Last year we wrote about how Congress and President Obama had passed a temporary (?)  payroll tax holiday for 2011, whereby taxpayers would see a 2% cut in the social security portion of their payroll taxes. The cuts meant that Americans would see a few more dollars in every paycheck, while social security deposits would decrease for the year.

In December of 2011 Congress was faced with an expiring tax cut for all taxpayers. While there was some serious discussion surrounding whether a tax cut should be extended at all, Congress ended up enacting a two month extension of the payroll tax cut.  That means that they would have to revisit the issue in February of 2012 before it expired.

This week as the deadline started creeping closer Congress enacted legislation in order to renew the payroll tax cut for the rest of the 2012 tax year.

2012 Payroll Tax Cut

After some debate this week Congress passed legislation to extend the payroll tax cut through the end of the year, as well as renewing jobless benefits for millions of unemployed. From FoxNews:

Congress has passed an extension of the payroll tax cut and long-term jobless benefits, handing to President Obama one of his election-year priorities despite widespread concerns about the bill’s deficit implications.

The Senate approved the bill Friday afternoon on a 60-36 vote. The $143 billion package, which also would forestall deep cuts in Medicare reimbursements to doctors, would extend the 2-percentage-point payroll tax cut for the rest of 2012.

The House earlier approved the bill on a 293-132 vote. Obama is expected to sign the bill, after having made the yearlong extension a cornerstone of the jobs package he outlined in September.

So the cuts are extended through the end of the year, as well as seeing a renewal of jobless benefits for the long term unemployed and a stall in deep cuts in Medicare reimbursements.

Election Year Helped Cut Pass

While there was quite a bit of opposition to the bill from Republicans, there was little will to come out against the payroll tax cuts in an election  year.  After the battle in December to block a 2 month extension of the payroll tax cut, and how it played so negatively with the electorate, they decided to give this extension a flyer.

“We don’t control Washington. Democrats still control Washington — they control the Senate and they control the White House,” said Rep. Dave Camp, R-Mich., the top House negotiators on the measure. “A divided government must still govern.” Camp cited stricter job search requirements for people receiving unemployment benefits and other reforms to the program as wins for conservatives.

How Much Extra Does The Tax Cut Mean?

If the tax cut had expired it would have meant an increase of 2% in payroll taxes.  In other words in the FICA portion of your paycheck tax withholding the Social Security portion would have increased to 6.2% from 4.2%. The taxes going to Medicare funding, the other 1.45% of your FICA taxes, would have remained unchanged.

Since the legislation means the tax cut will remain unchanged, your paycheck won’t be seeing any changes.

NOTE: The average taxpayer sees around a $1000 tax savings because of the payroll tax cut.  Social Security taxes are capped at an income of $106,800. So the maximum savings seen by a higher income individual due to the tax cut is around $2136.

• Taxmageddon: Will We See A Huge Tax Increase Due To Expiring Tax Breaks At End Of 2012?
• Will There Be A 2012 Payroll Tax Holiday, Or Will An Extension Be Blocked And Taxes Rise In 2012?
• 2012 Federal Income Tax Brackets: IRS Marginal Tax Rates
• Taxes Are Going Up. Why Are Some People Seeing A Federal Income Tax Increase In 2011?

Last year around this time we were in the midst of a debate in Washington D.C. about whether or not our legislators would be extending the Bush era tax rates. The Bush tax cuts lowered rates for everyone who pay taxes. The concern for a lot of politicians was that if they didn’t extend the rates and taxes went up – that it would reflect badly on them and their re-election chances.

On December 17th of 2010 the President signed into law a tax package that extended the current rates for everyone, meaning that in theory most part people would not be seeing a huge increase in their taxes. The only problem was that there were existing tax credits expiring like the Making Work Pay tax credit.  The effect of that credit expiring was an instant increase in taxes of $400 per worker and $800 per working couple.  Also, since the credit was refundable, even those who didn’t make enough to owe income tax were able to claim it.

The politicians knew they had a problem brewing – so they came up with a replacement for the Making Work Pay credit, the temporary payroll tax holiday for 2011.

What Is The Payroll Tax Holiday

So how did the  payroll tax holiday work  in 2011?

Usually when you get your paycheck from your employer they will withhold taxes, including on FICA portion of your paycheck – which funds Social Security and Medicare.  Last year Congress and the President cut the employee contribution for the Social Security portion from 6.2% to 4.2% – for the 2011 tax year only. So that means if you’re paying taxes you ended up getting more in your paycheck every payday.

For the average taxpayer that 2% cut in Social Security taxes meant a savings of about $1000 in taxes. The maximum savings seen by higher income individuals was around $2136 since the tax is capped at $106,800 in income.

So now that the payroll tax holiday will be expiring, the President and Congress are looking to act in order to extend the payroll tax holiday.  Nobody wants to be seen as the ones who created a tax increase for average taxpayers – even if the payroll tax holiday wasn’t meant to be permanent.

2012 Payroll Tax Holiday In The Works?

So now we have the President and Congress trying to come to some sort of a solution in order to extend the payroll tax holiday into 2012.

Senate Democrats on Monday unveiled a scaled-back version of a bill to extend the payroll tax holiday, but one that still pays for the cuts by taxing millionaires at a higher rate that Republicans have opposed.

At the White House, President Obama urged congressional Republicans to join Democrats in approving the extension, arguing that it is urgently needed to prevent what would amount to a tax hike on middle-class families next year.

The latest version of the Democrats’ bill was offered Monday by Sen. Robert P. Casey Jr. (D-Pa.), setting up a vote expected later this week. It comes as the two parties race to find a compromise to extend the one-year tax break for workers, which expires Dec. 31. Without a deal, taxes will rise on the average family by about $1,000 next year.

The Democrats have put forth a plan that would extend the cut, but in the process would increase taxes on millionaires, and rely on savings in the budget that some say are questionable. For many Republicans that has been a non-starter.

“Senate Democrats say they have a credible ‘compromise’ proposal, which presumably does not include job-killing tax hikes or phony war savings. We look forward to reviewing it,” said Michael Steel, a spokesman for House Speaker John A. Boehner (R-Ohio).

House Republicans are trying to come up with their own alternative, hoping to overcome objections from many rank-and-file Republicans who have resisted supporting the payroll tax holiday as ineffective at spurring hiring.

Boehner has floated the idea of attaching to the payroll extension other conservative proposals, such as a bill that would mandate a speedy decision from the State Department on a proposed energy pipeline from Canada to the Gulf Coast.

“We are continuing to work with our members on legislation to extend the current payroll tax holiday, protect Social Security, reform unemployment insurance and cut government spending,” Steel said.

So the Republicans are open to extending the payroll tax holiday.   The question is, just how will it get passed? What compromises will each side make in order to get the other side to vote for it?

Should We Just Allow The Payroll Tax Holiday To Expire?

To me, one of the real questions is whether or not we should be extending the payroll tax holiday at all.   Some experts have said that Social Security already has problems with remaining solvent in the future, and having payroll tax holidays like this only exacerbates the problem by borrowing against the future to have some gain now.

In the name of making Americans feel less bad about their situation now, lawmakers are proposing something that sounds good, but will actually make our financial future worse…

the government has often taken the cash from Social Security and left IOUs, and the program is confronting looming demographic challenges. But Social Security also resembles a bank: It doesn’t have all the money it owes, but it has always paid out in the past. Besides, it has a civic benefit. Paying money in, and then getting it back later, has taught Americans good things about savings and trust in government.

That virtuous cycle could continue. Social Security requires only a few reforms to stay solvent: raising the age at which pensions start, slowing the growth in benefit levels, and — crucially — ensuring that everyone pays the full amount due, every year.

But those payments haven’t been happening lately. In the name of economic emergency, lawmakers reduced Social Security payments in 2011.

…Each time lawmakers negotiate a cynical fiscal deal full of pretend holidays, they make the next deal — square or round — harder to seal. The best way to get public support for future reforms is to surprise everyone by honoring at least one of the old deals

Politicians are saying that the Social Security fund would not be affected by this tax cut, with losses in projected revenue to be made up by the Treasury and the general fund – but even so – we’re just doing fancy accounting here. In an age where deficits are skyrocketing, some say that money could be used elsewhere to offset increased spending.  Other say we need to focus on re-writing the tax code altogether, cutting spending and reducing taxes to spur growth.

I’m not sure what the answer is, but I hardly think that this payroll tax holiday will be the death of the republic.  In the end, our skyrocketing debt and deficits will be much more to blame  I think.

What are your thoughts on a possible extension of the payroll tax holiday?  Do you think they should extend it- or allow it to expire?  Does it matter much in the long run?

• Taxmageddon: Will We See A Huge Tax Increase Due To Expiring Tax Breaks At End Of 2012?
• Payroll Tax Cut Extended Through The End Of 2012
• 2012 Federal Income Tax Brackets: IRS Marginal Tax Rates
• Taxes Are Going Up. Why Are Some People Seeing A Federal Income Tax Increase In 2011?

I was reading several articles this morning about the unemployment rate posting a sizable drop from 9% to 8.6%, and the broader unemployment rate falling as well from 16.2% to 15.6%.

On the face of things this seems like good news, but as with anything coming out of Washington D.C. it needs to be taken with a grain of salt. There are reasons why the unemployment news isn’t quite as good as you might think.

The Unemployment Rate: How Is It Calculated

There are three kinds of lies: lies, damned lies, and statistics. – Mark Twain

One thing that a lot of people don’t realize is just how the unemployment figures are calculated, and what goes into them. While you might think it would be simple – just count the number of people with and without jobs, and you have an unemployment rate, right? Not quite.  From WSJ.com

The unemployment rate is calculated based on people who are without jobs, who are available to work and who have actively sought work in the prior four weeks. The “actively looking for work” definition is fairly broad, including people who contacted an employer, employment agency, job center or friends; sent out resumes or filled out applications; or answered or placed ads, among other things. The rate is calculated by dividing that number by the total number of people in the labor force.

So while those people who are actively looking for work are counted in the numbers for those who are “unemployed”, those numbers don’t include a broader segment of people in the US who are either underemployed in part time positions for economic reasons, or who are not working or currently looking for work despite wanting a job.  When you take that into account we get the broader unemployment rate, known as the “U-6″, which will be considerably higher.  But it doesn’t end there. There are others who are not included:

The truth is that even the broader measure of unemployment doesn’t fully capture how difficult the job market is for U.S. workers. It doesn’t include self-employed workers whose incomes have shriveled. It doesn’t look at former full-time employees who have accepted short-term contracts, without benefits, and at a fraction of their former salaries. And it doesn’t count the many would-be workers who are going back to school, taking on more debt, in hopes that advanced degrees will improve their chances of landing jobs.

So all of those self employed workers with shriveling incomes, full time employees now on short term contracts and those going back to school and incurring new debt aren’t taken into account.  So in reality the situation is much more grim than some realize.

Why Unemployment Numbers Aren’t As Good As Some Say

The unemployment rate dropped last month from 9% to 8.6%, but that doesn’t tell the whole story.   The real  question is, why did the rate drop?  Was it due to more people finding jobs?  In part, and that’s good news.  But it was also due to a large number of people just dropping out of the active job search.

But as the White House Council of Economic Advisers is always quick to remind us, it’s important not to read too much into one month’s data.

And while the jobless rate fell, about half of that came from discouraged workers giving up their job searches. Of the 120,000 payroll jobs added, while certainly helpful, they were still far less than the 250,000 jobs that would be needed every month to make a serious dent over several years in the jobless population of 15 million.

The WSJ lays it out:

So the decline in the unemployment rate to 8.6% was about half due to people finding jobs and half people dropping out.

So what we get on the news is politicians slapping each other on the back because of the declining unemployment rate, when in reality about half the gain is attributable to people just dropping out of the labor force altogether. That isn’t exactly a ringing endorsement to me.

People Are Unemployed For Longer These Days

The unemployment numbers aren’t as rosy as might be suggested, but the other thing that isn’t that great is the fact that people who are unemployed these days are unemployed for longer than was common in the past.

In the second quarter of 2010, about 46 percent of the 14.6 million unemployed persons were jobless for 27 weeks or longer and about 31 percent were unemployed for 52 weeks or longer. [Bureau of Labor Statistics]

It has also been suggested that the availability of extended unemployment insurance benefits has contributed to the increase in unemployment duration. [Bureau of Labor Statistics]

So of the unemployed, 31 percent have been unemployed for 52 weeks or longer.   So new jobs are few, and the applicants for those jobs are many.

Hopefully things will start improving in the near future, and we can report drops in the unemployment rate – wholly due to increases in employment – and not due to drops in people actively searching for jobs.

What are your thoughts on the unemployment figures?  Do you think they purposely paint a rosier picture than they should?

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The past couple of years I’ve heard from quite a few folks who are living on social security and were upset to find out that they wouldn’t be getting cost of living adjustments to their Social Security checks.  For the 2010 and 2011 tax years there was no increase in the amount that people on Social Security would receive.

This week the Social Security administration announced that there would in fact be a cost of living adjustment made for 2012 after a 2 year hiatus. I’m sure a lot of my readers will be happy to hear the news.

Social Security Cost Of Living Adjustment (COLA)

The Social Security Administration announced earlier this week that after crunching the numbers after the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) was released – it was determined that there would be an increase in Social Security benefits of 3.6%.

Monthly Social Security and Supplemental Security Income (SSI) benefits for more than 60 million Americans will increase 3.6 percent in 2012.

The 3.6 percent cost-of-living adjustment (COLA) will begin with benefits that nearly 55 million Social Security beneficiaries receive in January 2012. Increased payments to more than 8 million SSI beneficiaries will begin on December 30, 2011.

So benefits and income will rise slightly for the more than 60 million people who receive Social Security income.

How Does The COLA Work?

The cost of living adjustment is made to Social Security benefits in order to ensure that the purchasing power of the dollars given to recipients isn’t eroded over time.    Here’s how it works, from the government site:

The purpose of the COLA is to ensure that the purchasing power of Social Security and Supplemental Security Income (SSI) benefits is not eroded by inflation. It is based on the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of the last year a COLA was determined to the third quarter of the current year. If there is no increase, there can be no COLA.

So the CPI-W from the 3rd quarter of the previous year is compared to the 3rd quarter of the current year. If there isn’t an increase, then there isn’t an increase – simple as that.

How Often Are Cost Of Living Adjustments Made?

Normally there is a cost of living adjustment made just about every year tied to the Consumer Price Index.  If the CPI-W hasn’t gone up, then there is no adjustment made.  In the past, however, just about every year has seen an adjustment, until the last two years. Here’s a look at the COLA for Social Security from 1975, when automatic increases started, to 2012.

So as you can see not receiving a cost of living adjustment in 2010 and 2011 was upsetting for quite a few people since there had always been an increase.  Since increases are tied to the Consumer Price Index by law, however, there wasn’t much to be done.

The thing is, people often mention the two years of no increase in benefits, but don’t mention the larger than normal increase in 2009 of 5.8%.  TheFinanceBuff.com explains why that is significant:

..people conveniently forget that there was an unusually large 5.8% increase in 2009 . It was unusually large in 2009 because CPI spiked in Q3 2008. Had the increase been calculated using Q4 averages instead of Q3 averages, the Social Security COLA increases would have been 1.3% in 2009, 1.8% in 2010, 1.5% in 2011. Social Security recipients are actually better off with a 5.8% increase up front followed by zero increase for two years than with small but steady increases in last three years.

When the Social Security program started there was no adjustment made to benefits on a yearly basis at all – so someone entering the program would receive the same benefits year in and year out.   It was realized quickly thereafter that inflation was eating into those benefits and some change was needed.  Eventually legislation in 1972 mandated the automatic increases tied to the Consumer Price Index.

How Much Extra Will Be In My Check?

So with the increase, how much extra will be showing up in the average Social Security check?

Nearly 60 million Americans receive benefits, with an average monthly check coming in at nearly $1,100. The COLA increase would translate to a roughly $39 increase.

So a $39 average increase in benefits for 60 million Americans.  How will this increase be paid for?  An increase in taxes and withholding for current wage earners of course!

The maximum amount of earnings subject to the Social Security tax (taxable maximum) will increase to $110,100 from $106,800.  Of the estimated 161 million workers who will pay Social Security taxes in 2012, about 10 million will pay higher taxes as a result of the increase in the taxable maximum.

So some will see an increase in benefits, and some will see tax increases.

What are your thoughts on the increase in benefits for Social Security?  Do you think it’s high time an increase was made, or do you think that increases shouldn’t necessarily be automatic? Tell us your thoughts in the comments!

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Last year around this time we were right in the middle of a contentious debate in Congress about whether or not they would be extending the Bush era tax cuts, and whether or not the Obama administration would sign them into law, essentially making them his own.

In the end, despite not really wanting to Obama did sign them into law because Republicans gave in a few other areas that he and the Democrats were pushing for. Here are some of the things that happened as a result of H.R.4853 last year:

• Bush tax cuts extended for 2 years (2011-2012).
• Social Security tax on employee wages dropped from 6.2%  to 4.2% for one year (2011).
• Estate tax was reinstated at 35%
• Jobless benefits extended.
• Tax rates on capital gains and dividends extended for 2 years, even for higher earners.

So there was a lot of discussion in Congress around the tax related issues last year.  This year probably won’t see as much debate just for the simple fact that many of the tax rates/etc were continued through tax year 2012, so won’t be coming due this year.

2012 Federal Tax Rate Projections

Since the marginal tax rates probably won’t be changing much due to new legislation in Congress this year, we most likely won’t be seeing any major changes to the tax rates. The official IRS tax rates for the 2012 tax year haven’t been released  yet, but several tax related groups have now released their projections of what the rates will most likely be. They are using calculations created by the IRS to figure these things out – which take into account inflation, consumer price index and other things.  I’m just glad we don’t have to figure it out on our own.

The rates haven’t changed much this year from last.  The most we’ll probably be seeing are some slight changes in the bracket ranges due to inflation.

If you compare to the tax rates we have for 2011, we’re only seeing some slight variations in the bracket ranges.

If you want to check out what the rate ranges have been in past years (besides 2011) to compare, here are our posts for past years.

• 2009 Federal Income Tax Brackets
• 2010 Federal Income Tax Brackets
• 2011 Federal Income Tax Brackets

What Is Changing For 2012 Tax Year?

So what are the main things that are changing for this coming tax year?

• The standard deduction for married filing jointly is projected to rise to $11,900 in 2012  from $11,600 in 2011.
• The standard deduction for singles will rise to $5,950  in 2012  from $5,800  in 2011.
• Personal exemption rises to $3,800 in 2012 from $3,700 in 2011.
• Tax-bracket rate thresholds increase for each filing status. (Example: For a married couple filing a joint return the taxable-income threshold separating the 28-percent bracket from the 33-percent bracket is $217,450, up from $212,300 in 2011. (see chart above for other range changes)

Don’t forget to be  organized for tax season, figure out what you’ll need to file, and take all the income tax deductions that are available to you.

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• Taxes Are Going Up. Why Are Some People Seeing A Federal Income Tax Increase In 2011?

I don’t have a million dollars just yet; in fact, I’m far from it!  If I’m diligent with my savings, my retirement account will reach the big M, but what does that really mean in 30 years?

The number itself doesn’t mean anything – the purchasing power of those dollars is what counts.

I know you realize how inflation eats away at the purchasing power of our dollars year after year, but when we put it into perspective it becomes really apparent how one million dollars may not be as big of deal in 40 years.

Rewind 30 Years… Average Costs Then, Now And In The Future

I have no idea what things will cost in 2041, but what I do know is how to research what things cost 30 years ago.  There’s no guarantee that inflation will be the same in the next 30 years, but to put things into perspective, I’ll forecast each projected cost with a reasonable average of 3% inflation per year.

• Average Cost of a New Home in 1980: $86,400
• Average Cost of a New Home in 2011: $246,000
• Projected Cost of New Home in 2041: $597,000

That just sounds scary… over a half million dollars for a home on average!  I would hope that home prices don’t bubble like they did these last few decades, but for consistency we’ll use the same rates.

• Average Cost of a New Car in 1980: $5,413
• Average Cost of a New Car in 2011: $28,400
• Projected Cost of New Car in 2041: $68,934

Almost $70,000 for an average car?  That sounds crazy.  If a new car increased in price by five times in thirty years, who’s to say it couldn’t double in the next thirty.

• Cost of a Stamp in 1980: $0.19
• Cost of a Stamp in 2011: $0.44
• Projected Stamp cost in 2041: $1.07

Who knows if stamps will even be around in 30 years!

• Average Cost of a Gallon of Milk in 1980: $2.16
• Average Cost of a Gallon of Milk in 2011: $3.78
• Projected Cost of a Gallon of Milk in 2041: $9.18

• Average Income in 1980: $11,321
• Average Income in 2011: $46,323
• Projected Income in 2041: $112,438

With a quick glance at all of these common expenses, it’s easy to see how one million dollars may go by quicker than we expect.  I know that 30 years might seem far away, but ask someone who is age 50+ about the 80’s and 90’s and they’ll probably say it seemed like yesterday.  Even if prices aren’t this high in 30 years, the idea of a million dollars will probably continue to get smaller and smaller as people see an increase in income (and expenses!).

I’m still hopeful to have saved a million dollars one day, but if I’m spending $10 for a gallon of milk, I might feel better if my account had $2 million.

Are you shocked by these figures?  What other items are you curious about? Mention them in the comments and I’ll run a similar projection.

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This evening we heard President Obama announce the news that Osama Bin Laden had been killed in a U.S. lead attack on compound near Islamabad, Pakistan.  Apparently Bin Laden had been hiding in a mansion there near the capital city, and not in Pakistani tribal regions as some had thought.  While that news is certainly embarrassing for Pakistani security forces, the news certainly is very welcome to all freedom loving peoples across the world. People are celebrating in the streets in Washington, D.C., and across the country.

While the news of Bin Laden’s death means that justice has finally been served in the global war on terror, and for the 9/11 families, one thing I’m interested to see is the effect that the news of Bin Laden’s death will have on the markets.

What Effects Will The News Of Osama’s Death Have?

I’m already reading news on the wires talking about how there will be some positive effects in the markets because of Bin Laden’s death, while some other commodities markets – like the oil markets – may be more volatile in the short term.

The dollar rebounded from three-year lows and U.S. crude slid more than 1 percent on Monday on the back of news that a U.S.-led operation killed Osama bin Laden in Pakistan.

U.S. stock index futures SPc1 added to gains, while U.S. Treasury yields rose across the curve after U.S. officials said the body of Al Queda’s elusive leader has been recovered by U.S. authorities.

“By lowering national security risks overall, this is likely to bolster equity markets and lower US Treasury prices in a reverse flight to quality movement,” said Mohamed El-Erian, Chief Executive Officer and Co-Chief Investment Officer at PIMCO, which oversees $1.2 trillion assets.

“Oil markets are likely to be the most volatile given their higher sensitivity to the tug of war between lower risk overall and the possibility of isolated disturbances in some parts of the Middle East and central Asia,” he said.

Other commodities markets are also showing declines.  From MSN Money:

Meanwhile, crude oil for June delivery was down $1.56 to $112.37 a barrel late Sunday. Gold dropped $10.70 to $1,545.70 an ounce. Silver for July delivery was down $5, or 10.5%, to $43.60 an ounce.

So from the sounds of it, at least in the short term, the news is showing a positive effect in the stock markets globally.  Of course most are saying to temper your enthusiasm as gains are likely to be only temporary.

Other markets are showing a bit more volatility because of how unsure the whole middle east region is currently. There is unrest in so many countries even before this news broke, and add to that the news of Bin Laden’s death and the possibility of a retaliatory attack by Al Qaeda operatives is increased. That leads to some unsure markets.

Conclusion

Hopefully Bin Laden’s death will only be the start of the end of global terror in general, although I’m still part of the camp that is afraid we could see attacks going forwards, especially in the aftermath of today’s news.  I pray that won’t be the case.

For now, I’ll be celebrating that he has been brought to justice, and the thousands that he killed and had a direct hand in killing – will now have justice of some kind.

Update: As of this afternoon, yesterday’s news seems to have had little impact on the markets at all. From CNN:

If you were expecting a big rally Monday on the bin Laden news, guess again.Stocks initially rose, but it was hardly a euphoric move. By early afternoon, the market was flat. That makes sense.

Let’s be honest. It’s not as if the market had been held back as of late because Osama bin Laden was still on the loose.The death of bin Laden doesn’t really change anything for the financial markets or economy. Talk all you want about how this may boost confidence. But that’s a touchy-feely intangible that gets too much attention.

“There’s no long-term impact from bin Laden’s death. There may not even be that much of a short-term impact,” said Jack Ablin, chief investment officer with Harris Private Bank in Chicago.

What do you think the effects of the news of Bin Laden’s death will be on the markets?

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Who is to say how a government is run?  Isn’t it an establishment ‘of the people, by the people, and for the people’ designed to enhance our freedom to choose how we want to live?  So then the answer is this: people.

The most interesting part is that it’s both the answer and problem behind the question of government control.

So what?  I mean this isn’t anything new, right?  In fact, I’d argue that these principles were established well before the United States formed as a nation.  But that’s the beauty of it all – nothing’s new under the sun.

The point of this article isn’t to bring up any new ideas to the role of government but to revisit the foundational roles that were established by the father of economics, Adam Smith.

Adam Smith’s Three Roles Of Government

In his book, The Wealth of Nations, Smith outlines the role of government in cover three distinct areas: military force, administration of justice (law), and provision of public goods.

Role 1: Military Force

The first priority of the government should be to protect its citizens from outside forces that try to compromise our freedoms.  The ultimate reason for this provision is to ensure that the nation is sustained for as long as possible.

Smith presents a not-so-groundbreaking thought that if government spending is reckless during peacetime, that war will require the nation to borrow.  Unfortunately, this is a reality today.  The principles of budgeting still apply for the everyday person and for the most powerful of governments.

Role 2: Administration Of Justice

“Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice, in which the people do not feel themselves secure in the possession of their property…”

If there were no laws protecting society members in areas of property rights, legal contracts, or other rules of law, we’d probably live in a constant state of fear that someone would wrong us.  Smith explains that the government should have a role in creating laws that keep the peace.  Exactly how far these laws should reach, well that’s the big question.  His point is that we should have a common source for justice and the government makes the most sense as a source for legal resolution.

Role 3: Provision Of Public Goods

The third and most debated role of government involves spending for the public good.  This includes building roads, bridges, canals, parks, or any other public feature that no one person wants to fund.  Even more interesting is Smith’s suggestion that these features should be self-financing.  That means if you don’t use the road, you don’t pay.  Enforcing tolls or other fees to construct these public goods is his recommendation.

Another recommendation of Smith is that governments should subsidize the general education of its people in order to create a healthier society.  He stated that “an instructed and intelligent people…are always more decent and orderly than an ignorant and stupid one,” suggesting that it’s easier to govern those who are educated.  The scope of this funding, Smith argues, shouldn’t be extensive, but just enough to provide the basic needs to “read, write, and account.”

Government’s Roles In Society Today

The role of government in society today has reached far beyond the three basic roles that Smith proposed in the late 1700’s.  Unfortunately, a major cause of the expansion of government’s role has been founded on people’s natural tendency to feel entitled to get something in return for very little or nothing in some cases.

I know we’ll never completely rewind and reduce government to these three roles, but it is interesting to see how a government (elected by the people and made up of people) can expand beyond the basic roles outlined by Adam Smith.

What do you think of the three roles outlined by Adam Smith?  Agree or Disagree?  Would a simplistic government, as outline by Adam Smith, work in today’s society?

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A few months ago I published what I thought the 2011 Federal Income Tax brackets might look like. At the time I thought that taxes may be going up because congress was having a hard time passing a tax package of any kind. Others were projecting that the rates were going to go up as well.

Thankfully, Congress and the President signed a tax package into law on December 17th, 2010, that extended the tax rates for all taxpayers, meaning most people shouldn’t see an increase on their taxes in the coming year.

Even though the current tax rates were extended, some people are seeing a 2011 federal income tax increase in their paychecks already, and there is a lot of confusion about how that could happen when the rates are essentially the same.

Unfortunately, although the rates are staying the same, not everything else has remained as it was.  There were expiring temporary tax credits that will mean some people will see (or already have seen) an increase in the federal tax on their paycheck.

2011 Federal Income Tax Increase

As mentioned despite the rates remaining essentially unchanged except for rate range increases due to inflation, a lot of people will still see a difference in their paychecks this year.   Some folks will see their taxes go down, while other lower income folks will have an increase in withholding from their paycheck.

The Making Work Pay credit expired on December 31, 2010; therefore the 2011 income tax withholding tables do not reflect this credit.  As a result, employees in a lower income tax bracket may see an increase in their tax withholding amount, while employees in a higher tax bracket may see a decrease.

So it all really depends on how much you make, and how much of a cut you got in previous years from the Making Work Pay tax credit.

Making Work Pay Tax Credit Being Gone Means Higher Withholding For Some

As mentioned the Making Work Pay tax credit was available for the 2010 tax year, but is now expired.  That means taxpayers will no show the reduced withholding due to this tax cut.   How much was  the tax cut, and who got it?

• The February 2009 stimulus bill gave a $400 credit per worker and a $800 credit per working couple.
• The full credit would be paid to people making $75,000 or less ($150,000 per dual-earner couple).
• A partial credit would be paid to those making above those amounts but no more than $100,000 ($200,000 for couples).
• The credit was also refundable, meaning even very low-income families who don’t make enough to owe income tax would be able to claim it.

For most people that had a job and received the cut, it was paid over time at roughly $15 per period, assuming 26 pay periods in a year.  For some folks since the cut was enacted a couple of months into the year, the amount added to their checks was larger. Since the tax cut is expiring, you won’t have that extra $400-800 in your paychecks in 2011.  As mentioned that means a lot of people’s federal tax withholding will be about $15-40 more.

Cut Of 2% In Social Security Payroll Tax

One thing that was passed as a part of the tax act in December was the 2% payroll tax holiday for 2011.  It was put in as kind of a replacement for the expiring $400-800 “Making Work Pay” tax credit.

Many people will see this new tax cut completely replace the credit or better, but for some who have low incomes or don’t pay taxes, they won’t see as much as the Making Work Pay tax credit. In fact, some who don’t pay taxes will see nothing at all with the new cut since they don’t make enough.

How much of a cut does the 2% payroll tax holiday actually give for the average taxpayer? By some estimates it will mean an average of $1000 in tax savings.  Since the Social Security tax is capped at $106,800, the maximum savings that could be seen by a higher income individual is around $2136.    The previous “Making Work Pay” tax credit meant a $400 credit for singles and $800 credit for families.

Some Will Pay More Taxes. Some Will Pay Less

So because not everything stayed the same after last year’s tax package, not everyone will be paying the same amount this year – despite the rates being extended for everyone.  While  new tax cuts have been passed to replace the old tax credits, because they are setup differently it will mean that some people will be seeing an unexpected increase in their federal taxes, while others will be coming out ahead.    So depending upon your situation, you could be extremely happy with the tax package that was passed, or you’ll be frustrated because you have less in your paycheck or pension check.

Do you think that the federal government adequately explained how people’s tax withholding might be changing in the new year? Do you think it is taking a lot of people by surprise?  Have you shown an increased withholding?  Tell us about it.

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Yesterday we talked about how the energy efficient home improvement tax credit was extended into 2011, albeit at a lower reduced maximum of a $500 max credit per homeowner, at at a reduced amount for many eligible products.   While the credit is still around, the effect it will have at this reduced amount is anyone’s best guess.

Today I want to touch on another tax credit that was extended, this one for two more years, through 2012. That is the $1000 child tax credit.

$1000 Child Tax Credit Extended

Within the past couple of weeks Congress and President Obama passed into law an extension of the Bush era tax cuts, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 or H.R.4853.  There were several popular tax breaks extended in the bill including a slimmed down home improvement tax credit, an extension of the current tax rates (instead of a huge tax hike), and a payroll tax holiday, cutting Social Security tax withholding from 6.2% to 4.2% for one year.

One that a lot of families are happy about is the  extension of the valuable child tax credit for dependent children that many parents have taken advantage of for the past few years.   The Child Tax Credit (CTC) was at a level of $500 per child, until legislation raised it to the current $1000 per child level.

Under H.R.4853 the Child Tax Credit (CTC) of $1000 per child has been extended for the 2011 and 2012 tax years, and is available to parents or legal guardians of children who are 16 years old or younger at the end of the year.  That means my wife and I will be able to enjoy a new $1000 tax credit for 2010 & 2011 now that we’ve had our first child!  Daddy’s little tax credit!

Child Tax Credit Eligibility And Phaseout

Eligibility to receive the full Child Tax Credit is subject to income limits and phaseouts.

• Income limit of $110,000 for married couples
• Income limit of $75,000 for single parents.

After these income levels the credit is reduced by 5% of adjusted gross income.

The Child Tax Credit is a credit, as opposed to a tax deduction. A tax deduction reduces your taxable income, while a credit reduces the amount of tax owed.

IRS Facts About The Child Tax Credit

The IRS recently posted ten facts on their site about claiming the Child Tax Credit.  I thought I’d share them here.

1. Amount – With the Child Tax Credit, you may be able to reduce your federal income tax by up to $1,000 for each qualifying child under the age of 17.
2. Qualification – A qualifying child for this credit is someone who meets the qualifying criteria of six tests: age, relationship, support, dependent, citizenship, and residence.
3. Age Test – To qualify, a child must have been under age 17 – age 16 or younger – at the end of 2010.
4. Relationship Test – To claim a child for purposes of the Child Tax Credit, they must either be your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister or a descendant of any of these individuals, which includes your grandchild, niece or nephew. An adopted child is always treated as your own child. An adopted child includes a child lawfully placed with you for legal adoption.
5. Support Test – In order to claim a child for this credit, the child must not have provided more than half of their own support.
6. Dependent Test – You must claim the child as a dependent on your federal tax return.
7. Citizenship Test – To meet the citizenship test, the child must be a U.S. citizen, U.S. national, or U.S. resident alien.
8. Residence Test – The child must have lived with you for more than half of 2009. There are some exceptions to the residence test, which can be found in IRS Publication 972, Child Tax Credit.
9. Limitations – The credit is limited if your modified adjusted gross income is above a certain amount. The amount at which this phase-out begins varies depending on your filing status. For married taxpayers filing a joint return, the phase-out begins at $110,000. For married taxpayers filing a separate return, it begins at $55,000. For all other taxpayers, the phase-out begins at $75,000. In addition, the Child Tax Credit is generally limited by the amount of the income tax you owe as well as any alternative minimum tax you owe.
10. Additional Child tax Credit – If the amount of your Child Tax Credit is greater than the amount of income tax you owe, you may be able to claim the Additional Child Tax Credit.

Additional resources:

• Publication 972 from the IRS, Child Tax Credit (PDF 128K)

Are you claiming the Child Tax Credit this year?  How much does it stand to save you in taxes since it will remain at $1000 instead of reverting back to the $500 level?

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