What’s Ahead for 2009

First the bad news: The consensus among economists is that we are in a recession. Now the good: We’re likely seeing the worst of it now, and growth may return in the second half of 2009.¹

Heading into a new year, many Americans may be concerned about the potential for prolonged economic pain and are hoping for a return to prosperity and better fortune. Additionally, the incoming administration will bring a new set of economic and tax policies that are likely to affect the finances of most Americans in some way.

What’s Going On

Recessions are difficult to detect until several months after they begin. However, a range of current economic indicators is pointing toward a recession. Chief among them is the 0.5% contraction in gross domestic product (GDP) in the third quarter of 2008.² Economists expect a deeper decline in the fourth quarter. GDP represents the value of all goods and services produced in the United States and is widely regarded as the best way to get a snapshot of recent economic activity. The simplest definition of a recession is two consecutive quarters of negative GDP growth.

The employment situation is also pointing toward a recession. The economy shed more than 1.2 million jobs in the first 10 months of 2008. The unemployment rate climbed to a 14-year high of 6.5% in October 2008.³

What’s Ahead for GDP and Employment

In The Wall Street Journal Economic Forecasting Survey, which is based on the average responses of 54 economists, respondents expected GDP to shrink at a 3% annualized rate in the fourth quarter of 2008, followed by a shallower 1.5% decline in the first quarter of 2009. They called for GDP to grow at a slight 0.3% annual rate in the second quarter of 2009, marking the beginning of a slow recovery.⁴ However, the WSJ economists also project that the unemployment rate will climb to 7.7% by the end of the 2009.⁵

In the Federal Reserve Bank of Philadelphia Survey of Professional Forecasters, 51 panelists predicted a 2.9% drop in GDP for the fourth quarter of 2008, then a further decline of 1.1% in the first quarter of 2009 before conditions improve. They predicted a year-over-year contraction of 0.2% for 2009 and foresaw a jobless rate of 7.7% by the end of 2009.⁶

Overall, economists supported government efforts to stimulate the economy. More than 80% of economists in The Wall Street Journal survey favored a stimulus package in January or earlier, and 34% said permanent tax cuts should be the top priority in any economic stimulus. Based on the average response, they indicated that the total size of the government’s response this year and next should be more than $250 billion.⁷

Presidential Policy Shift

During the campaign, the incoming administration proposed several immediate and long-term policy changes that could have a wide effect on the economy. If enacted, several of these proposals are almost certain to affect your situation.⁸

Increasing the top marginal income tax rates: The new administration has proposed making permanent the 10%, 15%, 25%, and 28% marginal income tax rates and brackets, which were reduced to their current levels in 2003 and are slated to expire after 2010.

The top marginal rates, currently at 33% and 35%, would return to their pre-2001 rates of 36% and 39.6% for single filers earning more than $200,000 and couples earning more than $250,000. The personal exemption amount and itemized deduction phaseouts for these same taxpayers would also be rolled back to levels that were in place in the 1990s.

New taxes on capital gains and dividends: A new 20% tax rate on long-term capital gains would apply for individuals earning more than $200,000 and couples earning more than $250,000. A new 20% top rate on dividends would apply to people making more than $250,000. Individuals earning less than these amounts would continue to pay taxes on dividends and long-term capital gains at the current rates.

A permanent estate tax: It’s unclear whether the currently scheduled one-year repeal of the federal estate tax will be allowed to take place in 2010, but the new administration has proposed a permanent 45% tax rate on estates larger than $3.5 million ($7 million per couple).

Among other new proposals to deal with current economic conditions:⁹

• Penalty-free hardship withdrawals in 2008 (retroactively) and 2009 from IRAs and 401(k) plans of 15% of the account balance up to a $10,000 limit. Ordinary income taxes will still be due on the amounts withdrawn, but the 10% penalty would be waived for withdrawals prior to age 59½.
• Temporarily allowing individuals older than age 70½ to delay required minimum distributions from tax-deferred retirement programs.
• A permanent tax cut of $1,000 for families ($500 for single filers) making less than $250,000 ($200,000 for single filers), which could possibly arrive in the form of rebate checks in early 2009. (It’s worth noting that this proposal is for a permanent tax cut; most tax laws passed in recent years have had expiration dates).
• Extending unemployment benefits by 13 weeks.
• A $3,000 refundable tax credit for businesses that hire additional full-time employees in 2009 and 2010.
• Extending the $250,000 small-business expensing limit through 2009.
• A 0% capital gains tax rate for investments in small businesses.

Now is a good time to consider how the current economic conditions and upcoming policy changes could affect your long-term financial situation. We can help you consider strategies that take the changing economy and potential policy shifts into account.

1, 5, 7) The Wall Street Journal, November 13, 2008
2) Bureau of Economic Analysis, November 25, 2008
3) U.S. Bureau of Labor Statistics, November 7, 2008
4) The Wall Street Journal Economic Forecasting Survey, November 2008
6) Survey of Professional Forecasters, Federal Reserve Bank of Philadelphia, November 17, 2008
8–9) BarackObama.com

This material was written and prepared by Emerald Publications.
©2008 Emerald Publications