If Bush-era tax-bracket reductions disappear, so will bank deposits, according to Market Rate Insight.
Bank deposits will fall by $200 billion for each 1% increase in the ratio between tax and personal income. In August, the national ratio was 9.23%. In June 2001, prior to President Bush’s tax cuts, the ratio was 14.76%. A return to that level would mean banks would collectively lose more than $1 trillion in deposits, putting an additional strain on economic recovery. As of September, banks’ deposits totaled $7.6 trillion, according to MRI.
“At a time when the idea is to encourage lending, it’s counterintuitive to reduce the deposits upon which institutions lend,” said Dan Geller, executive vice president at MRI in San Anselmo, Calif.
It isn’t just rich folk who will feel the pinch—tax brackets’ return to pre-2001 levels would affect everyone. “If tax cuts aren’t extended, people will need to take money out of their deposits to pay higher taxes,” Geller explained.
The Bush cuts accounted for a 42% variance in deposits, or in other words, 42% of the subsequent gain in deposits can be attributed to the 2001 tax cuts, Geller said. Other factors include interest rates on deposits and inflation. “The message is very simple,” said Geller. “If tax cuts are not extended banks should expect a reduction in deposits starting in the first quarter of next year.”
The best advice for advisors’ clients is to keep some money liquid in order to pay the potential increase in taxes, either in a short-term CD or a money-market fund. “Don’t lock in money because people don’t know what their tax liability is going to be,” Geller said. “Keeping some assets liquid until January is advisable.”
It’s still possible that Congress will vote to retain the current tax levels, but Congress isn’t obligated to do anything. If it does nothing, Bush’s tax cuts will expire Dec. 31 at midnight.