Tom Sedoric and Casey Snyder

Dutch historian Rutger Bregman made his first appearance at the annual World Economic Forum in Davos with all the subtlety of a skunk at a garden party. His topic? Tax avoidance. “We can invite Bono once more but come on we’ve got to start talking about taxes,” he said at a forum on philanthropy. “All the rest is bull!!!! in my opinion.” He later told reporters he felt like he was “at a firefighters conference and no one was allowed to talk about water.”

In Part 1: Understanding Taxes we wrote about the unprecedent rise in budget deficits, a slower and disproportionate rise in tax revenue despite forty years of tax cuts, and the public’s lack of interest and overall awareness of the tax code. Today, we will first address the growing macroeconomic pressures that decades of tax cuts and government deficits have on the current climate. Second, we will consider how an unknown future tax paradigm may impact the net return of our personal balance sheets. 

Deficits matter. But to what extent do deficits matter? When will the bills come due? Where is the tipping point? What will the catalyst be? No one knows the answers to these questions, but when the wellbeing and basic comforts of so many people (Social Security, Medicare, Medicaid, and Public Pensions) requires an unprecedented amount of borrowing on an annual basis, even after a 10-year economic recovery, we know the equation becomes unsustainable and change is inevitable. 

Already, 60% of the annual budget is spent on servicing debt, healthcare and benefits. The costs of benefit and entitlement programs – including public pensions not mentioned here – are expected to balloon over the next 20 years as baby boomers move into their peak benefit and distribution years.

The graph below, although slightly dated, shows the change in real income from 1980 through 2014. According to the Economic Policy Institute, the top 1% take home 21% of all income in the United States, the largest share since 1928. 

The combination of an aging society, stagnant wage growth, and rising deficits, coupled with underfunded entitlements despite one of the friendliest tax environments of the last 40 plus years, underscores the contentious reality that changes are likely. It’s also important to note that the financial obligations coming due are largely meant to benefit ‘Baby Boomers’ on the backs of the next generation, yet Millennials and Gen X will make up the majority voting at the polls. It’s plausible to imagine a multi-generational family dinner where family members are divided, not by whether someone is on the ‘left’ or ‘right’, but rather whether they are of working age and a payor of benefits vs. a retiree and recipient of those benefits. 

Given the backdrop, is anyone surprised by the populism and extreme measures being proposed by the next crop of Presidential candidates? Freshman Rep. Alexandra OcasioCortez (D-N.Y.) has proposed a hike in marginal tax rates to 70 percent for incomes over $10 million to help finance her New Green Deal proposal. The marginal rate was at its highest in 1953 (92 percent) and 1980 was the last year for the 70 percent marginal tax rate before Reagan cut to tax rate to 50 percent. 

Massachusetts Democratic Sen. Elizabeth Warren has made a wealth tax proposal one of the policy priorities of her presidential primary bid. Warren wants a wealth tax of 2 percent on family assets of $50 million and up to 3 percent on assets over $1 billion. According to Slate, it would impact 75,000 families, the top .01 percent of wealth holders, who hold an estimated 10 percent of the nation’s wealth.

Initially, both proposals were popular. In February, a New York Times/Survey Monkey poll found that Warren’s proposal had a 61 percent to 35 percent favorability rating (including 51 percent of Republicans). The respondents found Ocasio-Cortez’s plan not as popular, but it still garnered a 51 percent to 45 percent favorability rate. The same poll found that Americans, by a 62 percent to 34 percent margin, believe the government should enact policies to reduce the wealth gap.

We often see strong political pendulum swings in America, but the most significant trends take a quasi-geologic pace until a critical mass is breached. 

Without the clairvoyance to predict when and how change will occur, savers of all ages and early retiree’s need to be assessing the durability of their plans. This means accounting for common “what if” scenarios like the cost of a healthcare related event or living longer (or shorter) than expected. We should also consider the more controversial “what if” scenarios such as: the prospect for cuts in Social Security or increasing the age for eligibility, pension cuts or their inability to keep up with the rising cost of living. 

We must also look at our plans from the perspective of future tax exposure. With the tax The Sedoric Group of Steward Partners I 29 Maplewood Avenue, Suite C I Portsmouth, NH 03801 paradigm apt to change, it’s an easy exercise within our control that most people overlook. For example, have you modeled future tax exposure – ordinary income and capital gains – based on projected sources of income, pre-tax, post-tax, and Roth savings? With a sense of your future tax exposure you now have time to assess and stress test potential future tax risks rather than the naïve fingers-crossed strategy so many people depend on.

Although uncomfortable, understanding the history of the tax code helps us appreciate the range of potential change. Without historical context we’re apt to succumb to the herd mentality that external variables impacting our financial situation will only improve in alignment with our own personal universe. As if 300+ million people will all see policy change that benefits them. 

What does this drumbeat for higher taxes and confronting income inequality mean? We can only speculate today. We won’t know for 5, 10, or perhaps 30 years but we do know a formula of continued tax cuts, rising government expenditures, and exploding national deficits and debt is a reckoning whose time will come sooner rather than later – and at a time when the next generation is politically potent. Now is the time to identify any overexposure to a singular tax or overdependence on a singular benefit (i.e. all pre-tax savings, Medicare, Social Security, pension). 

The polarizing political climate of today shows little evidence of abating but what we can do is prepare for a wide range of possible outcomes. 

We believe that ignoring this drumbeat is not an option. As we’ve expressed in previous updates, the world we plan for is going to require critical thinking.

This information has been obtained from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed. The views expressed are those of Tom Sedoric – Partner, Executive Managing Director and Wealth Manager and D. Casey Snyder, CFP® - Partner, Senior Vice President and Wealth Manager and are not necessarily those of Raymond James. Steward Partners Global Advisory LLC and The Sedoric Group maintain a separate professional business relationship with, and our registered professionals offer securities through, Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment advisory services offered through Steward Partners Investment Advisory LLC. 2985754