Tax Plan Offers Short-term Relief, at a Price

Think of it as a stimulus plan with a large price tag.

The tax deal between the White House and Congressional Republicans, if approved, will put a little extra money in your pocket for the next two years. But you're going to pay for it eventually.

Without sizeable cuts in federal spending, Americans can expect higher taxes down the road to cover the cost of the package.

The hope is that the plan will help boost spending, increase demand and get companies back in a hiring mood.

"This is real money for real people that will make a real difference in the lives of the folks who sent us here," Obama told reporters at a news conference.

But the deal doesn’t include spending cuts to offset the expiration of lower tax rates. That means the government will have to borrow to pay for the plan.

Congress and the White House are still hammering out the details. Without a deal, temporary tax cuts enacted in the early 2000s will expire this month, sending rates higher across the board and threatening to dampen an already feeble economic recovery.

The size of the package won’t be known until the details are finalized. Initial estimates put the cost of as much as $900 billion over two years. Here’s where all that money will flow:

Income tax rates
By extending the current rates across the board, you’ll see no change in the basic tax you pay on earned income: those rates will top out at 35 percent. The Obama administration had wanted to let the rate rise for wealthy taxpayers, but under the deal struck with Republicans, everyone gets to keep the current rate for two years.

Obama had also pushed for a gradual increase in the tax on capital gains, but that wil also remain at the current 15 percent rate.

Estate taxes
Wealthy taxpayers also benefit from other provisions of the deal. The estate tax on inherited money, which was eliminated altogether in 2010, was scheduled to return to 2001 levels of taxing estates above $1 million at 55 percent. Under the proposed deal, for the next two years, a new 35 percent estate tax will kick in on estates over $5 million ($10 million for couples).

Payroll taxes
Everyone will also get a break on their payroll taxes, but wealthy taxpayers will get a slightly better break. In exchange for dropping the so-called Making Work Pay tax credit, all taxpayers will get a 2 percent break on their Social Security payroll taxes for one year. The old tax credit, which maxxed out at $400 ($800 for couples), was limited to people who made less than $95,000 (or couples making $190,000.) Now, everyone saves 2 percent on the first $107,000 of their income. So the more you earn, the more you save.

The White House says the deal will also preserve the Earned Income Tax Credit for working families, a child tax credit and college tax credit.

Alternative Minimum Tax:
Middle class taxpayers get continued protection from a perennial monster called the Alternative Minimum Tax. Originally intended to tax higher income households, this tax was never indexed for inflation, so it has moved steadily down the income ladder. Under the proposed deal, the existing AMT “patch” will be extended for two more years, saving some 21 million middle class taxpayers from getting hit with these higher rates.

Unemployment insurance:
For jobless workers who have exhausted their benefits, the deal would renew the extended benefits that expired last week, abruptly cutting off checks for some 1.4 million people. After multiple rounds of these renewals became mired in politics, the tax deal would leave long-term benefits in place for 13 months. Republicans who blocked the latest renewal argued that extended benefits should be paid for with spending cuts. But the latest tax deal doesn’t require those cuts.

The plan is far from a done deal. With federal budget deficits already running about $1.3 trillion a year some members of Congress are grumbling that it postpones the day of reckoning, and will make it more expensive for everyone when that day arrives.

“I can understand need for short term additional stimulus,” said Sen. Mark Warner, D- Va., and a member of Senate Budget Committee. “If this is just a two-year punt, and it doesn't lead to major tax reform and deficit reduction, which has got to be up there simultaneous with this short-term stimulus, then I have real problems (with the plan). “

There are those who have doubts about how much the plan will boost the economy in the short term, especially if it adds to worries about bigger deficits and higher taxes in two years.

Rating agency Moody's said Monday that if the tax cuts become permanent, it could hurt U.S. finances and its credit rating down the road.

“The critical issue is, how do we get jobs going?” said David Malpass, president of Encima Global, an ecnomics research firm. “The way to get jobs going is to have some plan for small businesses that allows credit, that allows some certainty in the tax code. This doesn't.”

Investors seem to like the plan. The stock market rose on the news, based on the hope that the plan will help stimulate the economy. With the impact of the government’s fiscal stimulus fading, Federal Reserve chairman Ben Bernanke has embarked on another $600 billion round of bond buying, known as “quantitative easing,” to pump more cash into the economy. But many investors have been skeptical that the untested plan will work.

"Hopefully (Congress) will realize that this economy is not going anywhere until we start to get fiscal stimulus going,” said Art Cashin, UBS Financial Services’ director of floor operations at the New York Stock Exchange. “I think the most relieved person in the nation right now may be Bernanke because it's no longer 100 percent on his shoulders."

Bond investors were not thrilled with the proposed tax package: Treasuries sold off on worries that the government will have to sell even more debt to pay for the extended tax cuts and jobless benefits. That could get harder to do once the Fed’s second round of quantitative easing expires in June. In bond buyers balk, then interest rates could go up.

"If the Fed doesn't go with QE III, then come June we are going to have to finance not only the deficit we anticipated but this extra $500 billion a year from this program,” said James Tisch, CEO of Loews Corp.

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