Much can change with what is going on between Congress and the President over the “fiscal cliff,” the end of an extension to Bush-era tax cuts, but as we tell our clients, we’ve been here before. In August of 2011, we had the imminent downgrade of U.S. debt. In 2010, Washington passed the long-titled Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act to extend Bush-era tax cuts. What makes today important is not the “fiscal cliff,” per se, but the promises the federal government has made and an inability to grow fast enough to fulfill those promises. Nearly 71 cents of every federal tax dollar goes to four major items, according to the Government Accountability Office (GAO): Medicare, Medicaid, Social Security and interest on $16 trillion of debt. These obligations, by some counts, however, total approximately $87 trillion (more than 500 percent of GDP) and are off the federal balance sheet. The “fiscal cliff,” therefore, may be better characterized as a “fiscal iceberg” businesses must navigate around.
Bush-era Tax Cuts
The Bush-era tax cuts have given us the benefit of lower ordinary income tax rates, attractive estate tax exemptions and favorable capital gains rates, among other benefits. In Florida alone, the Tax Foundation estimates the average tax savings from a one-year extension of Bush-era tax cuts to be $2,079 per tax return. Some of the less talked about benefits of the Bush-era tax cuts have been the payroll tax holiday, a series of tax breaks for businesses and Alternative Minimum Tax (AMT) patch.
One of the benefits we have enjoyed has been the payroll tax holiday. Currently, each worker pays 4.2 percent of their paycheck for Social Security. With the expiration of the law, the rate could rise to 6.2 percent for the first $113,700 in wages. This rise would be on top of any rise in ordinary income tax rates and the payroll tax increase from what is commonly referred to as Obamacare.
Some favorable tax laws could also end for business. To date, for example, businesses have been able to depreciate capital asset purchases at faster rates over time. This has been known as bonus depreciation. In the 2010 tax law, businesses were allowed full expensing. In 2012, that became 50 percent.
Many businesses, moreover, may be impacted differently from the “fiscal cliff” because of spending budgets that are slated to go into effect. Automatic spending cuts would occur in the Defense Department’s budget, Medicare payments to hospitals and education programs.
In 2013, tens of millions of taxpayers could also become subject to AMT who, before, were not subject to it because of exemption levels, thus imposing the higher alternative tax to not only upper income but also middle income tax payers.
Many business owners accelerated the sales of their business to take advantage of 2012. Families took advantage of the 2012 estate tax rate of 35 percent and exemption of $5.12 million. Investors realized large paper gains on their assets before the long-term capital gains rate rose above 15 percent. Many took the tax laws of 2012 as a proverbial “bird in the hand.”
American Austerity
Any kind of American austerity would burden an anemic real GDP growth rate of about 2 percent. U.S. Treasury obligations would come under credit scrutiny from rating agencies. Higher inflation would put more pressure on long-term interest rates to rise, and there would be an impact on the value of the U.S. dollar. All of these will have implications for wealth strategies, investments and the general business climate. Despite the reality that we’ll face in 2013 and beyond, however, we remember that there was a time when taxes were much higher than they are today and innovation still thrived.
Consumer Still Key
The bright side is that opportunities are often created from challenges such as these. We can see the tip of the “fiscal iceberg” and know what is ahead of us and under the waters of uncertainty. Businesses, nonetheless, must continue to focus on product and service innovation and not be distracted by Washington politics. The economic engine of this country still rests first and foremost with the consumer. A series of temporary fiscal agreements could help lay the groundwork for more significant change in the future, but until then, we can only be watchful and keep doing what we do best, which is serving our clients.
Koss Olinger has provided its perspective based on the author of this article. For follow-up information or individualized recommendations on this topic, please contact W.J. Rossi, Partner, Koss Olinger at [email protected]