Archive

Posts Tagged ‘Social Security’

Where Did The Money Come From?

paying taxesThe Congressional Budget Office (CBO) released their preliminary estimate of the monthly budget deficit for January.  The CBO estimated the government overspent by a measly $2 billion in January 2013. This compares to a monthly deficit of $27 billion in January 2012.

Hold on before you think we’re making much progress towards reducing the $1 trillion plus deficits of the past four years.  This was only one month out of twelve.  The CBO estimates the cumulative deficit for the past four months is $295 billion (the U.S. fiscal year starts on October 1), and the Fiscal 2013 total deficit is projected to be $850 billion.

The CBO reported a $36 billion uptick in revenues collected in January 2013 over those collected in January 2012.  Some politicians and pundits are already citing these numbers as being indicative of the success of the increased taxes, which were part of the fiscal cliff deal reached on January 1, 2013. It’s a stretch to make this claim, but that rarely matters in the world of politics.

The CBO estimated the government collected $9 billion more in Social Security taxes.  These additional taxes arose from the additional Social Security taxes collected after January 1, 2013.  The 2% temporary tax holiday was scheduled to expire December 31, 2012, and further extension was never a serious consideration.  Social Security is already headed towards insolvency, and continuing a reduced rate would have only exacerbated the problem.  It’s a stretch, but since Congress could have extended the lower rate, you could make the argument these additional revenues were part of the fiscal cliff deal.

Although the remaining additional $27 billion may have been collected in 2013, most of it is not attributable to the fiscal cliff deal.  The increased tax rates only affected high income individuals on income earned after January 1, 2013.  Most super wealthy people pay their taxes through estimates, not withholdings, and the first quarterly payment is not due until April 15th.  Thus, the first real increase in revenue from the higher 2013 taxes won’t be collected by the Treasury until April 2013.

So where did the money come from?  In all likelihood, most of it was additional 2012 taxes which were paid in 2013.  Quarterly estimated taxes for individuals are due April 15th, June 15th, September 15th and January 15th of the following year.  Based on my experience, most wealthy people pay their fourth quarter installment in January of the following year.  Odds are that most of the additional $27 billion in tax revenues actually relates to taxes paid for 2012, not the increased taxes due for 2013.  It’s a reasonable conclusion, since many high income taxpayers accelerated income into 2012 to avoid the anticipated higher 2013 tax rates.

The additional revenues may be good for the country and the economy.  However, I think it’s a little too early to declare success and victory from the increased tax rates.  I believe the verdict is still out, but to make a fair assessment, you have to understand where the money comes from.

Advertisements

Arithmetic

A few weeks ago, former President Clinton scored political points while criticizing the economic plan of Gov. Mitt Romney.  He touted the Federal budget surpluses during the final years of his presidency.  He went on to say he was able to balance the budget by simple arithmetic.  He also invoked the simple arithmetic principle to argue that Gov. Romney’s plan didn’t add up and would result in a large tax increase on middle class Americans.

The truth is that neither Gov. Romney nor President Obama’s plans pass the arithmetic test.  A detailed analysis of their plans is far beyond the scope if this article, so I’ll briefly summarize.

The highlights of Gov. Romney’s plan:

  • Cut tax rates by 20% for individuals and lower the corporate rate to 25%
  • Have preferential rates for interest, dividends and capital gains
  • Eliminate loopholes and limit certain deductions for higher income taxpayers

The criticism of Romney’s arithmetic is there aren’t enough loopholes to close which will offset the reduced revenue from the lower tax rates.  Deductions would also have to be limited for lower income taxpayers to make the numbers work.

The main point of President Obama’s plan:

  • Increase the tax rates for people making over $250,000
  • Eliminate the preferential rate for dividends and increase the capital gains rate

These changes are estimated to raise an additional $70 billion in annual tax revenues.

The arithmetic doesn’t work for either of these plans to balance the budget.  For the 2012 budget year, the federal government overspent by $1.1 trillion, and the total national debt has exceeded $16 trillion.  Since the government spends approximately $3.5 trillion each year, it’s a monumental task to close a $1.1 trillion deficit.

The U.S. Treasury collects approximately $2.2 trillion in income tax revenue each year.  To balance the budget under the Romney plan, all current deductions would need to be cut in half to raise another $1 trillion.  Deductions would have to be limited even more if the tax rates are reduced.  The Obama plan is no better.  Even if his tax changes were implemented, he’s about $1 trillion short to balance the budget.  By simple arithmetic, the numbers don’t add up… for Romney or Obama.

We can’t tax our way out of the hole we are in.  We must cut spending in order to balance the budget.  This is not Washington semantics for cuts by reducing the rate of growth or cutting the amount you hoped to spend.  It means actually spending less than the $3.5 trillion we spent last year.

On this front, I give the edge to Gov. Romney.  You or I may not agree with his proposals or priorities, but at least he’s willing to talk about cutting federal expenditures.   He was criticized and ridiculed after the first Presidential debate for trying to kill Big Bird, because he advocated ending the federal subsidy to the Public Broadcasting Service.  He has also been willing to tackle the “third rail” of politics – Medicare and Social Security.

In contrast, I can’t think of one significant cut in federal spending proposed by President Obama.  Counting money which would have been spent for the war in Iraq but isn’t going to be spent doesn’t count in my book.  It’s like saying you cut your spending by $5,000 for the vacation you didn’t take.  Furthermore, the budget deficit for 2013 will still be over $1 trillion without any spending for Iraq.  Instead of talking about spending cuts, the President is pushing for more “investments” (aka spending) for teachers and infrastructure.  These may be good things, but it doesn’t address how to balance the budget, and taxing the rich more isn’t going to close the gap.

Politicians are very good at using sound bites and obscuring the truth.  President Clinton was right… balancing the budget is simply a matter of arithmetic.  In this case, both candidates (and most members of Congress) probably need a remedial math class.

Social Security Groundhog Day

You may have seen the movie “Groundhog Day” which was released in 1993.  In the movie, Bill Murray plays weatherman Phil Connors who was sent to Punxsutawney , PA to cover Groundhog Day, only to find himself repeating the same day over and over again.  No matter what he does, he can’t seem to escape Groundhog Day.

The annual report from the Trustees of the Social Security Administration seems like its own version of Groundhog Day.  Every report seems to be a repeat of the prior one.  The reports warn of the coming insolvency of Social Security and Medicare, but it’s projected to be far enough into the future, that no one seems to worry too much.

The 2012 report estimates the Social Security system will become insolvent in 2033, three years earlier than what was predicted a year ago.  The fiscal status of Social Security has been known for years, yet Congress and President Obama reduced the employee’s contribution rate to the Social Security system from 6.2% to 4.2% for 2011 and 2012.  The rate reduction was intended to stimulate the economy, and they argued it would have no long-term impact on the solvency of Social Security.  Anyone with a rudimentary understanding of economics and finance could tell you paying less taxes into a system that is already paying out more than it receives, will have a negative effect.  Only Washington politicians are surprised by the updated figures, or at least act surprised.

The staunch defenders of this ridiculous argument also contend the system is solvent for more than the next two decades.  They point to the trillions of dollars in the Social Security Trust Fund as the saving grace to the system.  You can read this article to learn the fallacy of this belief.

There are a couple of other facts in the report which might cause concern.  In 2011, the government collected $691 billion of Social Security Taxes and paid out $736 billion in benefits.  It appears there was a $45 billion shortage in 2011, but there wasn’t.   The Social Security Administration collected $111 billion of interest on its IOU’s from the US government, so it reported a surplus of $66 billion, rather than a deficit.  So where did the $111 billion of interest come from?  It’s part of the $1 trillion of additional debt the U.S. Treasury issued over the past year.

It’s easy to get lost and confused by the Federal government’s accounting methods, which may be intentionally arcane.  So here is the bottom line… call it what you want, but the U.S. government borrowed an additional $45 billion to pay out Social Security benefits in 2011.  If you read the report and analyze the projections, you’ll see this number is only going to grow exponentially over the next two decades.

What is it going to take to change the situation?  I really don’t know if we’ll ever realize what’s happening as long as the government keeps sending out checks.  But what happens if they stop?  It’s unlikely to occur, at least for a long time, but what would have happened if the U.S. Treasury wasn’t able to borrow the additional $45 billion? Since there are no real assets in the Social Security Trust Fund, $45 billion in checks would not have been sent.

So in essence, it’s like we’re stuck in our own Social Security Groundhog Day, but there is a difference between us and the character Phil Connors; Phil Connors recognized he was stuck and tried to change it.  Sadly, most of us don’t believe we’re living our very own Groundhog Day.

A New Record

On Wednesday, the United States of America established a new record, although it may not be one we want to boast about.  As of the close of business on Wednesday, the U.S. total debt exceeded $15 trillion.

This bad news gets worse… don’t expect the debt increase to stop or slow down anytime soon.  We’re already two months into the current budget year without an approved budget (that’s a different matter).   However, the 2012 Budget proposals put forth so far expect to add at least another $1 trillion to the debt, which is approximately $3 billion per day.

Interestingly enough, there was very little media coverage regarding this matter.  There was more coverage about Occupy Wall Street, the Supercommittee and the Penn State scandal than our debt breaking the $15 trillion barrier.  After all the acrimony earlier this year about raising the debt ceiling, it might not be considered important news.

Here are a few details about our national debt which might interest you.

  • The U.S. population is approximately 310 million people, which means there is approximately $48,000 of debt for every man, woman and child.
  • The debt is divided into two broad categories; intragovernmental debt and debt held by the public.  The intragovernmental debt is $4.7 trillion and the debt held by the public is $10.3 trillion.
  • The intragovernmental debt is essentially money owed to the Social Security system. When politicians refer to the Social Security Trust Fund, this is what they mean.  Its debt the government owes itself.
  • Even though it may be considered an independent government agency, the U.S. Federal Reserve is now the largest stakeholder of the debt held by the public.  The Fed currently holds $1.665 trillion of U.S. Treasury Securities.
  • China is the second largest holder of debt, with $1.148 trillion.
  • As a result of the Federal Reserve’s quantitative easing, its stake in U.S. debt obligations increased by over $850 billion over the past year.

I may be a bit cynical, but unfortunately I don’t think there is much hope Congress will act to stem the flow of red ink in the near term.  They battled a few months ago and agreed the debt will rise to over $16 trillion by the end of 2012, so I don’t expect much to happen on the political front.  The lack of media coverage is an indication of the lack of interest by Congress in this dubious milestone.

On the bright side, one thing that’s preventing us from being crushed by our own debt is that nearly one-third of the $15 trillion of Treasuries is effectively being held by the federal government (i.e., Social Security and the Federal Reserve).  Thus, our real debt to investors is effectively $10 trillion.  Not a good situation, but better than $15 trillion.

At the same time, it’s not a healthy position for the government to hold so much of its own debt.  Congress may have played fast and loose with the Social Security funds, but the day has arrived when the Social Security payments exceed the taxes collected.  It’s going to put more strain on the budget, and the real cash flow of the federal government, as Social Security starts cashing out its intragovernmental loans.

It’s also not great for the Federal Reserve to continually increase its Treasury holdings.  As I and others have previously written, the Federal Reserve essentially printed money to buy up a huge chunk of government debt issued over the past 12 months.  Quantitative easing may have some economic benefits, but there are tremendous long-term risks from this strategy.

Americans like to break records, and we just broke another one.  Unfortunately, it’s an honor we could have done without.  The real question is what are we going to do to stop the hemorrhaging and get our fiscal house in order?  We just set a new record, and it’s only a matter of months before we break the $16 trillion mark.

Decoding the Debt Debate

If you’re following the current debate on raising the debt ceiling, you’re probably frustrated.  Your angst may be triggered by, the partisan bickering, the lack of great leadership or the uncertainty of what may happen and what it all means.

Politicians from all political persuasions and affiliations have become very adept at obfuscation.  Knowing whatever they say or do can and will be used against them in a future election, politicians have become very proficient in deflecting and dodging direct answers.  They speak in vague terms and try to boil everything down to a 30 second sound bite.

Politicians and political commentators often use terminology that is confusing and often misleading.  You almost need a secret decoder to decipher what they are saying.  I don’t all of the secret codes, but I have a few.

As you listen to the debate, the following are a few terms to keep in mind.

  • The National Debt – The cumulative amount of money owed by the U.S. government. These are actual bonds held by various investors (including the Chinese government and your friendly bank).  The total outstanding debt is approximately $14.5 trillion.
  • The Debt Ceiling – The total amount of bonds the U.S. Treasury is authorized to issue.  The debt ceiling is currently equal to the National Debt.  A law must be passed to increase the debt limit.
  • Deficit – This is the amount of money the government is spending in excess of revenues it collects in one fiscal year (October 1 – September 30).  The deficit for fiscal 2011 is projected to be $1.4 trillion.
  • Credit Rating – Every bond traded on a public market is rated by an independent credit rating agency, which assesses the financial strength of the issuer and the likelihood of default.  The lower the rating, the higher the interest rate required.  For bonds already issued, a change in credit rating will often influence the price at which the bond is traded on the market.

Aside from these terms bantered about, I believe there are a few important factors you need to pay close attention to in any deal that is reached.  These will be the types of issues our  political leaders will attempt to obfuscate.

  • Time Horizon – The time horizon for the spending cuts and additional revenues will be calculated over the next 10 years.   If Congress and the President agree to cut $1 trillion in spending, it won’t all come in fiscal 2012.  They may sound like everything is happening this year, but any plan will be adopted over the next decade.  Raising the debt ceiling is the only thing to take effect immediately.
  •  Timing – Look at the timing for when additional revenue is received and spending cuts are enacted.  If history repeats itself, the revenues will start to be received soon, and the  bulk of the spending cuts will happen in the latter years.  In the world of pork barrel politics, elected officials use government spending to buy votes, and the termination of programs will frequently cost votes.  Thus, politicians have a real incentive to defer spending cuts to another day.
  • Details –It won’t be easy, but do your best to understand the details of the plan.  Congress is trying to make major changes to the tax code, Social Security, Medicare and  Medicaid, and they’re rushing to get it done in the next few days.  I don’t think you want a repeat of Nancy Pelosi’s famous quote, “We have to pass the bill so you can find out what is in it.”

I believe this is a serious issue, and how it is resolved could have far-reaching implications for the future.  No one knows what will happen if the government defaults on its debt, since it has never happened.  As I previously wrote, I think Congress will and should raise the debt ceiling, but it also needs to curtail government spending.  Racking up over $1 trillion of debt each year is just as perilous as defaulting on the current obligations by not raising the debt ceiling.

I also have serious reservations about our leaders’ability and willingness to cut spending.  The 2011 budget compromise is a good illustration of this.  Although they supposedly agreed to $38 billion in spending cuts, most of it was accounting gimmicks and money that wasn’t going to be spent anyway.  One analyst calculated the reduction in spending on specific programs to be less than $1 billion in comparison to fiscal 2010.

As the debate continues forward, follow closely.  Here’s why.  Last week, President Obama was pushing a plan to cut spending by $3.7 trillion and add $1 trillion of new revenue, for a net decrease of $2.7 trillion over the next decade.  Sound like a reasonable compromise?  Before deciding, you may want to consider this.  When the Administration presented their 2012 budget to Congress, they also provided a 10-year budget estimate.  The Administration projected total deficits over the next 10 years to be in excess of $9 trillion.  If the current deal cuts it by $2.7 trillion, that still means we’ll add over $6 trillion to the national debt, pushing out total debt close to $21 trillion by the end of the decade.  Still think it’s a good deal?

To me this is a good example of why we must watch this closely.  Despite the political rancor, everyone in Washington is looking for a deal which will make them look good.  Let’s just make sure the American people get as good of a deal as our politicians.

Tax Tip: Self-Employed Health Insurance

While the debate over health care and health insurance continues in the U.S., there is one thing we call agree on… health insurance is expensive.  If you are paying for health insurance, any tax benefits you receive will help reduce the effective cost of your coverage.

A majority of people in the U.S. receive their health insurance coverage as a tax-free employee fringe benefit.  You may contribute to the expense, but the portion your employer pays is typically tax-free to you.  In order to attain parity between an employer and someone who is self-employed, self-employed taxpayers are allowed to deduct 100% of their premiums in calculating their adjusted gross income.  While it may seem logical and fair, it was not always this way.

In order to take the deduction, you must have self-employment income equal to or greater than your health insurance premiums.  Your salary, wages, interest, dividends, pension and other income are not considered self-employment income.  Thus, the portion of insurance you are contributing to your employee benefits and premiums you are paying while unemployed do not count.  The premiums may be deductible as an itemized deduction, but they do not qualify for the self-employed health insurance deduction.

There are a couple of changes that can affect your 2010 tax liability.

  • Your health insurance premiums are treated as a deduction for calculating your net self-employment income, which will reduce the self-employment taxes you pay.  This benefit is only applicable for 2010, unless otherwise extended by Congress.
  • The IRS has determined that Medicare Part B premiums can be treated as self-employed health insurance premiums.  Thus, if you are over 65 and are having Medicare Part B premiums deducted from your Social Security check, you can deduct the premiums if you have net self-employment income greater than or equal to your Medicare Part B premiums.
  • After March 30, 2010, any premiums paid for a child who is under age 27 will qualify for the deduction.
  • After March 30, 2010, the deduction is not allowed for anyone who is eligible to participate in any subsidized health insurance plan for themselves, their spouse or dependent (i.e., you can’t deduct your portion of the premiums paid as part of a subsidized employer health plan).

If you are self-employed or have self-employed income, the self-employed health insurance deduction may help reduce the cost of maintaining health insurance coverage.  The tax savings may not make get you over the affordability hump, but if you are paying, you might as well take advantage of whatever tax breaks you can.

Tax Tip: Self-Employment Taxes

Self-Employment taxes are Social Security and Medicare taxes.  If you are an employee, half of the taxes are withheld from your paychecks and the other half is paid by your employer.  If you are self-employed, you get to pay all of the taxes yourself.   Lucky you.

Self-employment taxes are assessed upon your net self-employment income over $400.  Without delving into all of the various types of self-employment income, it basically means being paid for your hard work and efforts.  It does not include interest income, dividends, capital gains, pensions or other investment income.  Some of the common forms of self-employed income include:

  • Net earnings from a trade or business
  • Consulting and director fees
  • Tips
  • Payments for any services you provide to another person (e.g., maintenance, repairs, cleaning)
  • Pass through income from a partnership or limited liability company

A portion of your self-employed income may be reported to you on a 1099-MISC or a partnership Schedule K-1, but it’s highly likely that some self-employed income won’t be reported to you.  The income is taxable to you even if you don’t receive a 1099, Schedule K-1 or other tax reporting statement, and getting paid in cash doesn’t mean you don’t have to report the income.

Just like an employee, the tax is divided between Social Security and Medicare.  The Social Security tax portion is assessed at 12.4% on the first $106,800 of income for 2010 and 2011.  Since there is no cap on Medicare earnings, you’ll pay 2.9% on all of your self-employed income, no matter how high it goes.  The good news is that you get to deduct half of the self-employment tax in computing your adjusted gross income.  The bad news is that if you’re married, you and your spouse are subject to the tax separately.

There is one taxpayer favorable provision that you want to take advantage of in 2010.  For this year only, you can deduct your self-employed health insurance premiums in determining your net self-employed income.  It’s a one-year benefit, unless Congress decides to extend it.

Special rules can apply to farmers, real estate professionals, ministers, and investors.  It can get complex rather quickly, and the myriad of potential issues are beyond the scope of this article.  If you have questions or wonder if certain income is subject to self-employment taxes or exempt, you should consult a tax professional. 

With an effective tax rate that can be over 15%, self-employment taxes add up quickly.  Better to get it right, than be surprised with an unexpected tax bill later.