Image:
Patrick Semansky  /  AP
A sign turning away potential job-seekers is seen outside of a construction site in New Orleans. The hope is that the tentative tax deal will spur the economy to create jobs.
By John W. Schoen Senior producer
msnbc.com
updated 12/8/2010 10:41:54 AM ET 2010-12-08T15:41:54

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.

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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.

First Thoughts: You've gotta know when to hold'em

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

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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.

Vote, discuss: Is this a good compromise?

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 economics 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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Explainer: Breaking down the tax compromise

  • Image: President Barack Obama speaks during a news conference at the White House briefing room on the tax cut deal
    Getty Images

    The tax cuts compromise between the White House and congressional Republicans still must be passed. But here is how it would affect major categories of government, and personal, finance.

  • Income tax rates

    Image: Tax forms
    AP

    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.

    "If this package does indeed pass, it's going to make a significant difference over the coming year for middle-class taxpayers," said Melissa Labant, a tax manager for the American Institute of Certified Public Accountants.

    Economists expect the combination of maintaining current tax rates, reducing payroll taxes and boosting other tax benefits will induce consumers to spend more and investors to turn more bullish.

  • Capital gains and dividend

    Image: Counting money
    Reuters

    Current tax rates on long-term capital gains will remain in place for two years. The tax applies to profits from the sale of an asset, such as stock, held more than a year. The highest rate of 15 percent was expected to rise to 20 percent next year.

    Investors will also benefit from an extension of the historically low tax rates on dividend income, which top out at 15 percent. Had no action been taken, dividend payments would be taxed as regular income. This would raise the tax rate to as much as 39.6 percent for top earners. The extension means a savings of nearly a quarter on every dollar of dividend income for this group.

    Individuals with dividends paid to taxable accounts can collectively expect to save nearly $75 billion over two years, according to an analysis by Standard & Poor's analyst Howard Silverblatt.

    Cliff Caplan, a financial planner and president of Neponset Valley Financial Partners in Norwood, Mass., said the extension of the lower tax rates could lift prices of dividend-paying stocks as they become more popular with investors who can now avoid the higher tax rates for at least two more years.

  • Estate taxes

    Image: Mount Vernon estate
    AP file

    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).

    Except for the temporary repeal of the estate tax this year, the rate has not been less than 45 percent since 1931.

    Only about 4,000 to 5,000 estates will likely owe the estate tax under the plan, based on last year's tax filings. That compares with roughly 7,000 under Obama's earlier proposal of a 45 percent tax on value exceeding $3.5 million. Although that may not sound like a big difference, House Speaker Nancy Pelosi said the new estate tax proposal will add about $25 billion to the deficit.

  • Tax credits

    Image: Child
    AP

    Tuition tax credit
    Families with kids in college can benefit from a tax credit for tuition and fees. A maximum of $2,500 will remain in place for two years. A credit reduces taxes owed, versus a deduction which reduces taxable income.

    Parents familiar with 529 college savings plans may question what to prioritize. A 529 account encourages savings by enabling account holders to make tax-free withdrawals for eligible college expenses.

    Parents should set aside $4,000 per year to maximize the tax credit before contributing to a 529 plan, says Mark Kantrowitz, a college financial aid expert and publisher of FinAid.org. That's because directly lowering their tax bill exceeds the financial benefit of tax-free distributions.

    The extension is welcome assistance: The average annual cost of in-state public four-year schools rose to $7,605 this fall and private college expenses increased to $27,293.

    Child tax credit
    There's more good news if you're a parent: The $1,000 child tax credit is being extended for two years. Taxpayers with income of less than $75,000 — or $110,000 for married couples filing jointly — qualify for the full amount.

    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

    Image: Payroll taxes
    AP

    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 two percent break on their Social Security payroll taxes for one year. The old tax credit, which maxed out at $400 ($800 for couples), was limited to people who made less than $95,000 (or couples making $190,000.)

    Currently, the government takes 6.2 percent out of your paycheck, up to $106,800, for the Social Security payroll tax. That would drop to 4.2 percent in 2011 and give you an immediate increase in take-home pay. So the more you earn, the more you save.

    If you make $50,000 a year you will pay $1,000 less. If you get paid twice a month, you will have an extra $41.67 in your paycheck starting in January.

    Anyone who makes more than $106,800 a year will receive the maximum savings of $2,136.
    "That certainly provides an added level of dollars to do whatever people were planning on doing, whether that's saving or spending," said Greg Rosica, a tax partner at Ernst & Young LLP.

  • Alternative Minimum Tax

    Image: AMT
    Getty Images file

    Middle class taxpayers get continued protection from a perennial monster called the Alternative Minimum Tax. 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.

    The AMT was enacted in 1969 to make sure wealthy people couldn't avoid taxes altogether, but it wasn't indexed for inflation. This means Congress has to raise the amount of income exempt from the AMT each year to spare millions from tax increases averaging about $3,900.

    Had no adjustment been made, taxes would have gone up for individuals making as little as $33,750, and married couples making $45,000.

    Similarly, a married couple making $85,000 a year with two college-age children would have had to pay $4,500 more in taxes, according to an analysis by The Tax Institute at H&R Block. A married couple making $100,000 a year with two young children would have faced a tax increase of more than $6,100.

  • Unemployment insurance

    Image: Help Wanted sign
    AFP - Getty Images

    Million of job seekers will benefit from an extension of their benefits at current levels through the end of 2011. The extension applies to workers laid off for more than six months, and less than 99 weeks. Seven million Americans would have lost their benefits through next year without the 13-month extension. Obama's Council of Economic Advisers estimates the provision will create 600,000 jobs next year.

    That's because the unemployed live on the edge, and tend to spend every dollar they get, rather than save. That spending flows to businesses, putting them in better position to hire.

    The average weekly payment for the roughly 8.5 million people receiving unemployment benefits is $302.90. But it varies widely by state, from as little as $119 in Puerto Rico to nearly $420 in Hawaii. Each state sets the amount through a formula meant to replace a portion of an unemployed person's old income.

Video: Obama: GOP held middle-class tax cuts hostage

Vote: How do you feel about the Obama tax compromise?

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