Jim’s Big Picture: Taxmageddon−It’s Worse Than It Sounds
Also on the Big Picture: “To QE or Not To QE, That is the Question” and “The 2012 Presidential Election–Technology vs. Confidence”
Show transcript of Jim’s Big Picture: Taxmageddon−It’s Worse Than It Sounds
JOHN: Well, I hate to break bad news to all of you, but in reality it’s worse than it sounds. And I know you’re going to ask me what it is I’m talking about. We’ll let the audience do this, Jim.
All right, audience, ask me what I’m talking about.
What are you talking about?
We're talking about Taxmageddon. And the taxes that are going to hit us on January 1st, 2013, will provide a $7 trillion hit to the economy. It’s literally like rushing over a fiscal cliff. It’s going to hit us in four waves. We're going to go into this right here. And if we don’t address this, our GDP will probably take around a 5 percent hit and we will just be right back in a recession and worse, possible a depression. At the level we're looking right now, unemployment could double. And above all, these taxes are going to provide a major hit to American families and especially middle and small businesses, which are the majority job providers in this country.
Now, the unfortunate thing is that President Obama is not showing any leadership in this and what we've been doing, you know, Jim, over the last few weeks, we've been looking at the patterns that the economy and the government and the Federal Reserve have traced since 2010. We seem to start the years off well, things start to fall apart and then they do a Hail Mary pass right in the last six weeks of the year to try to make everything recover so it bounces back up in January. But we've also got an election in November.
The real problem is regardless of what happens in November these four waves of taxes are going to affect the economy and they will happen on the watch of whomever is the next president. So we need to look at this. It’s actually worse than you and I have discussed because you've been doing some dissecting and looking at government figures. [2:22]
JIM: Yeah. It’s worse than it’s being portrayed by the media. In fact, the media is almost silent on this very issue because they don’t want to talk about it especially ahead of a presidential election. The CBO assumes that the giant tax increases are going to bring in the revenues, but what we have shown historically -- and this has been shown empirically by professors on -- liberals, conservatives -- is that history shows no matter what the tax rates are, tax revenues are never more than between 18 and 20 percent GDP. You can raise tax rates to 90 percent, you’re still going to get no more than 20 percent of GDP. When the CBO has taken a look at this, it also assumes what’s called “static accounting,” meaning that if you do raise taxes that if you --
Let’s just take an example. If you have a million dollar economy and the tax rates are 35 percent, you take in 350,000. You raise the tax rates to 48 percent, you take 480,000 in. But it doesn't take into account what happens to economic activity. A good example is take a look at Greece. They raised taxes -- and we’ll get into this in another segment of the economy -- everywhere they’ve raised taxes in Europe, tax revenues have fallen and GDP has fallen as well. Greece is actually in a depression right now.
And it’s not just Europe. You can take a look at my own state of California. We've raised taxes several times and tax revenues have fallen in this state three years in a row. And what are we doing? We're going to raise taxes by another 30 percent -- or actually 40 when you take a look that they’re going to lower the brackets on which they assess the taxes. Tax revenues have been falling and that’s why we start out the year with a $9 billion budget deficit, and it now turns out to be 16 billion because expenses have gone up and tax revenues have fallen off a cliff. [4:24]
JOHN: You know, you would never know what you were just saying is true if you listen to the pundits, especially on the left side of the equation because they keep talking that if we just keep taxing the rich a little more -- you know, the ‘fair share’ argument -- everything would be okay. And you know that’s not true. And what you’re trying to say here is that as you raise the tax rates, there are compensations that happen in the economy. In other words, there’s either fraud, fight or flight. It also damages the economy so revenues are lower; businesses make less, pay less income tax. So no matter how hard you ratchet that thing up, it’s still not going to gain anymore tax than about 20 percent of GDP.
Now, before we went on the air and this surprised me: when we started to plan this program and you laid out wave after wave of tax, I went, Oh dear, this is worse than I thought it was going to be.
Let’s divide them up. Let’s take wave number one here. [5:18]
JIM: Okay. Let’s begin with wave number one, which is the expiration of the 2001 and the 2003 tax relief acts under President Bush. I mean some of the obvious things: the top tax rate goes from 35 to 39.6; the lowest rate will rise from 10 to 15 percent, all rates in-between will rise; itemized deductions and personal exemptions will be phased out again, which is the equivalent of raising tax rates. But let’s begin with some of the obvious ones.
In the first wave of taxation, there are going to be four of them that are going to take place. The 10 percent tax bracket disappears and the lowest tax bracket goes to 15 percent. So if you’re in a 10 percent tax bracket -- and remember, the first level of income -- we have a progressive rate structure, so the first level of income is taxed at 10 percent. That is going to disappear. The lowest tax rate will be 15. So the 10 percent bracket goes up to 15 percent. That’s really going to hit lower income groups because you’re talking about a 50 percent increase in the tax rate. The 25 percent tax bracket rises to 28 percent so there’s a 3 percent. The 28 percent bracket then rises to 31 percent, that’s another 3 percent tax rate. The 33 percent bracket rises to 36 percent and the 35 percent bracket rises to 39.6. So at the lowest bracket at 10 percent, that bracket goes up 50 percent and then from 25 to 33 percent, each one of those three tax brackets in between all go up three full percentage points and the top end tax bracket goes up by 4.6 percentage points. So that’s the first thing that happens.
The second thing is if you were married, the marriage penalty comes back. One of the things that the Bush tax cut fixed is they got rid of the marriage penalty. If you were married, you actually pay a higher tax bracket than if you and your wife got divorced and filed as single taxpayers. So the marriage penalty comes back. That will probably cost the average family another 2 or $3,000 in taxes. If you’re married, the child tax credit will be cut a half from $1000 to $500 per child and the standard deduction will no longer be doubled for married couples relative to a single level individual. What happened is to get rid of the marriage tax penalty is they doubled the standard deduction.
In addition to that, the middle class death tax comes back. The estate tax bracket goes from 35 percent to 55 percent and the exemption falls from 5 million down to 1 million. So the estate tax rates go up by 60 percent and the exemption that you can pass on tax free drops by 80 percent.
The next thing: For investors the capital gains tax will rise from 15 percent to 23.8 percent and the tax on dividends will go from 15 percent to 43 percent. So this is the first wave of tax increases. [8:45]
JOHN: You know, all I can think of when they’re doing this is what are they thinking? I mean can you see some husband saying to his wife, “Well, dear, the rates are going up next year, so I’m outta here. Heart attack.” At least she gets to make use of the estate tax this year; right?
JIM: Or the other thing is, “You know what, Honey, in order to maintain our lifestyle, we're going to have live together as a couple but file as a divorced.” Because if you’re married, one way to get rid of the marriage tax penalty would be to get divorced and still keep the family together. I mean it’s just absolutely crazy. [9:21]
JOHN: How much of this is due to repeal of previous tax cuts? We had tax cuts in 2001 and 2010 and how much is new tax out of that whole panoply that you listed?
JIM: This first wave is the repeal of the Bush 2001 and 2003 tax cuts, and actually, in this first wave, is also the repeal of the payroll reduction. Social Security taxes -- tax withholding were cut by a third so instead of paying 7.65 on your first 108 or 110,000, it drops to 4.65. So Social Security taxes dropped by a full two percentage points, meaning if you make $100,000, you’re paying $2000 less in Social Security. So that also ends January 1st. [10:14]
JOHN: Okay. So now we move on to wave number two and we’ve already been talking about the Supreme Court is already expected to have a decision on the constitutionality of part or all of Obamacare on about June 25th, which is about 9 days from the Saturday the show first airs. But some of the provisions are already being implemented this year. Insurance companies are having to pay for things, yada, yada, yada.
Now, the real question is: If it’s found unconstitutional, how are you going to untangle what’s already been started? [10:47]
JIM: They would put a halt to it. I mean some of the effects that have already gone into effect, there is a tanning tax so if you go to a tanning salon, that’s already in effect. There’s a medicine cabinet tax on drugs. There’s an HSA withdrawal tax. There’s a W-2 health insurance reporting requirement. So these have already gone into effect. So what I’m talking about here are those things that go into effect January 1st, 2013.
The first of these is the Medicare payroll tax is going to go up by 0.9 percent. It’s going to go from 2.9 percent to 3.8 percent. So why don’t we just round it off; instead of paying 3 percent Medicare tax you’re going to pay 4 percent Medicare tax. It also imposes a cap on FSAs of 2500; it’s now unlimited. There are a couple of things that are going to happen; the medical device tax is going to go into effect. Medical device manufacturers -- everything from heart valves -- this is an industry that employs almost half a million in 6,000 plants around the country. The law imposes a 2.3 percent excise tax on any medical device that’s made. So that’s going to raise costs.
In addition to that, if you are deducting and especially for families that have an illness -- let’s say one spouse is pretty sick, the ability to deduct your itemized deductions is going to limit. Currently, those individuals who are facing high medical expenses are allowed a deduction for their medical expenses to the extent that the expenses exceed 7 ½ percent of your adjusted gross income. So let me just make a simple illustration. Let’s assume that your taxable adjusted gross income is 100,000. If your medical expenses exceed 7 ½ percent -- in this case $7500 -- anything over the $7500 you would actually be able to deduct against your taxable income. Beginning next year, the threshold increases from 7 ½ percent of your adjusted gross income to 10 percent of your adjusted gross income. So these are the new medical devices.
And then of course, we have the investment tax of 3.8 percent. That 3.8 percent will be added to capital gains bringing the capital gains tax rate to 23.8. It will be added to the top tax bracket of 39.6 bringing the top tax bracket to 43.4, and that’s the tax on dividends. If you own rental property, you will pay an additional 3.8 percent surtax on your net rental income; that means taxable rental income. If you have an annuity or pension annuity payout, you will pay an additional 3.8 percent on that annuity tax. If you’re earning interest on a bank CD, you’re also going to pay 3.8 percent tax on your interest that you’re earning at the bank or any kind of bond. [14:05]
JOHN: Well, I guess after all of this, remember if President Obama the first time during his first election campaign ran on “hope and change” and we're left without hope here and only change in our pockets when this is done. I keep thinking what are they thinking of. What is Congress thinking of with this whole thing? All right.
Wave number three. Go ahead. Wave number three.
JIM: Okay. So those are the first two waves. Wave number one, the repeal of the Bush tax cuts. Wave number two, Obama’s healthcare taxes. Wave number three, the raising of the alternative minimum tax and employer tax hikes. When Americans file their tax returns in January 2013 there are going to be a lot of nasty surprises that they’re going to be faced with and at the top of the list is the alternative minimum tax. There will be no extension. Unless it’s extended or relieved, this could ensnare 31 million Americans. Congress’s failure to increase this is basically, John, I forget how many tax payers, but this affect probably around 31 million taxpayers.
And what the alternative minimum tax does is you take all of your taxable income -- whether it’s salary income, gross income, interest from rents, dividends, investments, capital gains, whatever -- and then you deduct, say you have a lot of itemized deductions -- you have your state tax deduction, you have your mortgage interest deduction, you have your charitable contributions, you have your medical expense, you know, your itemized deductions.
Well, if you have a lot of those, if it reduces your taxable income, your tax accountant has to do two calculations: what are your taxes due after all your itemized deductions and then they compute a separate tax which is the alternative minimum tax. It’s a special tax rate that they do and basically it gets rid of your itemized deductions and a lot of your exemptions and tax-free income and it computes a tax. And what happens is then the two taxes are compared and if the alternative minimum tax is higher than your regular income tax, you pay the difference.
Let’s say on a $100,000 income, your income taxes are 25,000, but the alternative minimum tax is 28,000. Then what would happen is you would have to pay an additional $3,000 in AMT tax when you file your tax return. So that is something that goes into effect January 1st. [16:43]
JOHN: It’s important to point out to people that the original purpose of the alternative minimum tax was to make sure that rich people -- here’s the rich-people argument again -- who had managed to structure everything in such a way as to avoid legally -- not evade -- paying tax vis a vis say Warren Buffett, they would have to pay at least some tax. The problem is that as the dollar has been inflating and the price of everything moving up and then of course if income does move up with it, now suddenly a whole bunch of people in the middle class that were not paying alternative minimum tax are now being snagged by this tax that originally was supposed to just hit the wealthy. So that’s the background of that tax. [17:20]
JIM: Yeah. And then an additional tax is going to go into effect is there -- right now, if you’re a small business, you can expense half of the purchases of equipment. Let’s say you buy a Xerox machine. I don’t know, you buy some press for your manufacturing plant, you get to write almost half of what you spend on that equipment in the year you purchase it. So if you buy $10,000 worth of equipment, you can write off I think it’s up to 25 or 30,000. That goes away next year. Taxes are also going to be raised on businesses. One of the biggest ones is the loss of the R&D experimentation tax credit. So if you’re an entrepreneurial company and you’re doing R&D research, whether it’s drugs, whether it’s new kinds of -- trying to come up with a new manufacturing process, that goes away. Tax benefits for education and teaching are going to be reduced. The deduction for tuition and fees will not be available. Tax credits for education will be limited; teachers will no longer be able to deduct classroom expenses. And the education savings account will be cut. Employer-provided educational assistance to employees, like, you know, we have an education program for all our employees; the deduction for that will end. Student loan interest deductions will be disallowed for literally millions of American families and the charitable contribution from IRAs will no longer be allowed. Under the current law, a retired person with an IRA can contribute up to $100,000 per year directly from their IRA to a charity. This contribution counts towards the required minimum distribution. That also goes away.
So those are the first three waves that are going to take effect January 1st and that’s why they’re calling it Taxmageddon because I mean this is going to hit the economy like Herbert Hoover in 1932 when he raised tax rates from 25 percent to 63 and he literally plunged the country into the depths of the Great Depression. [19:34]
JOHN: I’m afraid to ask, but let’s do the fourth wave. I’m wondering if this is going to get any worse. And I’m wondering why there’s no yell and scream about this right now.
JIM: For election purposes, the president wants these, in effect. And they’re baring this because this is a major, major issue and it’s an issue that the president has been ducking. We've been kicking the can down the road for two years and this is an election year and the president needs to appeal to his base. And in the middle of an election year, and this also goes for Republicans, nobody wants to deal with it. Now, there are some people -- there are a growing list of Democrats who are working together: Paul Ryan, Ron Wyden a Democrat from Oregon are saying, “Look, this thing is going to hit January 1st. It is so big that we need to address this, not another Hail Mary play.”
So there’s two ways to address this, John. The best way right now given that the White House could change, the make up of Congress could change is let’s postpone this for another year so that the new president, if it’s Obama gets re-elected or it’s Romney, can sit there with a new Congress, and instead of the last minute before the Christmas holidays come up with a last minute proposal and a patch job, really address this.
On top of that, and we don’t have time to cover this, is the new CBO report that just came out in the last two weeks on the long term budget deficit projections. I just did an interview with John Williams that will be featured on our premium site where the government’s net present value of future liabilities is $100 trillion, and that’s under Treasury gap reporting. And the CBO just published a new budget deficit, the numbers are quite frightening.
So it’s an issue that we've been kicking the can down the road and if you want to see what happens when you do that is you just take a look at what’s going on with Greece -- we will cover that in another topic in the Big Picture today as I mentioned, this is an extended edition -- because there are just so many things that are critical that are going to hit the news waves this weekend, next week and the week after.
But In the fourth wave -- I’ve got a copy here and we just don’t have the time to cover in this segment, it’s a 46-page document, it’s called a list of federal expiring tax deductions from 2009 to 2020. It was prepared by the staff on the Joint Committee on taxation. Let’s just put it this way: It is 46 pages of various tax deductions for businesses and individuals that are going to expire in the next three years. So a big wave -- let me just go here to 2013. This is just unreal, folks, if you look at this.
2013, we've got four full pages of tax deductions that are expiring next year and I’ve got five pages of tax deductions that expire at the end of this year.
So I mean we don’t have time to cover 46 pages of business tax deductions that expire. It’s probably the reason why you have seen a pullback by corporations sitting on the sidelines with over two trillion dollars with tax because they know at the end of this year these 46 pages of deductions are going to be expiring this year, the next year and the year after.
We know these first three waves that we talked about in this segment are coming due. So John, that’s why they’re calling it Taxmageddon. And it’s amazing: The media is keeping silent on this, or what we refer to in the media business, they’re spiking this In other words, they don’t want to talk about this and discuss because they don’t want the American people to know about it. [23:34]
JOHN: And the reason -- just so people understand, spiking a story as opposed to spinning a story. Spiking a story is not covering a story when you know the story merits covering; that there’s a real story there, you just don’t do it. And usually that’s done because the media -- well, they like Obama and they don’t want to cast a negative light and if people thought they were about to be hit with this giant panoply of taxes, which has been mounted upon, they’re not going to broadcast that. That’s what’s going to happen. And so that’s what you’re finding right now and that’s why the story is being spiked.
And what’s interesting, remember whoever gets elected president, President Obama is re-elected or Gov. Romney is elected, when we go off this cliff and the train wreck we've been discussing for a number of years here on the program, that’s all going to happen during the tenure of the next president. So he will be blamed for whatever happens. They won’t notice the fact that, well, this -- well, I don’t know. Maybe Gov. Romney’ll start in, you know, “I inherited this mess.” [24:32]
JIM: Hey, it worked for the president for four years, so maybe it will work for the next president.
JOHN: Maybe if there’s enough -- how would we describe it? Maybe if there’s enough feedback on this and people begin to realize what’s happening that something has to happen, then there may be some action between now and the election or the end of the year. Let’s face it, we're still just in June right now. So there’s six months to go. A lot can happen in June. [24:52]
In this segment of the Big Picture, Jim looks at three election-year topics, "Taxmageddon−it’s worse than it sounds," "To QE or Not to QE, that is the question" and "The 2012 Presidential Election- technology vs. confidence."
About James J Puplava CFP
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