91%. Can anyone guess the significance of that number? No, its not the number of people underwater on their houses, although at 25% and rising its not a bad guess. Actually, 91% was the highest marginal tax rate in the United States from 1951 – 1963. From there, it dropped to 77%, and stayed at 50% or above well into the 1980’s.
The point of all this is that while marginal rates are poised to reset to the 39% of the Clinton years as the Bush tax cuts expire, in the broader historical context of the last century 39% is actually still quite low. British tax rates on high-earners are already up to 50%. And the US will inexorably follow over the years.
The math on this is blindingly obvious. The US national debt today is somewhere in the range of $10-$11 trillion, or close to 70% of GDP, if you include the money owed to the Social Security Trust Fund (on another note, the entire concept of the Social Security Trust Fund is a fraud, but that is for another article). Over the next decade, the additional deficits are projected to be a further $9 million at least, and this is probably a conservative estimate. In sum, the US Government’s deficit is headed well over 100% of GDP, a point at which the interest payments on the debt alone start to spiral out of control and threaten to start a run on the dollar at some point in the future.
The obvious conclusion from all this is that taxes for high-earners are going to go up well beyond the impending 39% top marginal rate. In fact, it is inevitable that the broad middle class will also be seeing tax increases of one kind or another in their future, no matter how much President Obama denies that any middle class tax increases are planned. Already, there have been trial balloons floated in Washington regarding the implementation of a VAT (Value-Added Tax) here in the US. The VAT is widespread in western Europe, and is kind of like a sales tax, which is imposed at all steps in the line of production. Some kind of national VAT or Federal sales tax is probably going to be perceived as a less politically painful method for imposing a broad-based middle class tax increase then straight rate raises.
In addition, given the disastrous state of both Medicare and Social Security (especially the former), it also almost inevitable that there will be some kind of very aggressive means testing introduced for both social security and Medicare; in fact, its probably fair to say that many of you in the range of 45 years old or younger may never see a dime from either of these programs, despite what you may have contributed in taxes over the years.
So, what are some of the practical implications of all this? First, it goes without saying that if you do not have an aggressive savings and investment program already, now is the time to ramp it up. Second, it is worth thinking through some basic retirement investing strategies. For example, for younger people in lower tax brackets, it may make sense to concentrate your savings in a Roth IRA rather then a 401k. With a Roth IRA, virtually all income growth and withdrawals are tax-free – you put money in and then NEVER pay taxes on it again, even when you withdraw it years later. While this goes against accepted wisdom regarding the benefit of always maxing out one’s 401k due to its pre-tax contribution structure, it actually makes sense. If someone is in a lower tax 15-25% tax bracket today, early in their career, it may make sense to pay a higher tax rate today – i.e. with a lesser 401k contribution – in exchange for the opportunity to avoid all taxes 40 years in the future by concentrating on a Roth IRA. Of course, if your employer provides a matching 401k contribution to your own, you should contribute at least as much necessary to obtain the match – free money is a no-brainer.
For many people reading this article, the information above may be better for your adult children then yourself, but even older and wealthier Americans are about to be handed an opportunity to take advantage of the unique advantages of the Roth IRA. Currently, many people make too much money to use Roth IRAs. Individuals whose adjusted gross income (AGI) for 2009 is $120,000 or more can’t contribute; likewise, for couples who file jointly, the cutoff is $176,000. Finally, while it is possible to convert a regular IRA to a Roth, this is not allowed if your household’s AGI exceeds $100,000.
However, the rule on IRA conversions is about to change. Starting on January 1, 2010, the $100,000 dollar limit on converting regular IRAs to Roths is eliminated. Starting then, anyone at any income level with a regular IRA can convert this to a Roth. You will still have to pay taxes on this conversion – when you convert assets from a regular IRA to a Roth, you are required pay income tax on all pretax contributions and earnings included in the amount you convert. However, given the direction tax rates are headed in the future, it may still be better to pay taxes on a conversion to a Roth now then on a regular IRA in the future – think of it, essentially as a hedge against future tax increases.
If you do have significant investments in any kind of IRA, regular or Roth, you will be interested in a future article about how you can take your IRA offshore and for both increased investment flexibility and the ultimate in asset protection.
While the Roth IRA is a great savings tool, in my next article I will show you the ultimate LEGAL tax deferral measure for wealthier, high-income individuals, essentially a throwback to pre-income tax days.
Joshua Cohen
Offshore Investing & Asset Protection 
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