Movement in the Right Direction for the Economy

By: Victor Normand
Published: January 2013

Like the Y2K experience, the fiscal cliff had the potential to damage the economy, but was the threat overstated in both cases? Has the recent preoccupation with a looming economic doomsday been mostly the work of journalists and political operatives?

Both events were triggered on the start of a new year and both potential disasters did not happen. The threats were not imagined, but did they deserve the hype? It is impossible to know the answer. But what is real is the fact that the “chattering class” of government types and media folks will always find something to chatter about, and their chattering does have a psychological effect on consumers and businesses.

So, emotionally and practically, we have pulled back from the cliff for now.   In February, the national debt ceiling will be reached.  It is hard to believe the government will allow the country to default on its debt.  Then soon after that, automatic spending cuts are scheduled to occur.  Hopefully, the drama associated with the spending side of the deficit will have less of an impact than the revenue or taxing side. Not everyone is directly affected by federal spending cuts, but nearly everyone is directly affected by taxes.

Considerable uncertainty on several tax issues have been removed by the new law and that is a very good thing. Higher income individuals and families will face some big tax increases, but for most Americans, taxes will increase only slightly. More important for the economy, tax rates previously in place have been made permanent: they will not expire at some future date as they were designed to do under the old law.

Certainty, which markets love, was also included in two other forms of taxation. The old exemption limit of $5m was restored to the inheritance tax law and along with the Alternative Minimum Tax; the limits will increase with inflation. Unfortunately, the increased rates for the capital gain tax, including the gain on residential real estate, were not similarly indexed to inflation.

In any event, the hype associated with the fix to the fiscal cliff could be all that the economy needs, to finally get back on track and begin creating significantly more good jobs, the event we have all been waiting for.  So, let’s hear some more positive chattering.

A Closer Look at a Tax that Needs a Fix

By: Victor Normand
Published: November 2012

The health care reform proposal submitted by Richard Nixon in 1974 had many similarities to the current law.  Although his plan required no new taxes, it is very possible that Congress might have included a tax had deliberations ever progressed.  The current law actually did not include the 3.8% tax on investment income including capital gains until the eleventh hour, literally just hours before the final debate.

The National Association of Realtors (NAR) in their analysis estimates that only 2% to 3% of all home sellers will be affected by this law.  NAR does not support the tax, but their analysis is incomplete by the omission of a historic perspective.  This writer will argue that the tax provision in the new health care law is flawed and should be amended so that it remains a tax on significant gains by higher income taxpayers.

Let’s speculate that President Nixon’s health care reform had become law in 1974.  Now let’s further speculate that a 3.8% tax similar to the current tax was part of that law.  Once laws are passed, particularly social legislation along with taxes codified in support of those laws, they are very hard to change.  The constituency for any such program develops rapidly as its benefits are enjoyed, and the constituency continues to expand over time as does the programs dependency on a dedicated revenue stream.  So, where would we be today if such legislation with its tax provision had become law?

As it relates to real estate, the current law has two key benchmarks.  The first is a capital gains exclusion from the tax, which is set at gains of $500,000 or less.  The second is an adjusted gross income (AGI) threshold of $250,000 below which the new tax does not apply.  Both of these amounts apply to taxpayers filing a joint tax return.

I am not sure how these amounts were arrived at, but we can relate them to median home prices and median family income for the purpose of comparison.  The ratios for the nation in 2010 when the law was passed are as follows:

 

                       Median Existing Home Price         $173,000       =  .35

                        Capital Gain Exclusions              $500,000

 

Median Household Income              $48,340      = .19

                           AGI Threshold                          $250,000

 

In 1974, the median existing home sale price was $32,000, and the median family income was $9,902.  In this hypothetical situation using the above ratios, the capital gain exclusion would have been set at approximately $91,500, and the AGI threshold at approximately $52,100.  And arguments would probably have been written about how reasonable these limits are and about how few households would actually be affected by this tax.  Would we hold the same opinion 38 years later?

Would a 3.8% tax on capital gains or investment income above $91,500 for tax payers with AGI above $52,100 be acceptable today?  Thirty-eight years may seem like a long time, but really, is it?  Consider the Alternative Minimum Tax and the percentage of middle income tax payers affected by it today who were never intended to be affected. Let’s not make the same mistake again.

If the exclusion is fair and the AGI threshold reasonable, let’s keep it that way.  The amounts should be indexed to inflation so that we are not creating an unintended tax burden for our children and grandchildren.  Or, is it possible that Congress intended there to be an automatic tax increase every year that does not require a vote thanks to inflation?

Forward this newsletter to your Congressman or Senator and see what they have to say.