Morningstar Advisor - Fall 2008 - 37

candidate’s plan: another $3.4 trillion to $5 trillion added to the federal deficit, according to an analysis by the nonpartisan Tax Policy Center in Washington, D.C. Also absent from each candidate’s economic proposals was a logical explanation of how they would balance the budget while increasing spending during a protracted period of flat wages, declining tax revenues, and stagnant growth. Obama promised to keep many of the Bush tax cuts, add additional tax cuts for lower- and middle-income taxpayers, and raise other taxes by closing loopholes. John McCain pledged to keep the Bush tax cuts and cut the top individual and corporate rates to 35% and 25%, respectively. He said that he would balance the budget by 2013 and hold government spending to 2.4% annually. Congress Sets Its Sights Tax Rates Historically Low: Taxpayers, particularly high-income earners, have faced lower rates over the past 20 years than did previous generations. 100% Marginal tax rate Highest rate Lowest rate 80 60 40 20 1926 1936 1946 1956 1966 1976 1986 1996 2006 Fuzzy math and campaign rhetoric aside, financial advisors say they expect Congress to target rich taxpayers who received the biggest tax cuts since 2001 when it comes time to raise taxes. Taxpayers earning more than $1 million will have received a 7.6% annual reduction in taxes by the time the Bush tax cuts expire Dec. 31, 2010, a Tax Policy Center analysis found. “The Democrats control Congress, and there is an overwhelming opinion that the rich are not paying their fair share when it comes to taxes,” says Greg Valliere, chief political strategist for the Stanford Financial Group in Washington, D.C. “We are going to have a big debate in this country over who should pay what taxes.” The most likely scenario is eliminating the Bush tax cuts by allowing the law to sunset. Starting in 2001, Congress enacted a series of tax cuts and Bush struggled to get those changes made permanent. The rub for many in Congress has been this: How much longer can the country afford the tax cuts, which have cost the Treasury more than $2 trillion in lost revenue? Unless Congress votes to extend the cuts, the upper individual tax rate will automatically Low Cap-Gains Rate Helps Stocks: Spread between before- and aftertax stock returns is narrowing. Not so with bonds, which are taxed more heavily. Stocks Before tax After rate Government bonds Before tax After rate 14% Compound annual return 12 10 8 6 4 2 3-year 10-year 20-year 3-year 10-year 20-year climb from 35% to 39.6%, capital gains will jump to 20%, and qualified dividends will be treated as ordinary income, taxed at one’s particular bracket rate. Move to Munis? dividends taxes to 15%. Long-term capital gains rates are at their lowest rate since 1933. “These are the lowest tax rates we have ever faced, so we are telling our clients to think about taking gains before rates go up,” says Cheryl Holland, financial advisor with Abacus Planning Group in Columbia, S.C. Among the biggest and most popular changes under the Bush tax cuts was a reduction in the tax on long-term capital gains and qualified MorningstarAdvisor.com 37

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Morningstar Advisor - Fall 2008

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