Tax Rates-Now and Tomorrow

06/24/2008 12:00 am EST

Focus: MONEY MANAGEMENT

Terry Savage

Author, The Savage Truth on Money

As we enter this July 4th holiday weekend, let's take a look at something "patriotic"—paying income taxes!

It's not only your patriotic duty; it's your legal responsibility.  But you do have some leeway to plan when to pay your taxes and to arrange your finances to pay the least amount possible. That's not cheating.  It's sensible financial planning.

With that basic thought in mind, perhaps during this election year it's time to give some thought to your tax bracket now-and after the election.

American's tax rates are relatively low this year. Well, they're not low compared to the start of the income tax in 1913, when the top tax rate was seven percent on income over $500,000. But they are definitely lower than in the era of 1952 to 1963, when the top tax rate reached 92% on income over $400,000!

And at a 15% maximum, the capital gains tax rate is certainly the most favorable to investors in recent history.

But all that is likely to change no matter who is elected, and no matter what promises they make during the campaign. That's because the promise to give money almost always trumps the promise to keep tax rates low. In modern history only Presidents Kennedy and Reagan managed to keep their promises of massive tax cuts.

As our government faces huge budget deficits, and more spending demands during an economic slowdown, there will be inevitable temptation to pluck the goose that lays the golden egg. In other words, you can look forward to higher tax rates!

What does that mean for your personal financial planning? Well, for starters you might want to consider taking some capital gains right now-if you still have them-while tax rates are low. It looks like the market might already be feeling the weight of tax selling.

And then you might want to re-think your retirement plans. Traditionally, you opt for the tax deduction for today's contributions, choosing tax-deferred growth-and the assumption that you'll be in a lower tax bracket when you retire and withdraw from your IRA or 401(k). 

But if tax rates are likely to rise, you'd do better if your employer offers a Roth 401(k), or if you qualify for a Roth IRA.  Those accounts don't give you an immediate tax-deduction, but they do promise tax-free withdrawals at retirement.

Of course, no one has a crystal ball. But with the "official" national debt figures exceeding $9.4 trillion (and unofficial estimates of unfunded liabilities at over $56 trillion according to www.truthin2008.org), it seems the government will have plenty of need for your money.

Yes, tax increases are counterproductive. History demonstrates that higher tax brackets simply serve to slow the economy and lower tax collections, as the "smart money" goes elsewhere to do their business at lower tax rates.

In fact, you'd better act quickly if that's how you plan to fight the inevitable higher income tax rates.  A new law says that if you give up your US citizenship, all your assets will be taxed immediately, as if you had died!

So do you agree that income tax rates and capital gains tax rates are bound to rise? And how are you planning to deal with those eventualities? Just a reminder that it's not unpatriotic to do some tax planning!  And that's The Savage Truth.