Tom Sedoric and Casey Snyder, Wealth Managers

What might you respond to an advisor who emphatically tells you that taxes will, without a
doubt, increase in the future? Would you thank them for being a wise fiduciary and for thinking
proactively to help you prepare for a future of potential economic and tax volatility? Or, would
you chide them for being so pessimistic and encourage them to improve their outlook and
attitude?

It won’t matter if you thank or berate because if you don’t prepare there will always be
consequences. We advisors pay close attention to the numbers because tax revenues, combined with other micro- and macro-economic factors, impact current and future financial and tax planning decisions.

We are not alone in believing that too many Americans are either misinformed or lack an elemental understanding about current tax structure. Do you recall the $1.9 trillion Tax Cuts and Jobs Act of 2017? Most Americans do remember, which is not surprising because it has impacted their subsequent tax returns and refunds. But do you remember the details of the legislation and how it exactly impacted your tax obligations?

The Devil Is in the Details

Knowing about the tax laws and understanding the basics are not the same. A 2018 survey of
2,000 Americans by NerdWallet/Harris Poll found that 26% didn’t know there was a new
tax law and 51% didn’t know that income tax brackets had changed. Another 2018
survey confirmed the following information gulf: GOBankingRates tested 501 Americans in a
simple, 4-question survey about key fundamentals of the new tax law. The result: 77%
failed the test on questions such as the amount of the new standard deduction ($12,000 for
single filers, $24,000 for joint filers), how many tax brackets there are (7), and what is the highest tax bracket (37%).

Our point isn’t to castigate our readers for not understanding the dense and complex tax
code. The tax code is purposefully complex and dense. Professionals work hard to keep up
with changing laws and it’s not easy to do with the array of conflicting rules and regulations.
What we do know is that it is critical to understand the basics and the impact on your taxes
and tax planning now. It’s equally important to take a macroeconomic view and calculate
how the law—and future reactions to it—might keep you “ahead of the curve”. Taxes are, and
will remain, an individual’s single largest lifetime expense.

The Impact of Changing Tax Laws

Since the 2017 changes in the tax law, some trends are coming into focus that will impact the nation’s debt and long-term tax planning decisions. For example, a few days before the government shutdown ended in February 2019, the Treasury Department released a report saying that tax revenues declined 0.4% in 2018. This drop came despite strong economic growth and the lowest unemployment rate in decades. It also helped push the US budget deficit in 2018 to $873 billion, an increase of 28.2% from 2017. The budget deficit reached $984 billion in 2019, and is expected to top $1 trillion in 2020.

The decline in tax revenues is easily explained. In addition to lowering rates for top individual
earners, the 2017 Tax Act cut corporate tax rates from 35% to 21%. Proponents of
the law said it would boost job and wage growth, and hence tax revenues, but these increases
have been modest. According to an April 2018 report by the research and ETF firm TrimTabs,
corporations spent $305 billion in the first quarter of 2018 on share buybacks, cash
buybacks, cash mergers, and $131 billion in wage growth.

A February story in the Washington Post on research work at Duke University and Grinnell
College highlighted another trend from the December 2017 Tax Act. According to the researchers, a $300 billion business tax break to allow for immediate equipment depreciation
(rather than over a six-year period) led to minimal wage growth as more companies accelerated existing trends of acquiring automation to replace workers.

The decrease in tax revenues combined with increased federal spending has driven the
national debt up $2 trillion under the current Administration—to almost $22 trillion. That figure
has risen from $5.77 trillion in 2001 when President George W. Bush was President, presiding over two wars, major tax cuts, and major programs like Medicare Part D. Under President Obama, the debt increased from $11.5 trillion to $19.85 trillion.

The Age of Rising National Debt

Most of these “headlines” came within a two-day period and big numbers often make folks “glaze over”. At some point, all debts and deficits must be paid—that is what tax revenues are for—and it will become harder and harder to ignore the growing macroeconomic pressures of decades of tax cuts and government deficits. We must acknowledge that an unknown future tax paradigm may impact the net return of our personal balance sheets.

Deficits matter. But to what extent do they matter? When will the bills come due? Where is the tipping point? What will the catalyst be? No one knows the answers to these questions, but when the wellbeing and basic comforts of so many people (Social Security, Medicare, Medicaid, and public pensions) require an unprecedented amount of borrowing on an annual basis, even after a 10-year economic recovery, we know the equation becomes unsustainable and change is inevitable.

Already, 60% of the annual budget is spent on servicing debt, healthcare and benefits. The costs of benefit and entitlement programs—including public pensions not mentioned here—are expected to balloon over the next 20 years as Baby Boomers move into their peak benefit and distribution years.

The graph below, although slightly dated, shows the change in real income from 1980 through
2014. According to the Economic Policy Institute, the top 1% take home 21% of all income in
the United States, the largest share since 1928.

Addressing Income Inequality?

The combination of an aging society, stagnant wage growth, and rising deficits, coupled with
underfunded entitlements despite one of the friendliest tax environments of the last 40 plus
years underscore the contentious reality that changes are likely. It’s also important to note
that the financial obligations coming due are largely meant to benefit Baby Boomers on the
backs of the next generation, yet Millennials and Gen X will make up the majority voting at the
polls. It’s plausible to imagine a multi-generational family dinner where family members are
divided, not by whether someone is on the ‘left’ or ‘right’, but rather whether they are of
working age and a payor of benefits vs. a retiree and recipient of those benefits.

Given the backdrop, is anyone surprised by the populism and extreme measures being
proposed by the most recent crop of Presidential candidates? Freshman Rep. Alexandra Ocasio-Cortez (D-N.Y.) has proposed a hike in marginal tax rates to 70% for incomes over $10 million to help finance her New Green Deal proposal. The marginal rate was at its highest in 1953 (92%) and 1980 was the last year for the 70% marginal tax rate before Reagan cut the tax rate to 50%.

Massachusetts Democratic Sen. Elizabeth Warren made a wealth tax proposal one of the policy priorities of her presidential primary bid. Warren wants a wealth tax of 2% on family assets of $50 million and up to 3% on assets over $1 billion. According to Slate, it would have impact 75,000 families, the top .01% of wealth holders, who hold an estimated 10% of the nation’s wealth.

Initially, both proposals were popular. In February 2019, a New York Times/Survey Monkey poll found that Warren’s proposal had a 61% to 35% favorability rating (including 51% of Republicans). The respondents found Ocasio-Cortez’s plan not as popular, but it still garnered a 51% to 45% favorability rate. The same poll found that Americans, by a 62% to 34% margin, believe the government should enact policies to reduce the wealth gap.

Understanding Future Tax Exposure

We often see strong political pendulum swings in America, but the most significant trends take
a quasi-geologic pace until a critical mass is breached. Without the clairvoyance to predict when and how change will occur, savers of all ages and early retirees need to be assessing the durability of their plans. This means accounting for common “what if” scenarios like the cost of a healthcare related event or living longer (or shorter) than expected. We should also consider the more controversial “what if” scenarios, such as the prospect for cuts in Social Security, increasing the age for eligibility, pension cuts, or their inability to keep up with the rising cost of living.

We must also look at our plans from the perspective of future tax exposure. With the tax paradigm apt to change, it’s an easy exercise within our control that most people overlook. For
example, have you modeled future tax exposure—ordinary income and capital gains—based
on projected sources of income, pre-tax, post-tax, and Roth savings? With a sense of your future tax exposure you now have time to assess and stress test potential future tax risks rather
than the naïve fingers-crossed strategy so many people depend on.

Understanding the history of the tax code helps us appreciate the range of potential change. Without historical context we’re apt to succumb to the herd mentality that external variables impacting our financial situation will only improve in alignment with our own personal universe. As if more than 300 million people will all see policy change that benefits them.

Planning for Change

What does this drumbeat for higher taxes and confronting income inequality mean? We can
only speculate today. We won’t know for 5, 10, or perhaps 30 years but we do know a formula
of continued tax cuts, rising government expenditures, and exploding national deficits and debt is a reckoning whose time will come sooner rather than later—and at a time when the next generation is politically potent. Now is the time to identify any overexposure to a singular tax or overdependence on a singular benefit (i.e. all pre-tax savings, Medicare, Social Security,
pension).

The polarizing political climate of today shows little evidence of abating but what we can do is
prepare for a wide range of possible outcomes. We believe that ignoring this drumbeat is not an option. As we’ve expressed in previous updates, the world we plan for is going to require critical thinking to ensure we’re prepared for what lies ahead.

 

 

 

 

This information has been obtained from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed.

The views expressed herein are those of the author and do not necessarily reflect the views of Steward Partners or its affiliates.  All opinions are subject to change without notice.  Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.  Past performance is no guarantee of future results.

This material does not provide individually tailored investment advice.  It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it.  The strategies and/or investments discussed in this material may not be appropriate for all investors.  Steward Partners recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Wealth Manager.  The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives

Securities and investment advisory services offered through Steward Partners Investment Solutions, LLC, registered broker/dealer, member FINRA/SIPC, and SEC registered investment adviser.?? Investment Advisory Services may also be offered through Steward Partners Investment Advisory, LLC, an SEC registered investment adviser.?? Steward Partners Investment Solutions, LLC, Steward Partners Investment Advisory, LLC, and Steward Partners Global Advisory, LLC are affiliates and separately operated.??The Sedoric Group is a team at Steward Partners.