The Federal Budget and the Debt Ceiling

Written by Wendy Stultz   // July 29, 2011   // 0 Comments

by Rafiq Phillips

As we get closer to the potential default on US debts, lots of people are talking about the budget and all of the various Chicken Little predictions. The deadline to increase the debt ceiling is August 2, 2011.

So we really come down to 2 major issues or 2 sides of the coin:

1) Raising the debt ceiling to allow Congress to spend more knowing that it means taking on more debt


2) Cutting ongoing expenses and how this will happen

The big discussion of whether the U.S. will increase the debt ceiling in order to prevent a default on currently existing loans and debts around the world is the first issue. The debt ceiling refers to a portion of the United States public debts. The United States Treasury can spend what it needs to in order to meet the agency budgets for the year, so long the aggregate does not hit the “debt ceiling.” This ceiling was most recently increased in February 2010 to a whopping $14.294 trillion.

Just like a person who can no longer pay on all of the credit, car, house, medical, or other personal debts may need to consider debt consolidation, debt restructuring, or bankruptcy, the U.S. government is essentially faced with the same options. Basically, in layman’s terms, we either need to have a bigger available credit (raising the debt ceiling) or we need to make spending cuts to the Federal Budget, or both. (Big issue number 2)

If we still can’t make ends meet between raising the debt ceiling and cutting budgets, then the US Treasury has to start deciding what obligations to pay. Those obligations include everything from Social Security and Medicare, to government employee and military salaries, to interest on the national debt. It is the interest on the national debt that would cause the default internationally and which could significantly affect the world economy, but would certainly impact the U.S. economy and the value of the dollar. Again, think on the personal level- if you can’t pay your bills, you probably have a harder time getting new credit. If you do get new credit, you probably will have higher interest rates, worse terms, etc. on that credit than you may have had before when you could pay all of your bills.

This is a very politically charged issue, with folks from both sides of the aisle making suggestions and predictions about how things will shake out in the long run. Pick up a newspaper and you will see a variety of ideas about the entire budget process. Go one step farther and you will see that this person opposes tax increases, while this other one wants to close the tax loopholes. What are they really talking about? Since any credit or deduction people can claim on their taxes effectively reduces the U.S. Treasury collection in taxes, does closing a loophole actually count as raising taxes? Don’t say that too loudly, or you might find yourself in a deeper political discussion than you want.

Jonathan Henes writes for CNBC that Republicans are looking for a “balanced budget” while Democrats are looking for “increased revenues.” He also points out very clearly that the debt ceiling deals with obligations the U.S. has already taken on (debt already incurred) whereas the spending cuts and proposals currently in Congress to limit government growth and budgets deal with future obligations, since they deal with future budgets and future expenditures. Ezra Klein with Bloomberg also discusses the subsidies and tax expenditures and how those effectively are tax increases without being “tax increases”.

So what is potentially going to change? One would think that Congress would be pretty clear on this, but you would potentially be wrong. Both sides of the aisle have their proposals and both sides are talking budget cuts, but neither is giving a menu of what is on the chopping block. And they keep revising these plans for “bipartisan cooperation” (read to get enough votes to get it passed), so as of today Congress is still in the negotiations phase but getting closer to a vote. Of course, you know the topic is getting big (and likely politically charged) when The Onion writes a joke article about it, claiming that they air-lifted civics teacher in to Washington to teach Congress how to pass a bill into law.

Some of the items that are being discussed as possible cuts are items that the average U.S. citizen and taxpayer may not think much of until tax time, but may also see real benefit from when they do think of these deductions.

We already know that sectors like education, PBS, Planned Parenthood, or funding for arts or philanthropy are common targets for cuts. This time though, some of the cuts may cut closer to home if passed. Please do remember that nothing is finalized as I write this, and so we don’t yet know how this will impact folks. But here are some of the potential changes you may see as they relate to your taxes next year:

Mortgage Interest Deduction

This is a deduction primarily used on the Schedule A for interest paid on your primary and secondary home’s mortgage or to a lesser extent on home equity lines. It allows you to deduct (unless your income requires a limit) all of the interest you pay on your mortgage over the year. This, with the rest of Schedule A, is in lieu of the Standard Deduction.

Allowing this deduction ends up costing the U.S. government up to about $100 billion per year (in numbers that is $100,000,000,000). If this deduction is either reduced to only allow interest on the first $500,000 of the purchase price, or is altered to exclude second homes, the cost to the Treasury would decrease approximately $30 billion.

Of course, the folks most impacted by the possible change are the ones who can buy homes valued at over $500,000. As far as I know, you can still get a lot of house almost anywhere in the country and not be affected by this reduction.

Charitable Gifts/Contributions Deduction

Another common deduction on the Schedule A is gifts or contributions made to charities. And if your church is considered a charitable organization (they should be able to clearly tell you if they qualify) this includes tithing as well.

Since the economy hasn’t been growing by leaps and bounds the last couple of years, charitable organizations are relying more and more on personal donations rather than government or state grants and funding. If people stop making donations, some important programs will potentially dry up if there isn’t other money left to fund them. Many of these organizations are pointing out that this is unlike other deductions on the tax return since it rewards people for doing something with money that does not personally benefit them, and so should be treated differently than the other deductions.

Increasing Taxes

Gasp. Do I dare mention this? I don’t think an outright increase to taxes is likely at this time. I do think that other changes to the tax code are almost inevitable; changes which will have the effect or raising the tax paid through closing loopholes or through eliminating or reducing tax deductions.

I will be watching to see what actually comes of this. Specifically, I will be watching to see who supports what kinds of cuts or reductions. And I will be watching to see whether it is meant to be a temporary patch or a permanent fix (or at least permanent enough to get us through the next Presidential election). Time is going to force our hand, one way or another. I don’t know that we can come to a balanced budget or a plan that everyone will be happy with before August 2. And I see the downsides to letting it go much beyond that.

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