On June 3rd, 2023, President Biden signed into law the Fiscal Responsibility Act of 2023, thus narrowly avoiding a first-ever U.S. default on debt. It was predicted that the global economy would go into a tailspin, and the U.S. into a recession, had a budget agreement not been reached. Luckily that crisis was averted, safeguarding continued interest payments on national debt, Medicare, Medicaid, Social Security and veterans benefits, tax refunds, and military salaries, to name a few.
You might be wondering what was negotiated to secure the bipartisan budget agreement. The main concessions were a suspension to the debt ceiling until the first quarter of 2025 and a cap on government spending. Suspending the debt ceiling means temporarily allowing the Treasury to supersede the debt limit, rather than raise it by a specific amount. The Fiscal Responsibility Act of 2023 suspends the $31.4 trillion debt ceiling until January 2025. The bill also puts a cap on non-discretionary spending, keeping the $6.4 trillion budget flat in 2023, with a 1% increase in fiscal 2024. [i] Additionally, the budget agreement expands work requirements for food stamp recipients and reclaims unused Covid-19 relief funds, among other things.
However, discretionary spending is just one-seventh of the nation’s annual spending budget. Longer term, the U.S. is predicted to be in an annual revenue shortfall unless the nation can reduce public program expenses, or increase tax revenues.
In the current negotiations, President Biden and House Speaker Kevin McCarthy did not discuss adjustments to Social Security or Medicare. Avoidance of this controversial subject makes sense given the 2024 election year is just around the corner. A January 2023 Reuters poll found that 84% of Democrat and 73% of Republican voters opposed reducing spending on the two programs.[ii] However, the International Monetary Fund has recommended that the U.S. cut Social Security and Medicare costs by either increasing the eligibility ages or imposing other benefit restrictions.[iii] That is because the Congressional Budget Office projects Social Security costs to increase by 67% and Medicare costs to double by 2032. The increased cost projection is due, in part, to our aging demographics. Americans age 65 or older make up approximately 16% of the American population, an increase of 34% from the prior year.[iv] Together, Social Security and Medicare make up approximately 37% of our current federal spending. Unlike discretionary programs in which a nominal budget is set, Social Security and Medicare programs pay benefits to all who qualify without a dollar limit. If unchanged, these programs are predicted to be insolvent in just a decade.[v]
The offset to spending is revenue collection, which in the U.S. is primarily taxes. According to the Organisation for Economic Cooperation and Development (OCED), U.S. tax revenues as a percentage of GDP ranked 32 out of 38 of the most wealthy countries globally. In 2022, the United States’ top tax rate is 37%, which is lower than the top tax rate in 17 out of 27 European countries. For comparison, Denmark’s highest tax rate is 56%, and Austria’s 55%.[vi]
President Trump’s 2017 Tax Cuts and Jobs Act reduced taxation for many wealthy Americans. Those provisions are scheduled to sunset in 2025. However, many Republicans are already talking about extending the tax cuts. Further, President Biden was unsuccessful in passing many of his tax increase proposals during the last year, when Democrats controlled both the House and Senate. Long story short, increasing U.S. taxes will be a long, hard battle under any administration.
In summary, the debt ceiling crisis has been circumvented, however a bigger problem lies ahead and the resolution is not predicted to be clear or easy. The funding or dissolution of public programs such as Social Security and Medicare will be a hotly contested discussion. Considering our aging Baby Boomer population and the steady increase in medical costs, sufficient appropriations to keep these programs adequately funded could indicate higher future taxes. Traditionally, the U.S. has been hesitant of taxing corporations for fear of driving companies overseas. Therefore, the burden could lay with the American people.
President Biden’s last tax proposal was to raise taxes on the wealthy and corporations, while leaving Americans who make less than $400,000 per year out of future tax increases. However, the International Monetary Fund (IMF) says that the President’s promised tax-exclusion of the middle class is “unfeasible.” Instead, the IMF suggests all of President Biden’s tax increase proposals plus a reduction in our current tax deductions (employee-provided health care benefits, mortgage interest, gains on sale of primary residence, etc.), as well as broad-based user and consumption taxes. Fiscal experts believe that revamping a broken budgetary process requires both tax increases and spending cuts. From a financial planning perspective, tax changes will present challenges but also new opportunities. It is also prudent to realize that the tax benefits we have today should be valued and utilized, as they may not exist tomorrow. For example, our current lifetime gift tax exemption is $12.92M per person, or nearly $26M for a couple. Our primary residence exclusion from capital gains taxes is $250K per person, or $500K for a couple. Options to contribute to Roth IRAs or rollover pre-tax IRA funds to an after-tax Roth IRA (which cannot be taxed again) have been expanded in 2023. If you feel you can benefit from a review of your current financial situation, reach out to your Certified Financial Advisor™ or CPA with a Personal Financial Specialist credential. It may be time to seize an opportunity that could disappear in the near future.
[i] https://www.reuters.com/world/us/debt-ceiling-deal-ignores-us-debt-time-bomb-2023-06-05/
[ii] https://www.reuters.com/world/us/debt-ceiling-deal-ignores-us-debt-time-bomb-2023-06-05/
[iii] https://www.imf.org/en/News/Articles/2023/05/26/united-states-of-america-staff-concluding-statement-of-the-2023-article-iv-mission
[iv] https://www.census.gov/newsroom/stories/older-americans-month.html
[v] https://www.reuters.com/world/us/debt-ceiling-deal-ignores-us-debt-time-bomb-2023-06-05/
[vi] https://www.thebalancemoney.com/how-us-taxes-compare-with-other-countries-4165500#:~:text=The%20United%20States’%20top%20individual,%25)%20and%20Austria%20(55%25).