We underestimated the ability of Congress to do nothing - leaving investors to figure out how to blunt the effects of impending tax increases in 2012 and 2013 that will likely hurt our portfolios.
The congressional supercommittee's failure late last month to attack our deficit monster sets up a string of possible legislative maneuvers for what's left of 2011 and for 2012. We checked in with political analyst Andrew Friedman, who has provided his latest white paper for Washington Update, a firm he started after a long career as a tax expert. The report is available at his web site: http://www.thewashingtonupdate.com.
Friedman predicts the following: Under the compromise late in 2010 that extended the tax cuts by President George W. Bush, employees in 2011 are paying Social Security at a reduced rate of 4.2 percent. President Obama would like to lower the 2012 Social Security tax rate for both employers and employees to 3.1 percent. But if Congress does not take action by year's end, the Social Security tax rate in 2012 reverts to the usual 6.2 percent for both employers and employees. Higher taxes could thwart any kind of economic recovery.
A number of other tax provisions also are set to expire at or near the end of 2011. Of interest to investors is the right to move as much as $100,000 from an IRA account to a charity to satisfy your minimum distribution requirement (also known as an RMD on your tax statement) without incurring tax.
Congress also must pass legislation known as the "doc fix" to avoid a scheduled 30 percent reduction in reimbursements received by doctors who see Medicare patients. If that is not extended it could hurt health-care and pharmaceutical companies.
Extending the lower tax rate and other tax breaks sounds in line with Republican promises to keep taxes low. But, it is not consistent with the Republican goal to reduce the budget deficit.
If Congress passes these measures, the lost revenue in 2012 will exceed the entire cost savings achieved from the debt-limit deal that inflamed Washington this summer.
In other words, our budget deficit actually would increase in 2012 and again in 2013, because some of these taxes are staggered.
Investors looking to sell businesses or to address concentrated stock positions need to prepare now, Friedman advises. He expects the current 15 percent long-term capital gains tax rate to be in the low 20 percent range by 2013.
Also, he recommends aggressive gifting now. The current $5 million gift tax and estate tax exemptions ($10 million for married couples) will likely revert to $1 million in 2013.
Lastly, municipal bonds are worth another look. As tax rates go up, muni rates go up as well.
GOP Congress can't do the sensible thing for our own homegrown deficit. But Republicans in Congress say they won't bail out the eurozone; instead, they will try to block the International Monetary Fund from bailing out Italy and Spain, which they say could leave U.S. taxpayers with a huge bill.
The GOP complains that the Obama administration has refused to share details of what U.S. Treasury Secretary Timothy Geithner is discussing with European leaders amid reports that the IMF could intervene. Sen. Tom Coburn (R., Okla.) says he is planning legislation directing the U.S. government to veto an expanded role for the fund.
Senate Republican Steering Committee chairman Jim DeMint (R., S.C.) and Rep. Cathy McMorris Rodgers, a House Republican from the state of Washington, also have legislation to limit the proposed intervention.
"I'm adamantly against the IMF being involved in this," Coburn told TheHill.com. "We're throwing good money after bad down a hole that I think is not a solvable problem. Europe is going to default eventually, so why would you socialize their profligate spending?"
Coburn estimates that the United States could be liable for as much as $176 billion if the IMF shores up Italy and Spain and the European Union collapses.