• In a CNBC interview yesterday, Janet Yellen said, ‘I think the price of doing too little is much higher than the price of doing something big.’
• She argued that unemployment would be 10% if we measured it correctly.
• She said inflation is not a big concern because the Federal Reserve ‘has tools’ to deal with it.
• Finally, she said that there would ‘probably’ be a tax increase to pay for at least part of it.

Janet Yellen was interviewed by Sarah Eisen on ‘Closing Bell’ Thursday. She made arguments supporting the case for the $1.9 Trillion proposed stimulus package from the Biden administration. She argued that, “We think it’s very important to have a big package [that] addresses the pain this has caused – 15 million Americans behind on their rent, 24 million adults and 12 million children who don’t have enough to eat, small businesses failing”, Yellen said. She said, “I think the price of doing too little is much higher than the price of doing something big. We think that the benefits will far outweigh the costs in the longer run.”

Yellen said that unemployment would be ‘10%’ if we measured it correctly. There are 9 million unemployed, 4M dropped out of the labor force and 2M have reduced working hours. Sarah Eisen asked about stimulus money going to people who already have high paying jobs. Yellen said the administration would like to get it to people who need it. This has been a large debate topic among the legislators.

Unfortunately, highly targeted government assistance is very difficult to achieve. In an interview last March on CNBC, former Federal Reserve Chairman Hank Paulson said, ‘“One clear lesson from 2008 is that it is very difficult to quickly get all the money where it is most needed, and Treasury has a lot of money so Treasury and the Fed have a very big job ahead of them,” Paulson said .

What will the long term cost of the stimulus package be?

Yellen has indicated that taxes will ‘probably’ go up. Even before the $1.9T stimulus the CBO is projecting that the deficit in 2021 will be 10% or $2.3 Trillion. Economic studies have shown that governments are very likely to fail when they run deficits greater than 4%.

The CBO is projecting that US Debt to GDP will reach 102% in 2021. Average real GDP growth over the next ten years is forecasted at 2.3%.

So, in 2021 we will have the DEBT / GDP ratio in the history of the country. The deficit spending average over the next ten years is -4.8%. In other words, the US government is deficit spending is more than twice the growth rate. Of course, this is completely unsustainable and so as Yellen indicated, taxes would have to go up.

What are core elements of Biden administration tax proposals?

• Reverse tax breaks passed under Trump administration for all those making less than $400,000 per year.
• Increase corporate tax rates from 21% to 28%.
• Reduce the estate tax threshold set to expire in 2025.

The Biden administration will have a conundrum to balance stimulus while trying to raise taxes when, as Yellen says, we won’t be back to full employment until 2024. I’m very interested to see how the numbers pencil out. Are the tax increases proposed big enough to cover all of the spending and deficits? At some point, we need to come to grips with the fact that we simply cannot grow spending twice as fast as the economy. Large debt and deficits will certainly put pressure on the dollar. We have already seen substantial weakening.

What is the implication for retirees and investors?

Large debt and deficits are tied to lower future GDP growth. When we spend stimulus money today we are pulling demand forward. We end up with a pile of debt and then next year and the year after, growth is even more difficult to achieve since the prior spending was created out of thin air.

Given the numbers, taxes absolutely have to go up. Until we get new legislation, the final outcome is uncertain. Even prior to final legislation there are two areas that should be explored. First is ROTH conversions. Conversion of traditional IRA to a ROTH makes more sense when future tax rates are expected to be higher. Now, we don’t know with certainty what the future rates will be but even before legislation we can see the odds of higher taxes especially for those with higher incomes have gone up. This makes the case more compelling for ROTH conversions today.

Secondly, for very high net worth individuals who have assets above the estate tax limits to review their estate plans and potentially re-structure them. For example, it is possible to set up trusts today that take advantage of the larger estate tax limits prior to future reductions. The federal exemption is $11.7M in 2021. With a married couple the combined exemption would be $23.4 M. The amount is indexed to inflation but set to expire in 2025. In Oregon the estate tax exemption is only $1M. This amount is not indexed to inflation and did not increase when the federal estate tax limits when up under the Trump administration. Oregon has the lowest exemption in the country. Also, there is no spouse portability. Because it does not scale with inflation, it is affecting a larger number of people every year.
If you have questions on your tax situation, please contact us and we get discuss tax planning.