To woo voters, Washington revisits tax laws

Bush weighs changes to capital-gains tax and 401(k)s. Democrats draw up ideas, too.

With congressional elections looming, politicians from both parties are worried about how the stock market's tumble will affect voters.

So when President Bush and Congress return to Washington after Labor Day, there will be a new item on the economic agenda: whether to enact tax-law changes intended to rebuild investor confidence.

The president told reporters last Friday at his ranch in Crawford, Texas, that he was "thinking about all options" for a new economic package. "When I announce them, it will be well thought out. It will be part of a long-term plan," he said.

Not to be left behind, Democrats are working on their own alternatives.

As a result, economists and interest groups are already marshaling arguments for and against the idea of confidence-boosting tax cuts. The debate centers on whether government action is needed, what measures would most effective, and how much the Treasury can afford.

What could happen

The steps the president said he was considering include:

• Increasing the current $3,000 annual limit on investment losses that can be deducted from federal income taxes.

• Speeding up planned increases in the amount that workers can contribute to their individual retirement accounts and 401(k) plans.

• Reducing the double taxation of corporate dividends, which the taxman clips both as corporate profits and again when they flow into investor pockets as dividends.

• Lowering the rate at which profits (capital gains) on the sale of stock are taxed.

Democrats favor their own ideas, which include the possibility of giving retirees more time before they are required to start taking minimum withdrawals from their 401(k) plans. This would help individuals rebuild balances in retirement accounts hard hit by the stock market's plunge. Another Democratic option is increasing the length of unemployment insurance.

Confidence-boosting tax-law changes are far from a given. The schedule is tight for getting new legislation enacted before lawmakers leave town in advance of the Nov. 5 election. "Congress has a full plate from now until the election," notes Dorothy Coleman, vice president for tax policy at the National Association of Manufacturers. A key concern for the NAM is seeing that any tax-law changes don't include "any offsetting tax increases."

In addition to scheduling issues, there is the matter of affordability. This week, the Congressional Budget Office will release new figures on the federal budget deficit for 2003, which are expected to show $50 billion more in red ink than the $109 billion the Bush administration is predicting.

Brian Nottage, director of macroeconomics at Economy.com, notes that an increased deficit could boost mortgage rates and slow the housing industry. Add to that the cost of tax-law changes, and, "You start to get to the point where increasing the [federal budget] deficit to do any of these nice things may start to be counterproductive." He adds, "Most of the measures that are being proposed will do probably relatively little in the short run, even if some are good long-run policy."

Recent impetus

Despite concerns about the deficit, recent economic news has helped keep the issue of tax-law changes alive. Last week, the index of leading economic indicators, a set of data designed to predict the direction of the economy, fell 0.4 percent, the third decline in four months. Earlier this month, the Federal Reserve left interest rates unchanged, but said in a statement, "The risks are weighted mainly toward conditions that may generate weakness."

"They see it the same way we do," says Martin Regalia, chief economist for the US Chamber of Commerce. "The economy is still moving forward, but it is suspect." Mr. Regalia favors further tax cuts, noting the need to stimulate business "to invest again as they haven't for the last six to seven quarters."

"We are more sanguine about the economy," says Nariman Behravesh, chief economist at DRI-WEFA, an economic consulting firm. He sees the economy "chugging along at a 2.5 percent" growth rate and calls the case for further government action "not compelling."

There are a variety ideas about who should benefit most from any changes in tax policy. For Kenneth Mayland, president of Clear View Economics in Pepper Pike, Ohio, first on the list is doing "something targeted to the equity markets," given the battering investors have taken in the bear market. He suggests making a certain amount of dividends tax-free. "You can target that to moderate-income, middle-income people," he says.

Robert Greenstein, executive director of the Center on Budget and Policy Priorities in Washington, focuses on the impact of policy changes on low-income individuals. He says he would "give a failing grade by a large margin" to Mr. Bush's ideas. "If we want to ease hardship and help keep consumer spending up, the first thing to consider is some temporary strengthening of unemployment benefits" to help those whose stipend has run out and who still have not found jobs.

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