Submitted by Lance Roberts via STA Wealth Management [7],
Tonight the President will give his annual State of the Union address to a joint session of Congress. To be honest, this isn't a speech about the current state of the economy but more of a promotional platform for the President's agenda for the next year. The reality is that the majority of the suggestions made by the President never see the light of day since they need Congressional approval and bill passage. You might remember last year's speech discussed the new saving vehicle called "MyIRA" which never saw the light of day.
This year's SOTU address will be a continuation of the Administration's desire to redistribute wealth in America using what the administration calls “middle-class economics.” The proposals aim to eliminate loopholes that - in the administration’s words -
“let the wealthiest and big corporations avoid paying their fair share in taxes, and invest those savings to help middle-class families strengthen their standing in the 21st-century economy.”
The proposals would generate tax revenues that the administration intends to deploy into middle-class-friendly initiatives. These initiatives would impact retirement savings programs, second-earner credits for married couples, child care tax credits and tax incentives for education. It is a modern variation of a take-from-the-rich-and-give-to-the-poor agenda.
For some context, the chart below shows the historical top tax rates including the proposed changes for the 2015 tax year.
The following is a breakdown of some of the President's planned "Robin Hood Wealth Redistribution Plan."
Trust Fund Loop Hole
The President is set to go after what the administration calls the "trust fund loop hole" or the "single largest capital gains tax loophole" in current tax law which shields hundreds of billions of dollars from taxation each year.
Under current tax law, individuals can pass assets down to their heirs free of capital gain tax as the heir receives a "step up in basis". The President's focus is specifically targeting these "bequests and gifts," other than to charitable organizations, to start treating them as "realization events."
This would mean that an individual receiving an inheritance would be required to pay capital gains tax on the assets just as if they had been sold by the previous owner prior to transfer. For people who have spent a life-time building wealth, and paying their share of taxes along the way, this would substantially decrease the value of the estate as it transfers to their heirs.
One issue brought up by my friend and collegue Scott Bishop, CPA was:
"There is no apparent exemption for small businesses or family farms. This tax on illiquid assets can have very bad consequences and even potentially force companies to be liquidated with the loss of jobs. The very rich plan for this...many small businesses don't."
Considering that roughly 90% (5.4 million of the 6 million businesses in America that are active) have less than 20 employees but create the majority of employment in the economy, the long-term ramifications could be disastrous.
This proposal is not likely to sit well with the mega-rich donors that fund the Administrations campaigns, however, it will ring home with the roughly 80% of the "voters" that are functionally living paycheck-to-paycheck and have no assets to transfer anyway.
Capital Gains Tax Increase
In 2013, the capital gains tax increased from 15% to 20%. In 2014, that rate increased again by the addition of the Medicare Tax of 3.8%, a by-product of the Affordable Care Act, to a total of 23.8%
This year the President will request that the capital gains tax be raised once again to 28% for couples with incomes above $500,000 annually. (I am assuming that includes the 3.8% Medicare Tax)
History is replete with evidence that increasing taxes slows economic growth. As shown in the chart below, sharp increases in taxes as a percent of GDP has led to much slower economic growth and recessions. With the economy already extremely weak [10], there is little "wiggle" room for a policy error at this juncture.
With debt issuance by the government continuing to explode higher, the increase in capital gains taxes will eventually lead to larger deficits down the road. This will also push the "wealthy" to engage in more extensive offshore sheltering and tax planning to avoid additional taxation.
Senator Orrin Hatch, Chairman of the Finance Committee, summed it up well:
"Slapping American small businesses, savers and investors with more tax hikes only negates the benefits of the tax policies that have been successful in helping to expand the economy, promote savings and create jobs. The president needs to stop listening to his liberal allies who want to raise taxes at all costs and start working with Congress to fix our broken tax code.”
Tax The Banks
One of the more interesting proposals is a fee on banks with assets over $50 billion. The President's plan will call for a fee imposed on the largest and most highly leveraged financial firms. That proposal, administration officials suggest, was designed to make “risky activity” more costly for the roughly 100 such companies in the nation with assets more than $50 billion. Those companies would be assessed a fee based on the amount of debt they hold.
While I am all for reducing the "too big to fail" risks of large institutions, this will not impede the financial institutions from their ongoing activity but only lead to increasing costs to the banks customers. If you haven't noticed, the costs of banking have already been on the rise as banks increase revenue to offset the fines and penalties they have had to payout over the last few years. Taxing the banks will only lead to a pass-through of those costs to middle class Americans.
Where To Spend It All
Of course, all the money raised from these new taxes must be used to bolster the sea of individuals that are economically "boot-strapped."
The President's list of benefits to be paid out ($320 billion over the next decade) include the following:
Two Years of Tuition Free Community College (cost $60 Billion).
Can we just agree this is a bad idea all the way around. First, with a roughly 30% of 4-year college graduates sleeping on parents couches, a bunch of kids with junior college degrees are unlikely to fair much better. Particularly, junior college grads with a "C" average in some area of study that has a relatively low applicability to the economy's current needs. Maybe assisting in paying for technical and trade schools might be a better course of action.
Secondly, while the President suggests that this is only a $60 billion cost, that is based on today's tuition rates. Once colleges find out the government is paying for anything the costs will rise exponentially. All you have to do is look at current 4-year college tuition rates once the Federal government took over the student loan program.
$500 tax credit for child care where both spouses work AND Increased Child Care
There are already benefits in this area such as Dependent Care savings accounts. However, these two increases, while being of minimal actual benefit to the economy, will play well with the lower income voters.
Incentives to Save for Retirement
If at first you don't succeed, try again. Given that the Presidents "MyIRA" fell flat last year, this year he intends to propose an auto IRA enrollment for workers of companies that don't offer retirement plans like 401(k)'s.
This has been proposed in the past...with no effect. Why, because when 62% of the population is living paycheck-to-paycheck there is no excess income to "save." The "economic recovery" story is extremely fragmented when looking at median household before-tax incomes which have fallen from near $52,000 annually to roughly $47,000 currently.
I agreed with Scott when he stated:
"Forcing an employee to enroll without education, or funding the accounts for them (such as no 401k match), will have little or no effect to the employee, but will be just one more regulation small businesses will have to deal with. Large companies have plans, small companies (with little help in HR) don't."
Reality Check
However, whether you agree or disagree with my points, or the President's "wealth redistribution agenda" in tonight's SOTU address is of little matter. With both houses of Congress controlled by conservatives, the likelihood of any of these proposals actually passing into law nears "zero." This will leave the President with his nuclear option of "excutive orders" to move his agenda down the field, but even that is likely to be viciously contested in the months ahead.
