📅 How the Debt Ceiling is an Investor Lesson in Controlling the Controllable
The federal debt limit is once again in the news as the country rapidly approaches a critical deadline on June 1. Investors are understandably nervous about Washington failing to reach an agreement, a possibility that both sides agree would be a self-inflicted catastrophe. While it's unclear how this will play out in the coming weeks, the fortunate news is that financial markets are mostly taking these events in stride. How can investors maintain the right perspective around political and fiscal uncertainty?
We discuss in this episode of The Wealth Effect Podcast:
📊 Federal Deficit to GDP
📉 Treasury Yield Curve
📈 Federal Tax Rates
Matt Faubion, CFP®
Founder - Wealth Manager
Show notes and charts:
Federal borrowing reached the debt limit this past JanuaryThe debt ceiling is a mechanism that requires Congress to approve additional borrowing above these levels. So, this discussion needs to be clarified because the debt ceiling is not about government spending per se. The spending has already been authorized through the normal budget process, which happens every year.
Near-term Treasury rates have jumped but longer-term rates are steady
The one exception to markets staying relatively calm occurred in 2011 when a similar standoff led Standard & Poor's, a credit rating agency, to downgrade the U.S. debt. The stock market fell into correction territory, with the S&P 500 declining 19%. Ironically, the prices of Treasury securities increased during the 2011 debt ceiling crisis. Even though these were the exact securities being downgraded, investors still believed they were the safest in the world during heightened uncertainty. Congress eventually raised the debt ceiling and approved a new budget. With the crisis averted, markets bounced back.
Income tax rates are still low by historical standards
One factor beyond the market and economic effects is that the odds of higher tax rates may increase as the national debt worsens. Today, the highest income tax rates are slightly above their lows after the Reagan tax cuts but still far below historical peaks. High-earners in the mid-1940s paid rates as high as 94% on their marginal incomes. Even those in the lowest bracket would have paid 20% or more during the 1940s, 50s, and 60s - double today's rates. U.S. corporate tax rates were also among the highest in the world until the 2017 tax cuts. So, while higher tax rates are not guaranteed, engaging in wealth planning that takes advantage of relatively lower rates today can help to protect investors from future tax uncertainty.
The bottom line: The debt ceiling and federal debt must be resolved in the coming weeks. However, we've seen this debt ceiling movie many times over history. And as with many political issues, investors must learn to separate their political beliefs from their financial decisions that affect their hard-earned savings and investments.
This content is developed from sources believed to be providing accurate information and provided by Copyright (c) 2022 Clearnomics, Inc. All rights reserved. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.