Executive Summary
It's difficult to go far in the world of financial planning these days without hearing a discussion about the "inevitability" of higher taxes in the future, leading to a broad range of tax planning strategies to dodge the anticipated increase in the income tax brackets. But in practice, it seems that we might be confusing the idea that the government will need to collect more tax dollars in the aggregate from us - a higher tax burden - with the belief that today's income tax brackets are at a low point that must rise. One does not, necessarily, lead to the other.
Budget Deficits And Rising Tax Burdens
Although I would certainly be hard-pressed to make the case that our current government budget deficits will not lead to some form of future tax increase - it's difficult to believe we can bridge 100% of the gap with spending cuts alone - it is nonetheless not necessarily a requirement for our income tax brackets to increase in the coming years. The disconnect between the two is surprisingly straightforward, although we often just don't think about it - the government collects many different types of taxes, and any tax increase in the future doesn't necessarily have to be an income tax.
Income Taxes Vs FICA Taxes
For instance, one of the major contributors to our current government deficits are projected shortfalls attributable to our Social Security and Medicare entitlement programs. Yet we don't actually pay for our Social Security and Medicare benefits via the income tax system (at least, not directly); we pay for them through so-called payroll and self-employment taxes - the Federal Insurance Contributions Act (FICA) tax - which is levied not on gross income, but specifically on employment income.
And in point of fact, the Social Security Trustees' report has already pointed out that we could completely resolve the projected shortfalls in Social Security by raising the FICA tax rate by a few points. Granted, a tax increase on the population in the aggregate of that magnitude would have some notable economic effects; nonetheless, from the tax-planning perspective, it doesn't mean income tax brackets go up, and tax planning strategies that sought to accelerate income and defer deductions in anticipation of higher future tax brackets might not yield their anticipated results.
Income Taxes Vs Consumption Taxes Or A VAT
In addition to noting the fact that we collect taxes via a number of different policy mechanisms in the United States - an individual income tax, a corporate income tax, a payroll tax on wages, etc. - it is also crucial to bear in mind that there is another significant pillar of tax policy used in most other developed countries except ours - a consumption tax, such as a national sales tax or a value-added tax (VAT). Although many individual states use a state-level sales tax, we do not have a sales tax levied at the national level (or the levied-in-the-process-of-production equivalent, a national VAT). Without a doubt, applying a VAT or national sales tax to our system would have an economic impact, and would impact an individual's financial plan by raising the general cost of their purchases; nonetheless, a sales tax or VAT is not an income tax, and planning steps that sought to avoid higher income tax brackets in the future might again be unhappy with the outcome.
This is not to say that income tax brackets cannot or might not rise in the future - in point of fact, they are already scheduled to rise by several percentage points in just a few months with the expiration of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
Nonetheless, you might want to think twice before planning too aggressively, such as doing massive Roth conversions today, in anticipation of the "inevitability" of rising income tax rates in the future. We will have to tackle our government deficits at some point in the future, but the income tax system (and its tax rates) are not the only policy tool in the Federal government's quiver.
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