Paying for Deficits
Help prepare clients for rising taxes.
Lately, the burgeoning federal deficit has prompted a lot of discussion. When the economy ran into severe problems in 2008, the Federal Reserve System, the U.S. Department of the Treasury and the federal government intervened in the face of potential cataclysmic consequences. Whether this intervention was warranted is still being debated, and the financial consequences of the spending will be felt for years due to the massive deficit spending that resulted from the stimulus legislation. However, massive federal deficits are looming regardless of the recent economic trauma.
In the private sector, organizations that provide a monthly benefit through defined benefit pension plans are required to fund their plan according to prescribed methods allowed by the Internal Revenue Service. Social Security is very similar to a defined benefit pension in that it provides a monthly benefit. It also includes a cost of living adjustment (COLA) based on increases on the consumer price index (CPI). Even though employers and employees contribute to Social Security, there is one major difference between the two plans: funding. Social Security benefits represent a promise to pay because the benefits are not currently funded. In fact a trust fund was created in 1983 to ensure that the monies would be there to provide for the benefit payments of future retirees. Yet, even after more than 25 years of payroll tax increases, representing some $2.5 trillion in contributions, no actual funding has been set aside. Instead, the debt consists of IOUs from the federal government for future generations to pay.
Much like an individual who applies for more credit cards and needs a credit limit increase, the federal government is amassing huge debt obligations that are coming due. While most people consider this problem a long way off, the reality is that the problem will have a financial impact in 2010. The Congressional Budget Office (CBO) is projecting that Social Security will pay out more in benefits than it collects in taxes in 2010 and 2011, a phenomenon not seen for more than 25 years. This means that for the next two years, the current pay-as-you-go surplus that the federal government receives from payroll taxes will actually be a deficit of approximately $10 billion. This spike in Social Security benefit payments is attributable to the anemic state of the economy, which has led more people than usual to apply for Social Security payments.
So how will the government fund these burgeoning deficits? The answer is by raising taxes-but who will be affected and how much taxes will go up remains open to debate. While income taxes will increase in 2011, there are number of measures also being contemplated to close the deficit. One proposal to pay for health care reform under Sen. Max Baucus's (D-Mont.) plan in the Senate is a $2,500 annual cap on flexible spending account contributions. This would be detrimental to people who incur anticipated uncovered health expenses, such as orthodontia. A different tax proposal involves limiting the level of tax deduction to the current tax rate of 35%. In other words, should income tax rates increase from 35% to 39.6%, charitable contributions will be deductible at the 35% rate instead of the 39.6% rate. Aside from the complexity of the calculation, charities are concerned that the measures could limit the deductibility of charitable contributions.
Independent insurance agents should become aware of these proposals and the remaining avenues available to customers for lowering their tax bills.