Insights

Higher Taxes Ahead?

March 5, 2019

The Tax Cuts and Jobs Act of 2017 reduced personal income tax rates to the lowest they’ve been for decades. As the 2020 presidential race gets underway, Democratic candidates appear universally committed to undoing the recent changes (that is, before their scheduled expiration in 2025). Some proposals go much further and would impose significantly higher taxes on income, estates and wealth.

 We have no idea who will win the next presidential election, but we are willing to hazard a prediction about where taxes are going over the long run – higher. It is worthwhile to consider where rates have been in the past, why we think the future direction is up, and what we can do to prepare for that possibility.

To state the obvious, it is far easier for politicians to lower taxes than raise them. A recent WSJ article noted that Congress has managed to significantly raise taxes only when widespread public discontent has been intensified by a world war or a severe economic downturn.(1) Top income tax brackets reached 77% during WWI, 63% in response to the Great Depression, and 94% during WWII.

The inflation of the 1970's brought forth supply-side economics, including the concept that lower taxes and a lighter regulatory touch stimulate economic growth. Adopted wholeheartedly by the Reagan administration, top tax rates were slashed to 50% and then to 28%. In the thirty years since, rates have moved lower when Republicans hold sway in Washington, and higher when Democrats are in charge, but until recently, they have remained within a range that came to be viewed as normal.

The 2017 tax act’s lower individual and corporate rates are expected to reduce tax revenue by at least $1.5 trillion over ten years. Congress subsequently approved additional spending, pushing the annual federal deficit to levels 50% higher than the average of the previous five years.(2) There seems to be widespread complacency about running so deeply in the red. 

There is plenty of talk in Washington about higher taxes, but not much debate over the growing budget imbalance. We believe tax rates will climb even if we don’t expand our social safety net, overhaul our aging infrastructure, or undertake a large-scale plan to mitigate climate change. The combination of the current fiscal situation and the promises already made through programs like Social Security, Medicare, and Medicaid will require difficult choices in the years to come.

If higher taxes are indeed on the way, how might you prepare?

  • Think ahead. Start by understanding your average and marginal tax rates.
  • If you anticipate a “dip” in reported income in a particular year, you can consider ways to accelerate income recognition to “fill up” a lower-than-usual bracket.
  • If you are going to need cash from your investment portfolio in the next five to ten years, review your positions in taxable accounts with large unrealized gains and assess if it is a good time to trim any of them.
  • Consider contributing and/or converting traditional IRA’s to Roth retirement accounts. You’ll have to pay more taxes now, but it may save you money in the long run.

There are many angles to be considered in evaluating these ideas. Working with your tax advisor can help you identify the possible benefits and tradeoffs associated with each.

 We also note that the 2017 Tax Act doubled the federal exemption from estate taxes from $5.5 million to $11.4 million. Those affected may wish to consider whether it would be beneficial to try to “lock in” today’s increased estate and gift tax exemptions.

 Ben Franklin had it right - "Nothing is certain except death and taxes."(3) What he couldn’t foresee was the continual political tinkering that creates unnecessary uncertainty and requires so much of our attention.

 Coordinating tax, estate planning and investments strategies makes sense. The push to change tax policy may not materialize right after the next election, but when it does, it may happen fast.  Be prepared!

 

 

 

Footnotes

1) The Next Tax Revolution? By Richard Rubin WSJ February 16, 2019

https://www.wsj.com/articles/democrats-take-aim-at-the-reagan-tax-revolution-11550254446

2) Congressional Budget Office report April 20, 2018

 https://www.cbo.gov/publication/53787

 CBO estimates that the Bipartisan Budget Act of 2018 will add an additional $320 billion to the deficit                 over ten years.

3) Writing in November 1789 to a friend in France (where a revolution was just beginning), Franklin offered an update on the ratification of the US Constitution and the start of a new government: 

“Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.” 

 He died in April 1790.

 

 

 

 

 

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