Although the federal income tax rates increased slightly in 2013 with the end of the Bush tax cuts, the rates are still relatively low compared to historic rates.
For example, between 1982 and 1986, the income tax rates reached as high as 50 percent. Before that, the top tax rates reached 70 percent and as high as 94 percent, largely due to World War II.
Historically, there has been a correlation between the national debt-to-GDP ratio and the tax rates.
For example, the debt-to-GDP ratio increased due to the World War I and the federal income tax rates followed. Then, the roaring ‘20s arrived and the debt-to-GDP ratio decreased along with the income tax rates.
The Great Depression followed, along with World War II, bringing higher debt-to-GDP ratios, along with higher tax rates (reaching levels over 90 percent). The tax rates stayed relatively high (70 percent for top earners) as the debt-to-GDP levels decreased until the early 1980s.
This is where the correlation begins to weaken. Since the early 1980s, the debt-to-GDP and ratio has generally continued rising, but the tax rates have decreased or stayed level, with one exception in the 1990s when the highest tax rates increased from 31 percent to 39.6 percent, and the debt-to-GDP ratio declined temporarily.
In the 2000s, the US faced wars and a major recession. We’re currently seeing the highest debt-to-GDP ratio since the Second World War. However, our tax rates are currently less than half what they were then.
While there are many more political and economic factors that affect our tax rates, the trends and history suggest that the low tax rates of the 2000s have come to an end, as we have already seen in 2013.
In 2013, Congress both increased the tax rates and broadened the tax base with respect to a number of taxes – income taxes, Medicare surtax, personal exemption phase-out, itemized deduction limitation.
What does this all mean? Why spend the time to discuss the economic landscape, recent legislative history, and new tax rates?
It shows that taxpayers can probably expect to remain in a season of higher taxes than they’ve experienced in the recent past. It may last a long time. Individuals will want to implement strategies that are designed to lower their taxable income in the future.
You can never be completely sure what item of income or wealth will be taxed, and by how much it will be taxed. For all you know, Congress could decide to broaden the tax base by taxing life insurance proceeds as ordinary income to the beneficiary.
If you believe tax rates will only increase, one potential strategy is to invest in currently taxed assets to avoid future tax liability.
The only way to really prepare is to work out a plan with a really well-qualified advisor.
If you are ready to find out how you might lower your tax bill, give us a call for a complimentary tax-strategy planning session.