A Deeper Look at the Debt Debacle

Carol Schmidlin recently interviewed Rodney Johnson, President of HS Dent Publishing, an independent economic research company, about the spending cuts in the new debt agreement and who can be affected.

As talk of the debt ceiling and the new law agreed to between President Obama and Congressional leaders brought relief to many Americans, I had the opportunity to look deeper into this crisis during a live interview with Rodney Johnson, President of HS Dent Publishing, an independent economic research company that focuses on how people spend money as they go through predictable stages of life, and how that spending drives our economy.

Based on the feedback from so many federal employees that participated in this call, I decided to share these views.

The first issue is the severity of cuts on Defense.  The initial cuts would be split evenly between domestic and Department of Defense spending which includes $350 billion in savings from the base defense budget.  The second phase will occur when the 12 person deficit cutting committee makes its recommendation.  If the committee fails to report legislation that achieves $1.2 trillion in deficit reduction by the end of November, the Office of Management and Budget would impose across the board spending cuts, split evenly between defense spending and domestic spending.  The amount of defense spending cuts would be approximately $50 billion a year if this is triggered.

Carol:  What is your opinion on the severity of deficit cuts on Defense?

Rodney: We are rather dismayed by it.  Cuts in defense in some areas would be very helpful.  The US keeps many military based around the world that we believe could be diminished in their activity or closed all together like the big base in Germany.  Do you wonder why it’s still there?  We know why they were put there in the Cold War, but they don’t serve the same purpose that they used to.  We can pull some of that back and save some money on the defense side, but just going in and saying we are going to cut basically 6% – 7% on defense seems like a poor way to go about it.

Carol:  Many seniors were frightened that if the budget ceiling was not increased, they would not get their monthly Social Security payment and may not be able to use Medicare to pay for their healthcare.  A provision in the Deficit agreement states that there are exceptions to the cuts, and include Social Security, Medicaid and Medicare.  Specifically, it states that Medicare Savings will be capped at 2% and are limited to providers only.  There will be no Medicare cuts or increases in seniors’ costs.  How do you feel about this exception? 

Rodney: In regards to our countries long term deficit, the 800 pound gorilla in the room continues to be entitlements, and that’s the one thing that so far government and Congress are saying, “Let’s set that aside for the moment.”  We know that this plan doesn’t solve anything.  It puts some nice markers out there that people will talk about. Claiming that Congress will cut payments only to providers is like saying: Really?  One of the things that has been in place since the late 90s and was triggered in 2001 is automatic cuts to doctors’ fees in terms of their Medicare payments and reimbursements for service.  This doctor cut has come up every year and Congress has granted an exception to it every year.  It’s now to the point that if they implement this, they would have to cut the Medicare payments to doctors by 25%.  Even though Congress never implements the cut it remains in the budget.  We have a very dim view of how they set up these cuts, however, by putting this deal together Congress does get rid of this man made debacle of the debt ceiling, which is causing so much concern now.

Carol: How can you cut $2.4 trillion from our deficit without reducing these entitlement programs?

Rodney: I don’t think they can.  Our research, along with that of many others, is quite clear, in that Social Security is underwater and Medicare is ridiculously underwater in terms of what we are on tabs to pay out versus what is received in tax dollars.  We have three choices: (1) cut the benefits, (2) increase taxes, or (3) do something in between.  We think the third option is what’s going to happen: increase taxes and lower benefits.

Carol: It’s obvious that you believe, as I do, that Congress will need to raise income taxes to make this deficit reduction happen.  Do you think it will be just for those in the upper tax brackets?

Rodney: There is no question we have to raise taxes.  We cannot pay for the things we need to pay for with the amount of tax revenue we are receiving today and so we will have to raise taxes.  The question continues to be, who do you raise them on?  There are a number of loopholes that need to be closed.  This is where you run into the problem of what should be done vs. what will be done.

The common thing to point out is that there are people that make a lot of money, I’m talking a billion dollars, and have a low marginal tax rate.  They pay 15% – 16% tax rate due to the way they adjust their income to be qualified as long term capital gains instead of earned income.  Loopholes like that are infuriating, but even if you closed them all and increased taxes on the wealthy, you are still not going to reduced deficit gaps in a meaningful way.  We will have to increase taxes on the truly middle class.  The question is when?

Carol: Are you at least feeling some relief that the current debt ceiling issue has been resolved?

Rodney: Personally, I think the debt ceiling debate is shameful!  We set a fiscal budget for the US that is supposed to start on October 1st. (The fiscal year for the federal government is October 1st through September 30th).  The debt that we are talking about issuing, a part of that is to get us through the rest of this fiscal year.  What we should have done is made our debt ceiling match our estimated budget for the fiscal year and then had a comprehensive budget conversation over the next thirty days.  All this debt ceiling debate and the agreements made will be washed away over the next two budget cycles, this one and then the one in 2012.  Congress can go back and adjust many of the things we are talking about, be it in the next 30 days or a year from now.  As we go through the next two years, the discussion will be: There’s not enough revenue and we are going to have to raise taxes and it won’t be limited to the people earning over $200,000 a year.

Carol: I have been teaching classes over the past few years on tax efficient income planning, utilizing Roth IRAs, Roth Conversions and other opportunities to have tax free income in retirement.  Now more than ever, I believe that it is critical to retirement success to look at a person’s individual situation to see how to get the maximum retirement dollars into Roth IRAs. Also, federal employees may want to keep their fingers crossed that TSP launches the promised Roth TSP before tax rates rise!

Rodney: Position yourself for the thing that’s going to give you the greatest advantage as you look at what is going on in the US and around the world.  People are relying on us to sell more exports to help grow our economy, because we as consumers in the US are not buying as much.  That’s not going to occur because the rest of the world has its own issues.  If you look at this and say (1) we are not going to sell as much to consumers here in the US because we’re not buying, and (2) we are not going to sell as much to the people overseas because they have their own financial issues, and yet we still have all the debts to pay, including the deficits we are running and the entitlements that we have promised, what is going to occur?  Mmmm, could this be rising taxes?

Anything that you can do to move yourself out of that stream of income tax revenue is like giving yourself a raise.  You might be a year early; maybe the tax rates won’t go up until 2012 or 2013.  Preparing fourteen to fifteen months ahead of time is a whole lot better than not doing anything at all.

Part II will follow where Rodney and I discuss gold, the devaluation of the US dollar, and the dismal GDP that is being overshadowed by the debt.

About the Author

Carol Schmidlin, Certified Financial Fiduciary®, MRFC® is the President of Franklin Planning and has been advising clients on how to grow and preserve their wealth for 25 years. In addition to her financial planning practice, she is the founder of FedSavvy® Educational Solutions, which provides Financial and Retirement Literacy Programs for Federal Employees. She is passionate about helping families with all phases of Wealth Management and is a member of Ed Slott’s Master Elite IRA Advisor Group. Her practice maintains a home office in Sewell, NJ along with a satellite office in Washington, DC. Carol can be reached at (856) 401-1101.