Tuesday, July 7, 2009

Prepare for a major tax increase

(Welcome to those visiting from the Carnival of Personal Finance #213. Subscribe to this site.)

Your taxes are going to go up. Not just taxes on the rich, or the mass affluent, or the solidly middle class. Taxes for everyone will increase, since we're going down the road of needing a value added tax (VAT) in the form of a national sales tax to get us out of this massive national debt hole that we've dug ourselves into.

The bill is far too big for only the rich to pick up. There aren't enough of them. America will have to lean on citizens far below the $250,000 income threshold: nurses, electricians, secretaries, and factory workers. Within a decade the average household that pays income tax will owe the equivalent of $155,000 in federal debt, about $90,000 more than last year. What the Obama administration isn't telling Americans is that the only practical solution is a giant tax increase aimed squarely at the middle class. The alternative, big cuts in spending, aren't part of the President's agenda. To keep the debt from wrecking the economy, the U.S. would need to raise annual federal income taxes an average of $11,000 in 2019 for all families that pay them, an increase of about 55%. "The revenues needed are far too big to raise from high earners," says Alan Auerbach, an economist at the University of California at Berkeley. "The government will have to go where the money is, to the middle class." The most likely levy: a European-style value-added tax (VAT) that would substantially raise the price of everything from autos to restaurant meals.
(Added emphasis is mine.)

Anyone who tells you that our national debt won't be a huge problem is bs'ing you. Sure, politicians love to talk about how they'll bring down the national debt by eliminating earmarks, cutting discretionary spending, blah, blah, blah. Budget cuts ain't happening, unless China stops buying all those Treasuries which would negate our ability to do deficit spending. And then there is the required spending on entitlements: Social Security, Medicare and Medicaid. Do a search on 'generational accounting' to see what kind of financial damage entitlements are going to do to our children and grandchildren. Except we're the children and grandchildren and the problems are upon us already. Don't get me wrong, I think entitlements are a great thing and keep people out of poverty. However, we as a nation never figured out how to pay for them.
It can't go on forever, and it won't. What will shock America into action is the prospect of fiscal collapse, which will grow more vivid each year. In 2008 federal borrowing accounted for 41% of GDP, about the postwar average. By 2019 the burden will double to 82% by the CBO's reckoning, reaching $17.3 trillion, nearly triple last year's level. By that point $1 of every six the U.S. spends will go to interest, compared with one in 12 last year. The U.S. trajectory points to the area that medieval maps labeled "Here Lie Dragons." After 2019 the debt rises with no ceiling in sight, according to all major forecasts, driven by the growth of interest and entitlements. The Government Accountability Office estimates that if current policies continue, interest will absorb 30% of all revenues by 2040 and entitlements will consume the rest, leaving nothing for defense, education, or veterans' benefits.
National bankruptcies

The other option is national bankruptcy. It's not an option, obviously, and a national U.S. bankruptcy will never happen. But for kicks, I did some research on what happens when nations go bankrupt.

A couple of examples I found (thanks Wikipedia!) are defaults on debt incurred by previous national governments, such as post-Revolutionary France defaulting on the debts of Bourbon France and Soviet Russia defaulting on debts of Czarist Russia. There's also an example of a default of Danish bonds in 1850, and another Danish bankruptcy in 1813. Germany has gone bankrupt twice after the World Wars. More recent examples are Russia in 1998, Argentina in 2001-2002, and Iceland in 2008. A national bankruptcy may lead to massive inflation, as the country prints money to pay its debts. Gold could be a hedge against this situation.

Looking at the last Argentina bankruptcy:
Once the Argentine businessmen had transferred their dollars abroad, the second phase of the collapse began. The Argentine government froze all bank accounts, capping the maximum amount an accountholder could withdraw at only $250 (€198) a week. Small investors, those who had left their money in the banks, were the hardest hit. Tens of thousands of desperate citizens stormed the banks, and many spent nights sleeping in front of the automated teller machines.

The last phase of the downturn began in the Buenos Aires suburbs. After consumption had dropped by 60 percent, young men began looting supermarkets. In December 2001, 40,000 people gathered on Plaza de Mayo in front of the Casa Rosada, the presidential palace. There, they banged pots and pans together day and night, until an unnerved President Fernando de la RĂșa fled by helicopter.


Nevertheless, the country recovered from the crash with astonishing speed. In recent years, the Argentine economy has grown at impressive rates of 7 to 9 percent.

Again, it's inconceivable that the U.S. will go bankrupt. That's just not going to happen. But, I do see a large tax increase and increased inflation. The hardest thing to swallow about the tax increase is that since it may be a national sales tax, there's no way to avoid the taxes later by using vehicles like a Roth IRA or Roth 401(k).