This column is being written one day before the election, so I do not know which presidential candidate will be victorious. However, there is one tax that is almost certain to increase next year irregardless of who wins the election. The tax, which had virtually no discussion during the campaign, is the Social Security tax.
This tax, which most workers must pay other than certain government employees, was reduced from 6% to 4% over the past two years. This tax was lowered in hopes of stimulating the economy. However, with the election behind us, there is little political support in keeping the tax at a lower rate.
In theory Social Security taxes are supposed to fund Social Security benefits. However, the government does have the ability to pay benefits by borrowing, which in essence it did with the recent Social Security tax cut.
In a 401K plan or an IRA people have a known amount in their account. For Social Security individuals can estimate future benefits based on their earnings. However, politicians have the ability to change future benefit formulas, as they have done with tax rates.
For many workers the Social Security tax has become larger than the federal income tax. That is why a change in this tax will have a significant impact on consumer spending. For example someone earning $50,000 per year will see their taxes increase $1,000 per year, if this tax goes back to the old rate.
If someone receives a raise next year, that increase in pay will be offset by the higher tax rate. In addition, while inflation is still fairly low, prices are still rising. Therefore, someone would probably need a pay increase of 4 to 5% to maintain their same purchasing power with the increase in Social Security taxes.
For people who are saving very little from their current paycheck, now is a good time to closely monitor spending. Unless someone is expecting a substantial increase in pay next year, the increase in this tax will create a dent in spending.
It is too early to tell what might happen with federal income tax rates going forward. Both parties emphasized that “middle class” taxpayers would not see an increase in taxes. However, taxing the rich more would only have a modest impact on the deficit, since there are not that many people earning over $250,000 per year.
The year after a presidential election is normally when more painful choices are made. The current level of government spending versus tax receipts is completely out of sync. To close that gap, we will likely see an environment less favorable for consumer spending.
Some may perceive less government stimulus for the economy next year, as a negative for the stock market. However, if a plan is reached that will reduce the deficit in a meaningful manner, then the stock market could do quite well.