By George G. Jones and Mark A. Luscombe

Deciding that economic stimulus was more important than focusing on deficits, President George W. Bush has proposed a tax reduction package projected to cost approximately $674 billion over the next 10 years, double what he had been expected to propose just a week earlier.

He adopts many of the tax relief provisions sought by Democrats to provide immediate assistance to lower-income workers, but goes well beyond those proposals to provide relief across the board to all taxpayers. Many of the additional tax breaks would be tilted toward higher-income taxpayers, who pay most of the taxes.

The Bush proposals are likely to be taken up by the Republican-controlled House fairly early in the new Congress. Consideration may be delayed to complete work on a budget framework so that the Bush plan can be incorporated into that framework. Putting the plan into the budget will be important in terms of the number of votes needed for passage in the Senate. A budget bill can pass with 51 votes while a bill outside the budget might require at least 60 votes to avoid procedural hurdles.

Exclusion for dividends

Probably the most controversial of Bush’s proposals is the elimination of the double tax on stock dividends by creating an exclusion for dividends paid to individuals. The proposal is designed to help stimulate investment by making stocks more attractive, and perhaps make the equity markets relatively more attractive as a source for corporate capital as compared to the debt markets.

The proposal is justified on the basis that dividends currently face a double tax, first a corporate-level tax, since there is no deduction for dividend payments to individual shareholders, and then a shareholder-level tax.

Approximately half of the cost of Bush’s proposal is associated with the dividend exclusion. Although partial relief had been discussed within the administration (a small dividend exclusion had been in the tax law prior to 1987), in the end, they decided to push for a full exclusion.

Most dividends are reported on returns of higher-income taxpayers, and critics have charged that this provision will provide little immediate economic stimulus and benefit mostly the wealthy. Lower-and middle-income taxpayers tend to hold a higher percentage of their investments in tax-deferred retirement accounts where there is already no immediate tax.

The focus of much stock investing in recent years has been on capital appreciation rather than dividend payments, and corporations may still prefer to utilize excess funds for reinvestment in the business rather than dividend payments.

The possible impact on stock prices has been debated, but most estimates show at least some positive impact on stock prices, which will tend to provide the benefit of increased stock portfolio values in addition to the direct benefit of the dividend exclusion.

Acceleration of tax rate reductions in 2001 Tax Act

Many of the tax provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 were slated to phase in over as long as 10 years. The Bush proposal would accelerate many of those provisions. The expansion of the 10-percent tax bracket currently scheduled to occur in 2008 would be accelerated to 2003.

Reductions in marginal tax brackets currently scheduled to occur in 2004 and 2006 would be accelerated to 2003. Marriage penalty relief provisions involving expansion of the 15 percent tax bracket and an increase in the standard deduction, currently scheduled for 2005, would be accelerated to 2003.

The child tax credit, currently scheduled to phase in up to $1,000 in 2010, would increase to $1,000 in 2003, with the administration proposing advance refund checks to get the money into the hands of taxpayers in 2003.

The Democratic proposal includes a rebate based on earned income of up to $300 for single filers and $600 for joint filers. Under the Bush proposal, the Internal Revenue Service would be directed to immediately adjust withholding, upon passage of his plan, retroactive to Jan. 1, 2003, to reflect these reduced taxes.

Small business relief

Although proposals had been made for additional business write-offs of capital investments, and such a proposal is included in the Democratic stimulus package, the Bush proposal focuses on a significant increase in the Code Section 179 expense limit from $25,000 to $75,000. The Democrats have also proposed a Code Section 179 increase to $50,000.

AMT relief

Although not spelled out in detail in the president’s proposal, it indicates that none of the tax reductions are to be eliminated by the effects of the alternative minimum tax. Just how this would be achieved under the plan, beyond an increase in the exemption amount of $8,000 for joint filers and $4,000 for single filers, has been left for further clarification.

Non-tax relief

Also included in the president’s proposals are an extension of unemployment benefits, a key demand of Democrats, and new Personal Re-Employment Accounts of up to $3,000 to assist in finding a new job that could also be paid out to the worker if the job hunt meets with quick success before the account is exhausted. These accounts would be administered by the states and their funding is the only money that would be provided to the states under the president’s proposal. The Democrats have proposed additional funds to the states to assist them with current budget crises.

Prognosis

President Bush knows that he is working with thin Republican majorities in Congress and has included something for everyone in his proposal. This sometimes works well in Congress on spending bills, where every member votes for the bill to get his or her pet provision enacted while holding their nose with respect to everyone else’s pet provision.

In terms of dollars, President Bush’s package provides about as much relief to lower-income taxpayers as the Democrats’ would. It also provides about as much first-year stimulus as the Democratic proposals. For the Republicans, it accelerates much of what they put into place in 2001, and eliminates the double tax on dividends.

It is only those members of Congress who feel that the provisions in the bill that they oppose outweigh the benefits of the provisions that they want who could derail this bill. There are deficit hawks on both sides of the political fence who are concerned about the cost of what is on the table.

Will the deficits increase the cost of borrowing and counteract the economic benefits that the proposal is trying to achieve? Will the proposal hit already strapped state budgets even harder and cause states to take actions that will offset the economic stimulus sought by the president? Will the deficits leave the government in a much weakened position down the road as the baby boom generation starts to retire?

It is possible that the president started high so that a final compromise position could be in a range that he really wants. It is more likely, however, that he started high to provide some insurance for a still-struggling economy that could swoon again based on preparations for war or further adverse corporate disclosures.

To get anything done in a closely divided Congress, everyone recognizes that compromise will be necessary for passage. The president has put items in his proposal from most everyone’s wish list. This should guarantee, together with Republican congressional control, that the president’s economic scheme will be the focal point for congressional debates this year.

It appears likely at this point that he might well get a good portion of what he is asking for. Action cannot come immediately if the proposals are worked into the budget process to help insure passage. Many commentators are looking toward March and April for legislation to emerge from Congress.

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