Capital Corner:  iFortune vs. iBroke

Jim Brandenburg, CPA, MST, Shareholder - Tax  email | bio
August 2011

As "D(ebt)-Day" arrived for the United States in addressing its debt ceiling of $14,000,000,000,000 (remember last month's issue and all the numbers), an agreement was finally reached. The snarls of political gridlock have now eased just as they were moving outside the beltway toward Wall Street. In the past few days as politicians worked to forge a deal to help the government resolve (at least temporarily) its debt crisis, it was interesting to see a recent report that Apple Computer, with its recent growth and profitable products, now has more cash than the federal government. The iPad and other profitable innovations have pushed Apple's cash flow into, yes, the iClouds.

With the August 2nd deadline looming, stubbornness and finger-pointing eased in Washington and an agreement to raise the debt ceiling was accomplished. Uneasiness about our nation's creditworthiness occurred in the financial markets as United States' debt obligations have been downgraded recently and further downgrades are possible, even with his agreement.

Let's look at some of the major issues in this agreement to raise the debt ceiling.

Cuts in Government Spending. In order to raise the debt ceiling, both Congress and the president expressed their support and willingness to make cuts in government spending. The agreement to cut, however, also included disagreement over the nature of these cuts. There was discussion about whether they would cover entitlements, defense or discretionary spending, and in what proportion. The parties eventually agreed to nearly $1 trillion in cuts to be realized over the next ten years, and another $1.5 trillion in cuts to be identified and made by a special bi-partisan congressional committee. There will be much debate by this committee and final cuts must be made by the end of the year, but if no consensus is reached, an automatic trigger will take effect to force the cuts which will be primarily geared on defense cuts. The make-up of this "super committee" will be decided soon by congressional leaders. While the committee will include members from the House and Senate and contain equal numbers of Republicans and Democrats, apparently any senator who voted against the final deal will be ineligible to serve on this committee.

How significant might these cuts be? Only in Washington does a budget "cut" actually represent an increase in future spending; it's just not as much of an increase as it might have been. Thus, say the spending for a program was scheduled to rise by 8%, but then is reduced to a 7% increase, and...voila, we have a "budget cut." It is a perfect system for politicians--they can appease one group of constituents by telling them that they cut spending on a certain program, while appeasing another group by telling them that the actual spending on the very same program will rise. What a system! Why didn't Apple come up with that?

Tax Increases. The administration and some members of Congress were unwilling to only make spending cuts as part of a deal to raise the debt ceiling. They also wanted to increase taxes to provide additional government revenue. Support for any tax hikes slipped in Congress, but the president and others were able to permit the above-mentioned super committee on spending to include, if it so decided, tax increases as part of its $1.5 trillion in debt reduction rather than making it all via spending reductions. Tax changes could be in the form of overall corporate and/or individual tax reform. Even if this super committee recommended increasing taxes both the House and Senate would need to approve the increase. So, while it may not seem likely that taxes will be increased, the trigger mechanism that mandates cuts in defense spending (if the new committee cannot reach agreement on specific spending cuts) could cause some congressional members to be forced to decide between defense cuts or tax increases.

Finally, you might recall the "Bush tax cuts" that were extended at the end of 2010 through 2012. If these rates expire at the end of 2012 and tax rates revert to the higher 2000 levels, the increase is not part of the agreement reached this week to raise the debt ceiling. So taxes could still rise in 2013, even though this increase was not part of this week's deal.

Balanced Budget Amendment (BBA). In addition to addressing spending and tax policies, some House members sought a balanced budget amendment to force Congress and the president to balance the budget, as is currently required for many states. While a vote may eventually be held separately on the balanced budget amendment, its long-term prospects are uncertain.

Timeline. This was a delicate matter to resolve. As Congress and the White House were negotiating the increase to the debt ceiling, the question arose, "How long until the debt ceiling would need to be raised again?" The president and others wanted the current situation resolved and did not want to worry about it during next year's campaign. Thus, in the final agreement, the administration was able to hike the debt limit enough to last until early 2013, after the November 2012 elections.

It has been an interesting summer to say the least, and while the current crisis of possible default has been avoided, the debt issue remains. Stay Tuned (or, is it Stay iTuned?)...