The U.S. narrowly avoided default earlier this month with a debt-ceiling deal that was carried only by moderates of both parties and went to the deadline.
For weeks, the debate had rattled nerves and markets. The effects could be felt long-term: As part of the deal, for example, IRS funding from last summer’s Inflation Reduction Act got trimmed, and President Joe Biden was also unable to use the talks to leverage his proposed wealth tax.
Those two potential notches for high-net-worth clients might be paid for by more uncertainty in the next round of partisan brinkmanship over the debt and deficit—which is starting to feel almost inevitable given American politics.
“Our wealthy clients have been concerned for a number of years about the rising debt in the U.S.,” said Marc Scudillo, managing officer of EisnerAmper Wealth Management in Iselin, N.J. “What I fear is that it’s become that constant pain that unfortunately clients may have gotten used to through the years.”
“The only way to reduce the deficit is to do either or a combination of reducing federal spending or raising revenue,” he said, adding that his firm discusses various scenarios with clients, including tax increases on the wealthy.
“This could involve higher marginal tax rates, elimination of certain tax deductions or loopholes,” Scudillo said. “As a more drastic measure, the government could introduce a wealth tax.”
The deal’s cuts to the IRS funding increase probably caught the attention of many clients. But some advisors said the IRS will still get enough of a funding increase to make a noticeable impact on tax enforcement.
“First, $1.4 billion of the Inflation Reduction Act funding that was earmarked to go to the IRS in 2023 is effectively rescinded. That’s included in the debt ceiling deal. The second is a sidebar verbal agreement to cut up to $20 billion of the $80 billion designated for the IRS as part of their efforts to beef up their staffing and modernize their operational resources from the IRA in two tranches: $10 billion in 2024 and $10 billion in 2025,” said Dan Sudit, partner at Salt Lake City-based Crewe Advisors.
“The Congressional Budget Office estimates that the $21.4 billion reduction in IRS funding will result in a net increase in the budget deficit by approximately $19 billion,” Sudit added. “Even though $80 billion was earmarked, nearly three-quarters of the funding still exists. The money can’t be spent in one fell swoop. It takes time to hire new agents, train them and update their technology and resources as part of the IRS modernization.”
“It is safe to say that the majority of the goals or efforts to scale and modernize the IRS will still occur, probably with modest, if any, reductions,” Sudit said.
The debt debate is over but the problem is ongoing, advisors say.
“My key takeaway from the debt ceiling talks is that they reinforced the fairly widely held view that no meaningful tax changes are likely until after the 2024 election,” said Erik Preus, head of investment solutions at Envestnet PMC in Minneapolis. “I don’t think the debt-ceiling talks and deficit brinksmanship had much of an effect on the wealthy from a tax perspective. They just illustrated the inability to make significant tax changes while we have such an evenly divided government.”
With the debt-ceiling a likely issue in future years, several strategies can protect a client’s wealth, Scudillo said. Diversify investments; coordinate planning from financial advisors, estate attorneys and accountants; and maintain liquidity “to handle any potential short-term disruptions caused by debt-ceiling and deficit brinkmanship,” he said.
“Although the debt ceiling fracas is behind us, it’s not necessarily smooth sailing from here,” Sudit said. “In addition to funding and financing the increased debt load, the Treasury will work on replenishing its coffers by issuing around $1 trillion of Treasury bills over the coming months. All of this may result in a liquidity crunch affecting bank balance sheets, real estate and corporate deals, as well as possibly having a material impact on the economy tantamount to an increase in Fed funds rates.”