.7 trillion, that $300-$600 billion reduction would lower GDP to $14.4 trillion to $14.1 trillion, representing a 2% to 4% decrease from the current GDP annual growth rate of 3.1%.

In sum, a $100-$200 billion increase in taxes could lower that 3.1% rate to 1.1% or to negative 0.9%.

As far as a temporary extension of the tax cuts goes, Jason Huntley, the chief investment officer of Mars Hills Partners ETF in Colorado Springs, Col., figures it's no big deal since, he says, it's already expected and priced into the market. And if there is no extension? Huntley sees a further rally in the dollar, continued weakness in the stock market and some rush selling to lock in lower tax rates.

The bottom line: No doubt you'll soon be hearing and reading a lot more in the days ahead about extending or not extending the Bush tax cuts, the pros and cons and all the non-stop Congressional bickering that will go along with it.

But as Raab sees it, "the handwriting is on the wall for an extension unless Obama relishes Russian roulette."

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