Skip to comments.Taxes You Pay Now May Represent The 'Good Old Days'
Posted on 02/29/2008 8:53:38 AM PST by Incorrigible
By KATHERINE REYNOLDS LEWIS
WASHINGTON If you're grumbling about the size of your tax bill this year, brace yourself.
Many financial advisers predict that tax rates are going to rise to cover the escalating burden of an aging population and the federal debt.
"In all the discussions I have with contemporaries, we do expect rates to go up at some point in the future," said Ira Herman, a partner at J.H. Cohn, an accounting firm in Roseland, N.J.
Each American's share of the federal government's unfunded obligations amounts to $175,000 comparable to a home mortgage with no collateral, said Stuart Butler, a vice president at the Heritage Foundation.
To cover the gap between expected revenue and the cost of Medicare, Medicaid and Social Security benefits through 2050, income tax rates would have to almost double, according to a July 2007 analysis by the Congressional Budget Office.
Of course, the government probably would reduce promised benefits and increase payroll taxes rather than solely boosting the income tax. Still, it seems likely many Americans eventually will refer to the current income tax structure as "the good old days."
And who exactly would pay higher taxes?
There aren't enough wealthy people to cover the huge, looming burden, Herman said, so it will have to be shared with the middle class.
"Everyone agrees that, in order to fulfill the promises we've made to people who are going to be retiring, Social Security, but even more, Medicare taxes would have to go up very, very much," said Joel Slemrod, director of the office of tax policy research at the University of Michigan. "My guess is there will be a combination of tax increases and non-trivial cutbacks in these promises."
A combination of near-term factors also points to tax increases, Slemrod said: A Democrat could become president in 2009, and the Baby Boomers are beginning to retire.
What's more, if Congress allows the Bush tax cuts to expire in 2010, capital gains will be taxed at higher rates, marriage tax relief will end, and the 10 percent tax bracket will go away.
Since 1975, combined local, state and federal tax revenue has hovered around 27 percent of gross domestic product. That's lower than most other developed countries. Tax revenue averaged 36 percent of GDP for the members of the Organization for Economic Cooperation and Development in 2005.
What should you do to guard against the possibility that U.S. tax rates will creep closer to other developed countries'?
"It's very difficult to plan for taxes, other than the fact that you know we're going to have to pay them," said Tom Papanikolaou, chief operating officer of Pension Builders and Consultants in Cleveland.
Still, some basic principles do apply.
Take a long-term approach and save aggressively.
"People need to set aside as much as they can," Papanikolaou said. "You're going to get your best return by investing in equities."
Contribute the maximum to your 401(k) or other tax-deferred retirement plan, said Kevin Mahn, chief investment officer for Hennion and Walsh in Parsippany, N.J.
Keep your options open.
"The old boring rules continue to make sense ... : stay diversified, stay nimble, you can't lock in to certain positions," said Barbara Weltman, a contributing editor to tax guides published by Hoboken, N.J.-based John Wiley and Sons. "Different philosophies on taxation come and go."
If you're eligible, open a Roth IRA or Roth 401(k) account. You'll pay taxes on contributions now. But your investment earnings will be tax-free when you withdraw them in retirement.
Consider converting a traditional IRA to a Roth IRA. After 2009, even people who earn too much to contribute to a Roth will be able to make conversions, Herman said.
"Make sure your financial adviser runs the numbers for you," he said. "Even if I'm in retirement, if I have enough money, I'm going to be in a potentially higher bracket."
For David Strong, a certified public accountant at Crowe Chizek in Grand Rapids, Mich., the decision hinges on how long you have until retirement. If you have decades to go, you will be able to accumulate more earnings that you can then withdraw tax-free. If you are on the cusp of retiring, conversion might not make as much sense.
"You'd really have to analyze how long do I have to have those funds grow, and does it make sense to pay a tax bill now that I could certainly defer," Strong said.
Don't reject good investments solely because of taxes.
Even if tax rates rise, a well-managed mutual fund with low fees could outperform a tax-free annuity that is mismanaged and loaded with expenses.
Similarly, municipal bonds are exempt from federal and some state taxes, but you need to compare the overall yield with what you'd get on a taxable investment, said John Pridnia, a CPA in Muskegon, Mich.
"Just because you're paying income tax doesn't mean it's always a negative situation," Pridnia said.
Moreover, some financial advisers don't believe taxes will inevitably rise.
"Everything can change based on who's in the Senate and what party is in office," Mahn said. "I believe in our country and the capitalistic system and I believe we can always find a solution."
Raising taxes doesn't guarantee increased revenue, said Alan Reynolds, an economist at the Cato Institute in Washington.
If capital gains and dividends taxes increase, people will sell those investments or put them in a tax-protected retirement account. And if payroll taxes climb, employers will find other ways to compensate high performers, such as company cars, Reynolds said.
In the end, taxes are only one part of the picture for financial planning, said Leo Bruette, a tax partner with BDO Seidman in Bethesda, Md.
"You can't ignore it, but there are so many breaks for retired folks that it's not as significant a factor as you might think," Bruette said.
* * *
To cover the gap between expected revenue and the cost of Medicare, Medicaid and Social Security, according to estimates that assume health care costs grow 1 percent faster than GDP, income tax rates would have to rise:
from 10 percent in 2005 to 17 percent in 2050, for the lowest bracket
from 25 percent in 2005 to 43 percent in 2050, for the middle bracket
from 35 percent in 2005 to 60 percent in 2050, for the highest bracket
from 35 percent in 2005 to 60 percent in 2050, for corporations
Source: Heritage Foundation, Congressional Budget Office
(Katherine Reynolds Lewis can be contacted at katherine.lewis(at)newhouse.com)
Not for commercial use. For educational and discussion purposes only.
Our legislators continue refusing to learn the lesson of The Little Red Hen. Though here is a link to the modern version which may be what they are thinking:
The problem with all the saving mentioned in this article is that at some point, taxing income will not be enough. If I save and prepare for my golden years now, I will have that savings striped from me as it will go to finance those that did not prepare.
Nothing in this article addresses that aspect of the future.
If the government thinks the middle class, who can’t now keep up with inflation, will absorb 50% tax increases, then they haven’t read history.
The incentive will be for all to go on welfare.
Financial literacy is at an all-time low in our ruling elite.
We know who will pay for the old boomers don’t we?
You have discovered the rat plan. It is much worse than anyone can envision. Higher tax rates will confiscate your hard earned retirement savings. Tax rates are reasonably predictable compared to the impact of these higher rates. No one can make any reasonable predictions about the impact of higher tax rates on economic growth (or lack of growth), value of the currency, inflation, and stock and bond markets. If the tax rates do not get you, the impact of these tax rates may sink your retirement earnings. In addition, the rats have many other tricks. They intend to partially nationalize many industries, create monstrous new entitlements, flood us with a horde of welfare seeking immigrants, and choke our consumption with global warming restrictions. I wish that I could be optimistic but I cannot be at this point. The tragic element is that every part of this mess is self inflicted.
But the government can't afford to have me do that. ;)
Thanks! I feel so much better now! :-)
Ping list for the discussion of the politics and social (and sometimes nostalgic) aspects that directly effects Generation Reagan / Generation-X (Those born from 1965-1981) including all the spending previous generations are doing that Gen-X and Y will end up paying for.
Freep mail me to be added or dropped. See my home page for details and previous articles.
The tragic element is that every part of this mess is self inflicted.
Self inflicted by short sighted politicians in government who have never had an ounce of fiscal responsibility for us, the taxpayer. It’s a discrace to America!
The rat bastards are in permanent spend mode and their damn answer is to raise taxes to cover their incompetence! Crap on all of them!
According to the rats, much higher levels of taxes (on the rich of course) and rat control of private enterprise will bring us to economic utopia. Perhaps my pessimism is misfounded.
There is an old story about taxes. It's well worth the read.
I can live on rice, mangos, and fish in the Philippines if I have to.
I believe 20 years (or less) down the road, they will change the rules of the game, and tax Roth IRA’s as they are being withdrawn. The miserable bastards.
Good idea, until the looters decide that it's "not fair" you have accumulated a nice nest egg while "the poor" haven't. I am really worried that some Dem will come after 401(k) and IRA holdings to fund their spending.
I'm betting the Roths will get taxed, too.
Maybe then people will finally wake up. I think I am expecting (hoping) too much though.
Oh, they will try, but you all are forgetting that seniors have the time and intelligence to vote.
Just as SS has been the “third rail” of politics and no politician will face reality and get dumped out of office by speaking the truth, so will any changes in the tax structure of retirement accounts cause massive outcries. Again, craven politicians and voting seniors will try to stick it to the young and productive as they’ve done so far.
No, I see age warfare continuing at the ballotbox near you.
until the looters decide that it’s “not fair” you have accumulated a nice nest egg while “the poor” haven’t.
....And you can bet the farm that’s coming! The politicians will rob every business and individual!
Looks like I’ll have to take another look at that piece of property down in Belieze...
I don’t believe that 401Ks will always be untaxed. Nor do I buy that Americans will meekly accept insane tax rates. Many of us will leave first.