Post Pandemic Taxes

May 27, 2020
  • Taxes may increase over the medium to long term to pay for government pandemic stimulus and recovery programs
  • Tax changes hinge on the interplay of politics, elections, scheduled phase outs, and the economy
  • State and local taxes and fees may be more likely to see legislative increase than federal taxes
  • Our portfolios and investments leverage the benefits of tax advantaged accounts and investments, diversification, and long-term growth prospects, along with the synergies of a multidisciplinary family office team

My emails and perspectives are two-way communications; I appreciate the feedback, critique, and questions that I have received from many of our clients as well as industry professionals. They have been very helpful for Jim, Susan, and I, and have been the basis for several of my written perspectives.  Once again, today’s missive is based on a client’s question regarding taxes – thank you.  I’ve written about the momentous flood of dollars the U.S. government is throwing at the economic malaise caused by the pandemic shutdown, the trillions of dollars of defensive and offensive monetary (from the Federal Reserve) and fiscal (from congress and the administration) stimulus.  The question is how will the government pay for this stimulus; will there be an increase in taxes? In short, it depends; but over time, probably yes.

The chance and timing of increased U.S. taxes depends on several factors: when, how, what, and where.

  1. When – near-term timing – when and how strong the economy recovers from the pandemic
  2. How – November elections – Trump versus Biden and does congress remain split or fall under one party’s sway
  3. What and Where – there are several types of taxes – Federal versus state and local 
  4. When again – long-term timing – this is a question of years, not months

The U.S. government is spending trillions of dollars to prop up and stimulate the economy while people and businesses fight off COVID-19 infections and shutdowns. Additionally, Federal and state governments have pushed out the due date on annual taxes from April 15 to July 15 in order to help balance sheets. U.S. taxes will probably not meaningfully increase in the near term, mainly because it would be figuratively equivalent to kicking the economy in the legs while extending an arm to pull it up.  

Ahead of the November elections, taxes are unlikely to increase because even though the economy may be on an upswing, the U.S. will still be working its way out of an economic and healthcare crisis, with high unemployment and bankruptcy restructurings.  In such a scenario, the implementation of business disincentives, like higher taxes, will not be politically popular and continuation of economic stimulus will probably be favored instead.  Post-election, the spirit of Federal tax initiatives may depend on whether there is a Democrat or Republican majority across the House and Senate, and who is in the Oval Office.  

According to Running Point’s own in-house tax and accounting partner, Susan Lash, CPA,

“The assumption is that taxes will eventually rise, the question is more of where and when they’ll hit.  With taxable income expected to be lower across the entire economy due to the COVID-19 shut down and the volatile stock market, raising taxes immediately to help fund the recovery programs will be problematic. In addition, there will need to be large budget cutbacks at the federal, state, and municipal levels to help bridge the gap until the country is able to return to some sort of normalcy.”

Federal taxes don’t have to increase over the short to medium term for numerous reasons. First, although the Federal government extended the due date for 2019 taxes, it didn’t forgive taxes owed; those funds will still flow into IRS and Federal coffers. Second, the government owns the U.S. Mint and could print more money (although this is an unlikely currency debasement scenario). Third, and more realistically, the government has the ability through the Fed to keep interest rates low and thus keep its own debt interest payments low.  The Fed can keep purchasing U.S. government debt, a case of one pocket feeding the other – this is not as ominous as it sounds – the U.S. and Japan have already been successfully doing it for years.  As long as an entity, government, or person, can confidently continue to pay the interest on debt, the repayment of full principal can be refinanced and pushed out indefinitely.  In 1982, during President Ronald Reagan’s first term, U.S. national debt passed $1 trillion for the first time and more than doubled to $2.7 trillion by the end of his second term in January 1989; many pundits fretted about the country’s economic collapse under so much debt.  Nonetheless, by May 20, 1993, the U.S. had $4.3 trillion of debt and today that number is $25.5 trillion [according to the U.S. Department of the Treasury] – it has increased nearly six-fold in 27 years – yet still the U.S. dollar and U.S. debt remain relatively strong on the global stage. The ability to service the debt is more important than the amount of debt, and the Federal government can maintain that ability for a while without raising taxes.

State and local municipalities face a very different fiscal situation than the federal government, and thus may raise taxes sooner. States and local governments do not have their own currency, lack a central bank that can purchase their own debt, and although they will eventually receive state income and property tax due, they have permanently lost out on months’ worth of other fees, use taxes, and revenue in the form of permanently forgone business sales tax, licensing and administrative fees, toll road payments, hotel and visitor taxes, gas taxes, airport fees, parking ticket and meter collections, and other similar fees. For local governments, as a percentage of their entire budget, these additional taxes and fees are a much more critical part of their relative finances than they are for the Federal government. Some states have dipped into their reserve funds (also known as economic stabilization funds) to cover expenses, but not every state has significant money set aside. California’s rainy day fund is $20 billion, but according to Governor Newsom, that will be depleted within three years, as the state’s budget is revised. To balance post pandemic local budgets, an increase in state income taxes may be visibly unpopular, but increases in transactional fees, like sales tax, a value added tax on luxury items, inheritance tax, licensing fees, fuel and parking fees, and the like may be enacted to make up for revenue losses.

Tax timing is everything. The government’s 2017 Tax Cuts and Jobs Act (TCJA) significantly reduced business taxes, individual income taxes and the estate tax, however the income and estate tax provisions expire December 31, 2025, after which individuals will see a tax hike unless provisions are extended.  

As our Tax Partner, Susan Lash details,

“Beginning in 2021 through 2025, there are many provisions of the current tax law that are scheduled to expire.  Some of these include individual income tax rates reverting to their pre-TCJA rates and thresholds (post 2025), expiration of the increased estate tax deduction (post 2025), and a phase out period of the 100% expensing for short-life assets such as machinery and equipment (beginning after December 31, 2022.)   Congress will have the ability to raise taxes by allowing these, and other provisions to expire without renewing them. Thus, tax planning will be important in making good decisions as we move forward during the next few years.”

As we know, the when, how, what, and where of taxes is a complicated accounting and political process. Much will hinge on elected officials, the pace of economic recovery, and consumer propensity to spend. State and local taxes and fees seem more vulnerable than federal to a fresh increase once the economy is stabilized, but some federal taxes have mandated phase outs which means they will automatically increase if nothing else is done. Whatever happens, know that our investment management combines with financial planning, tax planning, and other family office services under one roof. From an investment standpoint, we will continue to balance the utility of tax free municipal bonds, the strategic placement of investments in tax advantaged accounts, the primacy of long term capital growth, and where possible alternative investments and the tax benefits conferred on real estate.

Michael Ashley Schulman, CFA
Partner, Chief Investment Officer

Disclosure: The opinions expressed herein are those of Running Point Capital Advisors, LLC (“Running Point”) and are subject to change without notice. Running Point reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. This should not be considered investment advice or an offer to sell any product.  Running Point is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Running Point, including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request. RP-20-17