Who gains from tax-cut bill

Middle America could see some relief, but those at high-income levels stand to benefit more.

There is a nice tax cut waiting for you - that is, if people refer to you as Dr. or "my lawyer," not Mr. or Ms. And possibly, you might notice the relief if you and your spouse make between $100,000 and $200,000 a year. But if you're laying bricks or working as a teller at the local bank, you might wonder what all the fuss is about.

President Bush is expected to sign into law a one-year, $31 billion cut for 2006, along with extending current tax cuts worth $39 billion over the next five years.

Some economists think the timing could be good: By the time much of the tax relief is distributed next April 15, the economy is likely to be slowing. But the cost of the cuts worries those concerned with the budget deficit. And yes, most of the immediate benefits will go to those with high incomes, even though the legislation is supposed to bring relief to middle-income taxpayers faced with the alternative minimum tax (AMT) - something originally designed to ensure that upper-income Americans paid Uncle Sam their share.

"It will only apply to a small share of all consumers, but it will have a positive impact on consumption," says Richard Curtin, director of consumer surveys at the University of Michigan in Ann Arbor. "It will be well timed since we expect the economy to slow down in the second half of this year and the first half of 2007."

The effect of previous tax cuts

The Tax Foundation, a nonpartisan research group in Washington, believes the current economic recovery coincides with the tax cuts that went into effect in 2003. Since then, some 5.3 million jobs have been created, the unemployment rate has fallen from 6.3 percent to 4.7 percent, household net worth is up $13 trillion, and the budget deficit has dropped $38 billion.

"The economy has definitely recovered starting with the tax cuts enacted in May of 2003," says Bill Ahern, a Tax Foundation spokesman. "That included income-tax cuts as well as dividend and capital gains cuts, and it's impossible to untangle the effects of those different tax cuts."

But even among economists, the subject of the economic impact of tax cuts is controversial. Democrats argue that after every recession, there is some kind of snapback - and this one was aided by the Federal Reserve reducing interest rates all the way down to 1 percent.

Max Sawicky of the liberal Economic Policy Institute (EPI) argues the economic recovery "is one of the weakest." After the tax increases of the 1990s, he says, the economy performed better. "The latest tax cuts will have no impact on the economy in 2007," he maintains.

There is no question, however, that some 15 million taxpayers will be spared the hassle of figuring out a federal tax liability under the AMT. The legislation will increase the exemption for filing from $58,000 for a married couple filing jointly to $62,550.

This may save taxpayers who make $100,000 to $200,000 a few hundred dollars. But the bulk of the tax break will go to some 1 million Americans who earn between $200,000 and $600,000 a year.

"People who are AMT filers, whose liability is far above the regular tax rate, for every dollar of that new exemption, will be a dollar they don't have to pay tax on," says Mr. Ahern.

Other elements of the tax bill are equally controversial. For example, the new law will extend the more favorable treatment of capital gains and dividends for 2009 and 2010. Proponents point to the stock-market recovery, with the Dow Jones Industrial Average close to its all-time high.

"At the end of the day, having individual investors [encouraged] to continue to invest in the markets is a good thing," says J. Michael Barron, CEO of Knott Capital in Exton, Pa. "There are still a fair amount of people who are driven to invest by tax benefits."

In fact, some financial advisers argue that if the law had not been extended, it might have put more pressure on the financial markets.

"If they had let the Jobs and Growth Act of 2003 expire, I think you would have seen a lot of people with substantial capital gains selling their stocks before the law's expiration," says Fred Burke, president of Johnston Lemon Asset Management in Washington.

Some of Mr. Burke's clients have invested in companies such as Altria, Bank of America, and ExxonMobil because of the favorable treatment of dividends. "Investors love that they are not taxed on dividends," he says.

The lower tax probably does encourage more savings, agrees Len Burman of the Urban Institute. But he worries that "it also presents an enormous opportunity for tax sheltering so that income that ought to be taxed at the 35 percent rate ends up looking like the 15 percent rate for capital gains."

How to pay for it?

To help pay for some of the new tax cuts, Congress is giving high-income individuals the opportunity to shift their Individual Retirement Accounts (IRAs) to Roth IRAs. The money that goes into a Roth IRA is "after-tax" income, but it is not taxed when it is withdrawn. The Treasury estimates that the provision will raise more than $6 billion in tax payments the first year it goes into effect in 2010. But the government also estimates that over the longer term of five years, the provision will end up costing the federal budget $447 million.

This will be a big hit for investors, says Burke. "They resent the taxes they pay on their distribution," he says.

But Mr. Burman argues it will dry up another source of government income in the future. "Eventually, the revenue losses will catch up to you," he says.

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