Key takeaways:
- Covid-19 is stress testing in our education system
- An increasing government deficit seems to signal increased taxes
- The importance of understanding expenses
I’m sure a lot of us are wondering about children or grandchildren and what the upcoming school year will look like for them. There are many options (part-time, full-time, hybrid, homeschooling) and each has its own positives and negatives. For many with school-aged children, sending them to school has been an underpinning of family life. Many school districts are still trying to pull together plans that allow for a safe return to school. Where we live, the school district has decided to start the year with virtual learning and will reassess closer to the start of the school year if a return to the classroom is feasible.
We are now starting to see Covid-19 be a stress test on the inequity on our education system. In many cities, public schools are doing distance learning while private schools are returning to the classroom. Private schools have historically had better funding and more flexibility and that disparity is increasing as parents decide what’s best for their family. Currently the average private school is running a ratio of 11.1 students to one teacher/assistant and these small class sizes are critical in a return to the classroom. Ratios like these are hard to find in any public school with the national average at 1 to 16+(Source – nces.edu) . And this disparity in education will continue to grow as funding for public education remains uncertain as state and local governments grapple with long term deficits due to Covid-19. As a parent making some of these decisions with my own children, it is hard to find any middle ground.
At the college level there is more discrepancy. Harvard just announced that the entire upcoming school year will be virtual, and, at the same cost. Many high school’s seniors are considering a gap year. Many of the small colleges will have significant challenges around remaining financially sustainable. What does all this have to do with your money? As education slows down so does innovation. Innovation is a critical component in job growth and job quality. Increasing the number of good high paying jobs has been one of the key factors in growing our economy.
With a fundamentally different landscape of education and as schools still figure out how to offer high quality distance learning options, there remain many unanswered questions about the long-term implications of these changes on our economy.
A lack of access to high quality education will continue to widen the wealth gap which implies an increase in the social safety net funded by an increase in taxes.
The chart above highlights our growing deficit. The bipartisan budget policy has raised alarm bells around the total deficit spending that has happened as of late. Large budget gaps or deficits leave less flexibility for the US government. Yet policymakers are already looking at ways to create another trillion dollars plus for more needed stimulus. The treasury stands ready to print money to the tune of $4.6 Trillion dollars in 2020. Last June (2019) the deficit was $8 billion; this last week it reported the current deficit is now at $864 billion. That is over 100x more in less than year.
There are two pieces of information that are not shown here. One is that the government has delayed tax returns to July 15th. The other is that there are 30-year bonds that are maturing at a lot higher interest rate than today’s 0% rates. Think of it like refinancing a mortgage loan where the debt is the same, but the payment should drop significantly. Both of these will offset some of the numbers above but the overall trend towards an increased deficit will continue and the trajectory doesn’t change. Unconstrained government spending means two things will start to increase: inflation and taxes. This newsletter will focus on taxes. We talked about inflation in this previous newsletter.
The pie chart above details sources of revenue for the government. Individual income taxes and payroll taxes comprise the majority of income for the Federal government. In this newsletter, we look at potential changes to the largest piece of the pie, individual taxes, and to the smallest piece, estate and gift taxes.
When the Tax Cuts and Jobs Act was signed into law at the end of 2017 it was the largest change to the tax code in several decades. There were three significant changes for individual income taxes:
- The personal exemption amount was raised to a level where most people would use the standard deduction.
- Each tax bracket was widened with equal or lower rates. Therefore, more income was taxed at a lower bracket.
- State and local tax was maxed at $10,000.
Capping the deduction for state and local taxes impacted most high-income earners or retires with significant assets since ten thousand is a very low bar in most states.
Looking forward, regardless of who wins the presidency or the senate, increasing taxes looks likely given our increasing deficit. The difference is where and by how much. For the current President, his plan above is in action right now. However, with Covid-19 and without significant economic growth, this plan likely needs a revision. The front runner for the Democratic Party, Joe Biden, has laid out key tenants for his plan.
- Effectively double the tax rate on material long-term capital gains from 20.0% to 39.6% for those with adjusted gross income (AGI) exceeding $1 million
- Add a new 12.4% “high-earner” payroll tax on all income above $400,000
- Raise the top individual tax rate back up to 39.6% from 37.0%
This plan would be another large tax legislation change and to get this level of change a lot would have to happen.
Another area of the tax code that is getting more visibility is Estate and Gift taxes. When the country has had disastrous unemployment, some people are looking to tax the rich as a symbolic statement. Although estate taxes do not represent a huge amount for Federal income, any proposed changes are again more symbolic. Changes here range from elimination of the estate tax exemption to bringing the exemption as low as 3 million per person, a removal of step up in cost basis at death, and changes to annual gifting limits placed on the donors.
The key takeaway here is that both parties will need to increase tax revenue. It may be a good year to accelerate some gains while we understand the current tax code.
Expenses are more important than assets.
This is a problem that affects all retires. In my career as an advisor I have seen people successfully retire with significantly less than a million dollars and I have seen people fail with savings of greater than 30 million. Having a good grasp of your expenses is the most important thing you can do in retirement. As years go by in retirement you may have to make adjustments up and down and that may impact how you invest. More than likely in a down year you will want to reduce expenses; while in an up year it is okay to spend more than you typically would. Auditing your expense allows you to see if your money is going towards your goals and things you value. Within Client First Capital’s portal you have access to tools to track and budget your expenses regardless from which credit card or bank the expenses are coming from. Most importantly, your data is not sold to third party vendors. We have worked with many clients having conversations about the ‘Smart Money’ philosophy which creates alignment between Goals = Values = Behavior.