Well, the Internal Revenue Service’s — the infamous IRS — numbers are in from the 2018 tax-filing year. It’s the first under President Trump’s tax reforms, and the results won’t make anyone particularly happy.
It’s not that most Americans are paying more in taxes. In fact, most are actually paying less. It’s just that the difference isn’t big enough to matter to most taxpayers. The narrative is all wrong.
Red-state voters were really hoping for a windfall, but that didn’t happen. Seventy-nine percent of taxpayers got a refund. Of that, the average was $2,879. The year before the tax cuts, 80% of taxpayers got refunds, and the average was $2,908.
Sure, most taxpayers also benefitted from lower tax withholding throughout the year. It’s just that it wasn’t all that much money. The median taxpayer saw a tax reduction of less than $800. Spread out over an entire year of paychecks, that’s simply not enough to notice, let alone matter.
Meanwhile, blue-state voters believed the tax cuts to be a handout to the rich. Yet exactly the opposite was true. Many high-income earners actually saw their taxes rise by a significant amount, particularly if they were previously benefitting from a large state and local tax (SALT) deduction. The Trump reforms capped the SALT deduction at $10,000, meaning that taxpayers with large state income tax or property tax bills had a major tax deduction taken away.
Those self-employed are happy. The Trump tax breaks on self-employment income and income from LLCs and partnerships likely lowered your tax bill by a meaningful amount. And everyone else who isn’t self-employed has something to be unhappy about.
Well, I have some bad news for you. It’s not likely to get better any time soon…
Tax Rates Will Only Go Up
Let’s say the Democrats take presidency, the Senate, and manage to hold the House of Representatives in next year’s election. It’s going to be tough for them to say with a straight face that they support the downtrodden while simultaneously raising the SALT deduction for high-income homeowners. They’d be more likely to raise taxes across the board and keep Trump’s SALT deduction cap in place.
Now, let’s say that Donald Trump wins reelection and that the Republicans managed to win back to House of Representatives and hold the Senate. Additional tax cuts are still going to be a tough sell with the country running a trillion-dollar budget deficit… in peacetime… and during a steady, stable economy. The rates we have today are likely the lowest we’re going to see for years… if not ever.
Looking at the bigger picture, it’s hard to see a scenario where taxes don’t rise from today’s levels.
Next year, interest payments are expected to make up little over 10% of the total budget. One out of every 10 dollars spent will be to pay the interest on expenses from previous years. Interest is projected to be 13% of the budget by 2024. And from there, it should just snowball due to the compounding effect of interest, eating up a larger and larger share of the budget. New borrowing used to pay back old borrowing won’t leave much room for anything else.
If bond yields continue to drift lower, these numbers might end up being a little smaller. But what difference would a few hundred billion really make when you’re looking at numbers this large?
Enough hand wringing. Let’s talk about more practical matters…
Solutions That Could Save You Thousands
To start, think long and hard before upgrading your house. If you already own an expensive home, consider downsizing. I know that’s easier said than done, but you’re likely facing a future of rising property taxes with no offsetting relief via the SALT deduction. Run the numbers. It could be that renting makes more sense for you.
Secondly, get in the habit of stuffing as much money as you can into a 401(k) plan or IRA. There’s no guarantee that the government won’t move the goalpost and start applying a tax on large retirement plans if things get bad enough later. But if something like that happens, it will likely be years down the road. In the meantime, you can grow your nest egg tax free.
And consider tax-free municipal bond funds as a destination for your savings held outside of 401(k) and other retirement plans. The federal government is unlikely to eliminate the tax-free status of muni debt because it keeps the borrowing costs low for states, cities, and other local governments.
In Peak Income, these are precisely the kinds of opportunities I look for.
At today’s prices, we’re getting tax-free yields of 5% to 7%. If you’re in a high-tax bracket, that could be a tax-equivalent yield of over 11%. It pays off to be well-positioned when change comes…