The Independent Investor: And Now For That Deficit

The lame-duck Congress is finally getting to work. The president is horse trading with the Republican majority to extend the bush tax cuts before the end of the year. At the same time, the Obama budget deficit commission has released its findings and the full 18-member panel will vote on these proposals on Friday. Be prepared for some fireworks.

When the President Obama first appointed the bipartisan panel led by Erskine Bowles and former Sen. Alan Simpson, to come up with ideas to cut the exploding deficit, I wrote that we would have to wait until after elections before their findings would be revealed. Given some of the radical suggestions these deficit doctors have suggested I can understand why they are only now being revealed.

At long last the "untouchables" are on the table; those sacrosanct programs that no politician has had the guts to address in my lifetime. Taboo subjects such as Medicare, Medicaid, Social Security, farm subsidies, defense spending and mortgage interest rate deductions are on the table. If accepted in its entirety (and it won't be), the plan would reduce the deficit by $3.89 trillion between 2012 and 2020. The current national debt is about $13.9 trillion.

Here are some of the high points. Our complicated tax system and tax brackets would be collapsed into three brackets – 12, 22 and 28 percent. Itemized deductions would be eliminated; capital gains would be taxed as ordinary income. Contributions to tax-deferred accounts would be capped at 20 percent of income or $20,000, whichever is lower.

Although the plan would reduce income tax rates, there would be a price to pay. Your mortgage interest deduction would disappear, gas would be taxed at a higher rate, the retirement age of Social Security would increase and benefits for both Medicare and Medicaid will be cut. Over on the corporate side, taxes would be reduced as well to 28 percent from 35 percent. But employer provided health care exclusions would be capped and phased out altogether by 2038.

Now before you take sides on what you like or dislike about the proposals, understand that just about every interest group, every age group, every demographic profile you can come up with will both gain and lose by these proposals. Lobbyists will trash those proposals that threaten their clients and promote those that don't. On an individual level, I who have just purchased a home (and therefore a mortgage) in Pittsfield while less than five years away from social security and Medicare, will want my representatives to vote against those proposals but vote for a reduction in my income taxes.

You, my dear reader, will have your own agenda and want the deficit reduction to play out in a way that benefits you but takes nothing away from what you already have now.

This would be a mistake.

Our deficit is out of control. Many Boomers, their heads stuck in the sand, believe that if we pretend to ignore it, the deficit will soon become the problem of our future generations. We have gotten into the habit both individually and as a nation of kicking the can down the road. We mouth statements like "I'm glad I'm not growing up in America today" or "kids today will just have to work harder" or "our generation supported them, now it's their turn."

Maybe prior to the financial crisis, that short-sighted attitude would have worked. Now, several trillion dollars in debt later, the hard, sober facts are that if we don't make the sacrifices now to reduce the deficit dramatically, the Boomer generation is going to get clocked at the time when they can least afford it — in retirement. We share a number of economic and social conditions that could quite easily put us in the same position as Ireland, Italy, Spain and Greece. It wouldn't take much for our big lenders, like China and Japan to go on a debt buyer's strike, especially if the deficit continues to grow.

Nations around the world have already warned us of this possibility. Actions to replace the dollar by a basket of currencies are simply another warning shot across our bow. If the deficit continues to rise while America once again backs away from the hard choices we have to make in deficit reduction, then we will all see a spike in interest rates that will make your hair stand on end. Those rates will drive the economy into a depression and the stock market to new lows. Your retirement savings will disintegrate and we baby boomers will be bagging groceries at the supermarket at age 85 — if we are lucky.

So what's it going to be?

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.