The Cliff, The Deficit and What It Means To You

A few weeks ago (the December 8th entry) I told you that the world wasn’t coming to an end because of the Fiscal Cliff. I said that “it is HIGHLY UNLIKELY that every tax increase and spending cut will, in fact, come to pass. Some compromises will certainly be made by our leaders in Washington, despite the radical bleatings of the far right and far left. Whether the deal is brokered in the next two weeks or the next two months, I’m confident a deal will be made that will leave both sides less than happy but will stave off the worst result, which would be simply doing nothing.

As I predicted, a deal was struck with much fanfare and with thundering applause from Wall Street which rewarded the hack show by staging a huge two-day rally. That’s the good news. The bad news is that the deal accomplished virtually nothing for the long-term health of our economy. It is simply a tiny band aid on a festering wound. It feels better now but it does nothing to stop the internal bleeding.

The bigger problem is looming: the fight over the deficit and increasing the debt ceiling. And this time, the Republicans in Congress hold the power. Mr. Obama is going to have to negotiate legitimate spending cuts in Social Security, Medicare/Medicaid and other sacred cows whether he wants to or not. I don’t think there’s really any way to avoid it much longer. It’s time to take the medicine. It’s past time for America to tighten its collective belt and start living within its means. As anyone who runs a household or a business implicitly understands, you simply cannot spend more than you earn, going deeper and deeper into debt. Eventually, you either go bankrupt or someone breaks your kneecaps. I believe the national debt is now approximately $17 trillion, give or take a trillion. It’s time to start to reducing this of our own volition before our creditors force Greece-like austerity measures down the road.

But before we get to the debt ceiling drama, let’s see what the Fiscal Cliff agreement means to you and your money. First of all, if you make less than $400,000 (or $450,000 as a couple), you should be pretty happy. The only real change for you is your payroll taxes will rise 2%. The dividend and capital gains taxes remain at 15% and your income tax levels remain where they are. For those high income citizens, you will face the same 2% payroll tax increase, plus you’ll be subject to a higher tax bracket and capital gains and dividend taxes of 20%. None of this is end-of-the-world stuff. The estate tax exemption remains at $5 million which is good news for everyone. So, in the end, this really isn’t a horrible agreement; it could have been much worse. But the flip side is that while it isn’t bad for people, it’s bad for the government as it actually reduces its long-term tax receipts. Hence the looming fight over the deficit.

And what does all of this mean for our investments? The agreement on the capital gains and dividend tax rates are a plus for the stock market. The higher estate exemption is also good for the market. Any increase in payroll taxes, or income taxes, is a net negative, but it really isn’t a huge problem. So for now, we’re ok. We just need to listen to the rhetoric about the deficit and pay close attention to what kind of spending cuts are forthcoming because that will directly affect the economy, which will immediately impact the stock market. So stay tuned.

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Musings on Death and Taxes

Last night my family enjoyed our blended holiday celebration. We shared gifts, laughter and hugs and kisses just days after an entire community was devastated by the horrific act of a madman and less than two months after Superstorm Sandy cut a path of devastation through much of the New York/New Jersey area. There are 27 families in Newton, CT who will not be celebrating the holidays this year as they mourn the loss of their children or siblings or parents. And there are likely hundreds of additional families still homeless or trying to piece their shattered lives back together. It truly makes you appreciate life’s blessings and reminds you to never take them, or your loved ones, for granted.

This random act of senseless violence in the Newton massacre once again brings the issue of gun control front and center. It’s hard to understand how any logical, sane person can oppose the idea of keeping automatic and semi-automatic weapons of mass destruction out of private hands. The Founding Fathers, when they crafted the 2nd Amendment to the Constitution, never envisioned weapons such as these. There is simply no place for them in civilized society. Period. I challenge any gun advocate to reply with a cogent reason why those types of weapons should not be banned. It’s time for our politicians to stand up to the NRA, and the rest of the gun lobby, and loudly proclaim that enough is enough; that they will not be bullied any longer and that’s it’s time for a national debate on what weapons can and cannot be owned by private citizens. President Obama, if you’re reading this, since you are not up for re-election, it’s your job to take a stand and get something done.

And Mr. President, while I have your attention, it’s time to get a deal done on the Fiscal Cliff. Enough is enough. Both sides MUST stop the posturing, eliminate all the partisan BS and craft a compromise that the entire country can live with. It shouldn’t be that difficult. You all have to agree that taxes will go up on many, if not all Americans. And those tax increases will likely be tilted towards those Americans who make the most money. Republicans, just accept it and move on. And at the same time, the government must spend less. There is simply no alternative. Democrats, deal with it and move on. So lock yourselves in a room until an agreement is reached. Because if you can’t get this deal done, then as a nation we are truly screwed because the bigger debate is forthcoming.

What nobody is talking about is that the Cliff negotiations are just the first act in what will be a much more contentious debate over the big issues of what to do with Medicare and Medicaid and Social Security. Those expenditures represent about 41% of the entire federal budget. Throw in another 15% or so for the military and you see that those three programs account for a staggering 56% of the entire $3.5 trillion spent by our government. Cutting a billion here or a billion there is simply noise. We, as a nation, must accept that we have been living well beyond our means for far too long. That unless we want to leave our massive debts for our children and grandchildren to deal with, leaving them with far diminished prospects and lives to that which we’ve enjoyed for so long, we must all make sacrifices for the common good. As a society, are we ready to do that? We’ll find out. And in the meantime, let’s talk about it. Write to me and let me know what you think.

 

Prepare For Year-End, Not the Fiscal Cliff

There are three weeks left in the year and the world won’t be coming to an end, literally or figuratively, regardless of what the various doomsday prognosticators have to say. It’s impossible to turn on the television or open a newspaper without being assaulted with dire warnings about the impending disaster that is the “Fiscal Cliff”. It’s gotten to the point where I can only watch CNBC is when it’s on mute.

For those of you who’ve been living under a rock, the Cliff is the December 31st deadline after which substantial tax increases and mandatory spending cuts will take effect. The tax increases are largely from legislation passed by President Obama to pay for his health care program along with the end of the Bush tax cuts. The spending cuts were mandated during the last failed deficit negotiations. It’s been estimated that should all of these tax increases and spending cuts come to pass, it will shave 4%-5% from GDP growth, sending the country into a deep recession.

While I’m growing more and more angry and frustrated (if that’s even possible) at the intransigence emanating from both parties in Washington, I honestly don’t think the looming fiscal cliff is really the nightmare everyone is saying it will be. It is HIGHLY UNLIKELY that every tax increase and spending cut will, in fact, come to pass. Some compromises will certainly be made by our leaders in Washington, despite the radical bleatings of the far right and far left.

Whether the deal is brokered in the next two weeks or the next two months, I’m confident a deal will be made that will leave both sides less than happy but will stave off the worst result, which would be simply doing nothing. It is truly in the best interests of everyone, other than perhaps that fiscal terrorist Grover Norquist, to get a deal done. There is simply too much self-interest in Washington, especially in the House of Representatives, where they must stand for re-election every two years, to allow a fiscal calamity to happen on their watch. That’s a great way to get thrown out of office by a pissed off electorate.

So if we’re able to drown out the noise about the cliff, what should you be truly focused on between now and the end of the year? Given all of the current uncertainly, there are no simple answers, but here are a few suggestions for you to ponder:

  1. If you have large unrealized gains, consider realizing some of them this year to take advantage of the low capital gains tax rate, which is likely to rise next year.
  2. If future capital gains taxes aren’t really an issue, don’t forget to match gains with losses where possible to minimize your tax bill this year.
  3. Check your portfolio to see if your holdings need to be re-balanced. Avoid having any one position be too large a percentage of your overall holdings. I generally like using 10% as a maximum position size. Similarly, either add to, or get rid of, positions that are simply too small to make a difference.
  4. If you have a large estate, consider making gifts of up to $5.1 million before year-end to take advantage of the large estate tax credit that expires this year. Unless a compromise is reached, it reverts back to $1 million next year.
  5. Speak with your adviser to make sure your investments are suitable for your financial objectives and risk tolerances. Times and conditions often change, and our investment approaches sometimes must change as well.
  6. If you don’t have a will; write one. If you have a will, but haven’t updated it in more than five years, it’s probably time to look at it again.
  7. If you haven’t already done so, consider giving some of your time and/or money to a worthwhile charity. There are so many organizations out there that desperately need your help, especially during the holidays. So open your heart and your wallet and make a difference for those in need.

Post Election Traumatic Stress Disorder

This is an excerpt from my latest newsletter.

About the only good news these days is that the election is FINALLY over. In my Fearless Forecast edition back in January I said “I believe President Obama will defeat Mitt Romney in a relatively close election as a divided GOP is unable to coalesce behind Romney. The Tea Party is marginalized and the Senate remains in Republican control. Fiscal austerity, job creation and tax policy are the main debate points.” I’d say I nailed that one right on the head. Now, Obama and the lame duck Congress MUST figure out a way to avoid pushing this country over the “fiscal cliff”. Should every possible tax increase and spending cut go through, the 4-5% reduction in GDP would push the United States into a deep recession. But I believe that the self-preservation instincts of our politicians won’t allow that to actually happen. Somehow they will figure out how to avoid the cliff. It’s likely that they’ll compromise on some easy tax increase wins and entitlement cuts then push the harder decisions into next year to let the next Congress fight it out. And the sooner they do this, the better for the stock market, which hates uncertainty.

At the end of the day, I don’t think the results of the election will change things very much. We still have a left-leaning president with no real mandate and a divided Congress with a weakened Tea Party. That’s a great prescription for more of the same where there’s lots of talk and very little real action. I think the best we can hope for, in the short run, is some modest compromise and lots of procrastination. Looking longer term, I truly hope the President looks to his legacy and makes a real effort to articulate a tax and spending policy that makes sense. If he does, the Republicans will be forced to the table and maybe a plan that can save us from becoming Greece and Spain can be shaped. Or not.

What is really sad is how little confidence I, and so many people I talk to, have that our leaders will really work together to shape an intelligent policy that will hurt everyone a little in the short run but help us all in the long run. There will have to be tax increases. There will have to be spending cuts. There will have to be reductions in entitlement programs. Many good programs will have to be cut back or eliminated. People will lose their jobs, especially those in the government.

Unfortunately, standing in the way of what must be done are the special interests and the lobbyists, the ones with the real money and power. These groups have too strong a voice in what happens in this country. It really is no longer about “we the people”; it’s “we with influence”. Maybe someone in Washington will show some courage and leadership and prove me wrong and do what’s right, even if it isn’t what’s popular. I hope so, but I’m not hopeful.

Thoughts on the 1st Presidential Debate

Last week President Obama and challenger Mitt Romney squared off in the first of three debates. It is widely reported that Romney “won” the debate and gained some momentum in his otherwise stagnant campaign. Personally, I thought Romney came off as a bit more forceful and more conversational than I had seen him previously, while Obama didn’t seem to bring his A game. That being said, I don’t think it will swing the election to Romney; I still believe Obama will win a tight race.

Clearly Romney was prepped very well. While both candidates hammered their messages wherever possible, the former governor appeared more decisive and engaged. A few thoughts:

  • Romney asserts that his energy program would create 4 million new jobs. That’s an absurd claim and one that he never bothered to back up with any facts. Even more implausible was his proclamation that he would somehow create 12 million total new jobs. We are creating around 125,000 jobs a month now. If we double that, which isn’t likely, it would take five years of uninterrupted growth to get there. Does that seem reasonable to you? It simply can’t happen.
  • Throughout the debate Romney tried to position himself as the champion of the middle class, which after his 47% remark came off as a bit disingenuous to me. That being said, he was absolutely correct when he said that price increases crush the middle class. That is the brutal effect of inflation.
  • Romney was clearly pandering to middle America by claiming to support coal, which is on its way out as an important power source in this country. It is too dirty and has been supplanted by cheaper natural gas.
  • Romney hammered Obama for proposed tax cuts on the military. The truth is that our military budget is larger than the next dozen countries combined and can easily be reduced without sacrificing our defense one bit. Cuts must be made as part of a larger effort to reduce the deficit.
  • Romney was correct when he stated that raising taxes, as Obama proposes, will likely slow economic growth and stunt job creation. The best way to increase tax revenue is to broaden the tax base, not increase the tax burden. I also agree that we should move more spending from the national to the state levels.
  • I don’t understand how Romney can justify his opposition to Obamacare when it is build on virtually the same model as the health care program he instituted as the Governor of MA.
  • Obama correctly hammered Romney on his lack of specific details in his economic plans. It’s easy to say you’ll reduce taxes, add jobs and reduce the deficit. It’s harder to show how that’s actually possible. 
  • Romney had the best line of the night accusing Obama, with a nod to the Reagan-era, of “trickle down government”. I like that a lot.

Overall, Romney came across as better prepared, more on point and better engaged while Obama was hesitant and disengaged as he attempted to remain above the fray. I’m sure that will change with the next debate. Still, the debate is simply a beauty contest; more style than substance. It’s still Obama’s election to lose. And it’s one in which every American should vote because it affect’s your money and your life.

Pending Taxastrophe

Notwithstanding the chance that anything can change between now and January 1, we are facing a devastating barrage of tax increases next year. We face the expiration of the 2001 and 2003 tax cuts, the alternative minimum tax (AMT) patch, numerous tax extenders and various economic stimulus programs. If our elected officials do nothing between now and the end of the year, which is unfortunately quite likely, this taxastrophe could send our already weak economy right back into recession. Here are just a few of the problem areas:

  1. The five income tax brackets will move from 10% through 35% to 15% through 39.6%.
  2. The child tax credit will be lowered from $1,000 per child to $500.
  3. Education credits: Hope scholarship credits will be reduced or phased out. Contribution limits to the Education IRA will be reduced. Income levels for the phaseout of student loan interest deductions will be cut in half.
  4. High income taxpayers will see the return of the phaseout of certain itemized deductions.
  5. High income taxpayers will also be subject to the personal exemption phaseout.
  6. Thanks to dramatically reduced exemptions, tens of millions of additional taxpayers could be subject to the AMT.
  7. The estate tax will revert from $5.12 million with a top rate of 35% to $1 million with a top rate of 55%.
  8. The capital gains tax will rise from 15% to 20%. All dividends will rise to marginal tax rates from 15%. In addition, taxpayers with an AGI over $250,000 will be subject to an additional 3.8% tax on all investment income.
  9. Flexible Spending Accounts (FSA) will be less flexible and less helpful.
  10. Various tax extenders and economic stimulus programs will all expire.

What does all this mean to you and me? According to the nonpartisan Tax Foundation, a family of four with parents earning $75,000 each would pay $4,500 more in taxes and see their payroll tax increase by $3,000. To check out your own situation, you can visit http://interactive.taxfoundation.org/taxcalc.

It’s impossible to sugarcoat how bad this is. If nothing is done, our government will be vacuuming ever more money out of our pockets. That in turn will mean less we have to spend on other goods and services, which will mean our economy will likely contract into a recession.

Thanks to Phillips Hinch, August 2012 edition of the Journal of Financial Planning.

Taxes on Performance

Did you know that our US athletes can earn prize money for winning Olympic medals? $25,00 for a gold, $15,000 for a silver and $10,000 for a bronze. Good for them; they certainly deserve it. It wouldn’t bother me at all if they earned 10x that amount for the years (or decades) of sacrifice and hard work that they put in to become the best in the world at what they do. Most of us cannot comprehend what it takes to attain that level of excellence.

Now we find out that this income is subject to taxation like any other form of income. And why shouldn’t it be? Any money I make is taxed, as is any money that you make. Why shouldn’t the prize money Michael Phelps makes be taxes as well? Apparently, Sen. Marco Rubio, R-Fla., doesn’t agree. In a blatant attempt to gain national attention by pandering to the anti-tax crowd, Rubio introduced a bill yesterday in the Senate that would exempt U.S. Olympic medal winners from paying federal taxes on their medals and prize money earned in the Olympics. Rubio gushed that “Athletes representing our nation overseas in the Olympics shouldn’t have to worry about an extra tax bill waiting for them back home.”

Give me a break!! It’s not an “extra” tax bill. It’s a tax on earned income; the same tax paid by all of us. This is just another example of our moronic elected officials showboating for the cameras instead of worrying about the important issues we elected them to solve. Let’s hope this bill fails quickly and quietly and they go back to working on something important, like the federal deficit or the tax code.