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Dear Micah,
I don't normally make a big deal of Halloween, but I may reconsider this year if only because we'll finally put October 2008 in our rearview mirror. It has been, to put it mildly, a turbulent month. I will be sending out a note next weekend specifically on market performance and outlook, but for now it does appear as if the bailout is making a positive impact. Normally, this might lead to a market rally, but the markets have moved on to worries about just how severe the global slowdown may be and volatility continues at record levels.
Between the need to provide stimulus for the short term and the concern about reigning in the yawning deficits over the longer-term, the next President will have his hands full. Both McCain and Obama have released key elements of their economic policies and we review those below. While they don't directly answer the question of how they plan to address the current economic situation or the deficit, at the very least we can get a sense of how their plans will impact you as both a taxpayer and an investor. This article in Business Week, for which I was interviewed recently, also provides food for thought for investors on the upcoming election.
Several clients have sent questions regarding the government deficit, and the client question of the month below centers around the government's ability to finance the deficit. Lastly, beginning this month we'll be including a new financial planning tips column.
As always, we hope this newsletter is useful for you and let us know if you have any questions or suggestions. Please feel free to forward it on to family and friends if you think they would find this newsletter helpful (to do so, just click here).
Sincerely,
Micah Porter, CFA
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Comparing the Budgetary Plans of the Presidential Candidates
Micah Porter, CFA
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In last month's newsletter, I examined the budget deficit and growing national debt. Regardless of who is elected, it is an issue that will loom large. With that in mind, I wanted to examine both candidates' tax platforms to understand their impact on you, as well as to understand the impact on the deficit. In analyzing the two platforms, we'll split the analysis into tax rates on income and capital gains, estate tax and lastly the impact on the national debt.
Tax rates on income and capital gains
In understanding the proposed tax rates on income, a picture is worth a thousand words. The chart below examines the impact of the proposed tax rates depending upon income level.
Source: Washington Post, based on an analysis by the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution
As is evident from the chart above, the two approaches differ fundamentally in whom they benefit. McCain's proposal offers larger cuts to the highest earners, while Obama's does just the opposite. Obama seeks to provide deeper tax cuts for middle and low income earners, and financing those cuts via increases for the highest income earners.
Another area of broad impact is capital gains taxes, which among other times come into play when you sell a security at a gain in a taxable account. Gains on a security held over the short term are taxed as income, and the tax rates in the table above would come into play. However, securities held for longer than a year are taxed at long-term rates, and the highest bracket for long-term rates is 15%. This rate was established in 2003, and the rate had previously been 20%. Obama has proposed raising the rate back to 20%, and McCain recently proposed cutting it to 7.5%, at least temporarily.
Estate Tax
The estate tax was one of the first taxes targeted when Bush entered office, and the amount that can be passed on in an estate without being taxed has increased over the last eight years. Amounts above the exemption - which in 2009 are set at $3.5 million per individual and $7 million per couple - are taxed at a rate beginning at 45%. Given the high exemption levels, estate tax is an issue for relatively few households.
McCain has proposed raising the exemption amount to $5 million, and lowering the tax rate to 15%, equal to the current capital gains rate. Obama, on the other hand, has proposed freezing the estate tax at 2009 levels, with a $3.5 million exemption and a 45% tax rate. In either instance, the overall estate tax would be much lower than it was even just a few years ago.
National Debt
If past recessions offer any guidance, addressing the deficit should take a back seat to providing stimulus to get the economy moving again. However, once growth takes hold, addressing the national debt is critical.
In numerical terms, the national debt appears staggering - over $9 trillion as of the end of the 2007 budget year, and climbing rapidly particularly if you factor in the cost of the bailout. However, the best way to examine the national debt across time is to calculate the debt as a percentage of gross domestic product. Recent estimates have shown that by that measure, the debt would increase to in excess of 70% of GDP. The last time the debt was that high was 1954, when the U.S. was still paying down the cost of WW II. While higher levels of debt might be sustainable, they certainly wouldn't be desirable.
So how do the candidates measure up when it comes to addressing the debt? Unfortunately, neither has offered concrete plans as to how they would address the debt. As a result, the Tax Policy Center (see the chart above for who these folks are) has estimated that McCain's plans would increase the debt by over $4.5 trillion over 10 years, while Obama's would increase the deficit by $3.3 trillion. Note that these numbers are based on where the tax and spending plans the candidates have rolled out, and not where they would cut spending. However, this is because both Obama and McCain have been much more nebulous about where they would cut - and while this might be expected for two politicians running for office, as taxpayers invested in the future of our country, we have to demand more.
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Financial Planning Tips - Home, Auto and Umbrella Coverage
Micah Porter, CFA
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I sat down with a client recently to review her homeowners, auto and umbrella coverage. The client asked to review them after changing insurance agents and being told by her new agent that she was eligible for discounts which she was not receiving.
During the review, we identified a few other areas of possible savings, and I thought it might be useful to share what we found as it might result in a bit of savings for other clients. Here are a few tips:
- Check with the agent that handles your homeowners policy to confirm that you're receiving all discounts to which you are entitled. The most common is a discount for a security system, but various carriers have other discounts, including discounts for newer homes and discounts for living close to a fire station. Your agent can provide a list of discounts available with your policy.
- If you have an umbrella policy, make sure you don't have more liability coverage on your underlying homeowners and auto policies than your umbrella policy requires. Your umbrella policy requires a specific amount of liability coverage, and beyond that amount the policy will provide liability coverage. Again, check with the agent on your umbrella policy to confirm that you have sufficient, but not excess liability coverage on your auto and homeowners policies.
- Think about how much your homeowners deductible should be. Insurers can raise rates or even drop coverage for homeowners that file an excessive number of claims. Exactly what constitutes excessive varies, but we know policyholders that have been denied coverage for filing two relatively small claims within a 24 month period. As a general rule of thumb, if you'd be comfortable paying a specific amount out of pocket, make sure your deductible is higher than that amount.
We hope the above tips are helpful. Keep in mind that reviewing coverage and providing suggestions is one of the services we provide as part of the retainer relationship. If you are a retainer client and you'd like us to take a look at your coverage, just let us know.
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Client Question of the Month
Micah Porter, CFA
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How can the U.S. government continue to raise money in the face of such a large and growing debt?
The government typically raises money by issuing bonds to buyers - often foreign governments - who purchase those bonds and in turn, receive interest payments and ultimately their principal back on maturity of the bonds. The debt in this instance is not unlike a mortgage with a balloon payment at the end.
Why would these governments and other investors keep buying bonds from an entity that is running up ever larger debts? Because the borrower, the U.S. government, has never defaulted on an interest or principal payment in the history of our nation. That is an extraordinary record, and it explains why Treasuries are still viewed as the safest investment available. |
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