More On Tax Planningfrom The Advisor's Professional Library
- IRAs: In General Individual Retirement Accounts are highly popular tools for contributing funds that grow on a tax deferred basis. Depending on the type of IRA, the accumulation can be tax free.
- Annuities: Variable Annuities Annuities are hot. The tax rules vary with the circumstances. Advisors must be aware of these intricacies when discussing annuities with clients.
Taxes and the U.S. deficit, China, QE II and the crisis in Euroland were some of the topics that T. Rowe Price Vice President and Chief Economist Alan Levenson touched on at a breakfast for the news media in New York on Wednesday.
Since taxes are scheduled to rise unless Congress acts by year-end, Levenson (left), noted the dilemma the U.S. government faces. A reporter asked: Is it more beneficial to the economy if the cuts are kept in place for everyone for another couple of years, adding about $3 trillion to the deficit over 10 years, but potentially enabling more spending now as we try to recover—or is it better to let some or all of the cuts expire and reduce the deficit starting now?
We “need higher tax revenue,” he says, “the sooner we raise rates or cut the budget, the smaller the increase needs to be. As a macro economist this is not a political view. We don’t want to raise income taxes when we want to support consumer spending, but marginally higher rates [would] have a relatively small impact on someone who makes $100 million a year—[so] two or tree percentage points—it’s not going to change their spending.” Levenson says he would support keeping the rates as they are for all but those making “$1 million or higher in income,” and recommends that the added tax revenues from those higher earners “be put into infrastructure or something that would have a higher multiplier effect,” on the recovery.
GDP, Unemployment, Inflation
Levinson forecasts a lower unemployment rate in the months ahead, falling to 8.6% in 2011, with real GDP rising to 2.8%, a tad higher than his 2.4% estimate for 2010. He’s not overly concerned about inflation or deflation, at this point.
On the housing front, Levinson noted that mortgage lending, in fact lending standards in “all categories, are getting easier,” he says, “though still tight, and mortgage standards are tightening again.” There’s a “smaller cohort of qualified buyers than three years ago.”
“Anyone who bought in spring 2006 is 30% underwater…and won’t be in the money for a long time,” he observes. To mitigate what he calls a “shadow inventory” in housing, Levinson would have banks do a “debt for equity swap” with these underwater homeowners, “write down the equity but allow the lender to participate in price appreciation, and have the federal government subsidize the loss.” A modernized Home Owner’s Loan Bank would be a model for this.
What if, as Robert Shiller and Alan Blinder called for in late 2007 and early 2008, this had been done back then—would we have avoided the steep decline or depths of this recession? Levenson “can't quantify that, but [things] would have been better off than they are now,” he says.
What of the haircut that investors may take on sovereign debt in Portugal or Ireland, Greece or Spain (the PIGS)? Does that have the potential to make investors lose confidence on other sovereign debt? “If you swap 5-year maturity with 30-year debt—that would be a haircut. Let’s get over it, that’s what’s going to happen.” For European Central Bank president Jean-Claude Trichet to say “default is out of the question—the European Central Bank is out of the question if there’s sufficient political will,” Levenson notes. “Greece needs to take steps [toward] austerity.”
Levenson’s concern about the Euro crisis is, “connecting the dots,” to the U.S. “Debt in European banks is a major asset class in U.S. money market funds. Attacks on peripheral Euro banks show up as paper losses in the core of Europe—paper losses in U.S. money funds.” We could potentially see, “forced selling [of the type we saw] in 2008—we’re seeing some now; can't sell the European banks [as prices are too low] so sell the U.S. banks.”
There is the potential for the U.S. to have to intervene “if non-PIGS countries have funding problems—that could be a problem for the U.S.” If that’s the case, and the U.S. intervenes, we could see “funding facilities” from the Fed that are similar to what we saw in the 2008 of the crisis.