With the August government debt ceiling approaching, you may be concerned about what it means to you, your financial security and the probable outcome. While guessing exactly what politicians will do is impossible, it is widely believed that not extending the debt limit could result in a worse financial situation than we just went through. For this reason alone, we believe the following solutions and results are most probable.
Since 1917, the debt limit has been increased numerous times, usually associated with great political drama. If history repeats, the outcome will be a compromise. For the average investor, the probable result will be higher taxes for those in the upper-income ranges as well as higher taxes on dividends and capital gains. Budget cuts will most likely impact older Americans as Medicare and Social Security pose the greatest future financial challenges to the country if not addressed. And with the end of the Federal Reserve monetary easing programs (QE2), interest rates are naturally expected to rise.
The summary outcome appears to be a compromised “fix” at the expense of those who are older and those who are wealthier. If this is the case, you need to be prepared to have saved enough and that you are protected sufficiently against higher taxes and increased interest rates.
Without diving into particulars, the issues are straight forward, our government has been running huge deficits and we are maxed out on the national “credit card.” We have only a few options which span the spectrum of increasing our “limit” once again or making tremendous spending cuts mixed with increased taxation. Some combination seems to be the direction we are heading toward.
Regardless of the solution or political party posturing, the numbers indicate that the budget cannot be balanced strictly by cutting discretionary government spending. If we cut 100% of the non-defense discretionary spending, that would only account for half of the current deficit according to the government budget reports. Well, then how about cutting 100% of defense? That does not do it either. You would have to cut 100% of defense along with 100% of Social Security and then you cover the deficit.
From all the reports and numbers we have reviewed, it does not appear as though the budget can be balanced without spending cuts to Social Security, defense, Medicaid and Medicare while increasing taxes as well. This is our conclusion, what do others say on the matter?
Last December the Deficit Commission issued a report that was supported by 11 of 18 members with the following major points. Discretionary spending levels should be cut to pre-2008 levels with increases at 50% of inflation (thus not keeping up with price increases…a further “cut”). A recommended 15 cent gasoline tax for a few years. A cut to corporate and individual tax rates but taking back some mortgage deductions and tax benefits associated with municipal bond interest, dividends, capital gains and health insurance. While increasing Social Security age eligibility and making reforms to Medicare and Medicaid.
The “Ryan Plan” focuses on spending controls to Medicare and Medicaid (mostly State driven to put them in control to promote hopeful efficiency). Then some kind of subsidized health care premium program along with some similar Deficit Commission recommendations for cuts to taxes but a reduction to some tax breaks. Social Security and defense spending seems to be largely untouched.
The President’s plan focuses on tax increases, lower interest costs and the majority of savings coming from non-defense discretionary, defense and medical programs. His proposal already assumes the repeal of the Bush era tax cuts already set to expire on their own in 2013.
So why not just cut some spending and increase taxes to fix this today? If the “fix” was immediate, the last recession would seem like a walk in the park as the economic hit would be too great. The reason why we believe the politicians will address this “appropriately.”
So what is the most likely scenario? Your guess is as good as anyone but we would expect a rise to the debt limit associated with some kind of budget limitation. This will kick the can down the road into 2012 where we have the same argument again. But from all the proposals and reviews from both sides of the aisle, the themes are clear. As a society we will have to save more for ourselves, rely less on government, pay more in taxes, especially those over $250k of earnings and expect less benefits coming from Social Security, Medicare and Medicaid. And every government program will be under fire, including defense which has to be cut as well.
When the family hits financial troubles, everyone feels it. From top to bottom, we all need to chip in on this one…and for a long time. Save more, protect your portfolio, globally diversify, position for higher taxes and stay tuned for changes and remain nimble
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