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Taking the measure of Bush tax plan

Who would benefit from the president's proposed tax relief package, and how much?

By HELEN HUNTLEY, Times Staff Writer

© St. Petersburg Times
published February 9, 2003


Lisa Gillette stands to benefit from nearly all the goodies President Bush has stuffed into the tax-relief package now pending before Congress, but she's still not quite sure what to make of it.

She thinks some proposed changes are long overdue but worries about budget deficits burdening her children and future grandchildren:

"The marriage penalty should have been gone long, long ago, and the child tax credit helps my personal household tax bill, but the cost to our future generation bothers me a lot."

Gillette, 40, lives in St. Petersburg and is one of more than 5-million Floridians with a personal stake in the proposed legislation. The government calculates that about two-thirds of the tax returns filed in Florida would benefit from at least one aspect of Bush's plan.

Of course, the calculations any of us do now are only guesstimates because Congress is not likely to pass Bush's plan exactly as he proposed it.

At the moment it appears the plan will move through Congress in two separate pieces:

* A savings package calling for a potentially far-reaching overhaul of tax-sheltered retirement savings plans, including the elimination of the individual retirement account as we know it.

* The president's "growth package," a set of initiatives aimed at putting more money in taxpayers' pockets and giving the economy a boost. Its most widely-publicized feature is a proposal to eliminate the tax on most stock dividends. It also includes acceleration of a package of tax breaks already approved but not scheduled to take full effect for several years. On average, it is supposed to provide $1,083 in savings this year to each of 92-million taxpayers.

*Permanent elimination of the estate tax, which is being phased out and is already scheduled for elimination in 2010. As the law now stands it would be reinstated the following year. The situation has created considerable uncertainty.

The savings package

The savings package is a supersaver's dream, but its almost-too-good-to-be-true benefits have little congressional support, even among Republicans. The package calls for the creation of three types of tax-sheltered accounts that would allow a married couple with two children to sock away up to $45,000 a year in individual accounts plus $11,000 to $12,000 apiece in employer-sponsored accounts.

The centerpiece of the package is something called a Lifetime Savings Account, a highly flexible, all-purpose account that could be used by anyone of any age for any purpose to avoid taxes on investment returns.

Contributions of up to $7,500 a year would not be deductible, but the money and any interest or other investment returns it earned could be withdrawn without tax or penalty at any time. It could be a place to save for college or a house or just to stash extra cash and protect it from the IRS.

The second key piece is the Retirement Savings Account, which would function much like the current Roth IRA with a higher contribution limit of $7,500 a year. Existing IRAs could be converted to RSAs by paying any taxes due or could be left intact with no new contributions.

Contributions to RSAs would not be deductible, but withdrawals after age 58 would be tax free. The current IRA deduction -- claimed on about 3.5-million returns for tax year 2000 -- would be eliminated.

The third is the Employer Retirement Savings Account, an employer-sponsored plan similar to a 401(k) that would replace existing 401(k)s, 403(b)s, 457s and other retirement savings plans. Its key virtue is simplification of a hodgepodge of rules for each plan.

Some Tampa Bay investors say they would take full advantage of the chance to shelter $15,000 a year in the two new individual accounts.

"These plans will help me to save more without the debilitating effects of taxes on earnings," said Julie Peeler, 42, of New Port Richey. She said she likes the flexibility the plans offer.

Bill Athanasulis, 36, of Palm Harbor, echoed her enthusiasm.

"Any time savings can be tax free, it should be taken advantage of by all," he said. Athanasulis said he would contribute to both individual plans but doubts that most people would do the same. "I do not believe that the majority of low- and middle-income people will suddenly start to save money because of the tax benefit."

In fact, most people save less in tax-sheltered accounts than the law already allows. Right now a worker with sufficient earned income could contribute up to $11,000 to a 401(k) and $3,000 to an IRA. The limits are $12,000 and $3,500 for those 50 or older. College savings plans offer extra tax-sheltered savings opportunities.

"The common person of moderate means doesn't do all that because they just don't have the money," said New Port Richey financial planner Steve Athanassie of Trademark Capital Management. "A family making $45,000 a year with two kids doesn't have a whole lot of discretionary income. Without extra income, the extra savings opportunity is meaningless."

James Thayer, 60, of Indian Rocks Beach, said contributing to a 401(k) is all he can manage.

"I cannot afford to save more at the present time," he said. "The only benefit I would receive from proposed changes is a reduction in tax rates, which I personally oppose. As a nation, we need to do a better job of paying the freight and borrow as little as possible."

In the short term, the new accounts would raise money for the Treasury since taxpayers would lose out on $7.5-billion in annual IRA deductions. In addition, conversions from regular IRAs to RSAs would bring in new tax revenues. But in the long run, the accounts would be costly, conceivably eliminating all taxes on investment earnings for people of moderate wealth, who could gradually move all their assets into the plans.

One big question about the new plans is whether they would inspire people to save substantially more or merely to move money from taxable to tax-free accounts. Since the Lifetime Savings Accounts are so flexible, it would be a no-brainer for financial advisers to urge their clients to shift money from other accounts.

"There has always been the argument whether IRAs actually increase the savings rate or if people simply move money that they have saved already or would have saved anyway," said Jim Seidel, senior tax analyst for RIA, a tax research and information company in New York. "Economists argue about that constantly."

Seidel said if new accounts did encourage new savings, they might actually be counterproductive to Bush's efforts to stimulate the economy by increasing spending.

The very simplicity and flexibility of the Lifetime account is one of the reasons it faces tough hurdles in Congress.

"The tax code tries to do some social engineering with all its complexity," said Mark Luscombe, principal tax analyst for CCH Inc., a tax research and information service in Riverwoods, Ill. The current law offers benefits for saving for retirement and education, and penalties for withdrawing the money for other purposes.

"If there's no punishment for not leaving it in there until your kids are ready for education, will it be there?" Luscombe asked.

In the past, Congress has not been willing to leave such things to chance.

The growth package

The growth half of Bush's tax package is in no danger of being labeled simple.

So far the piece of that package attracting the most attention is elimination of the tax on corporate dividends. The problem, as Bush and his supporters see it, is that dividends currently are taxed twice: first as corporate income and then as the shareholders' income. Under Bush's plan, dividends would be tax-free to shareholders only if corporations first paid tax on the money.

Implementing the plan would require complex calculations on the part of corporations. They would have to notify shareholders annually how much of their dividend payments were taxable and how much were tax free. In addition, corporations that chose to pay out less in tax-free dividends than they were allowed would distribute "deemed dividends," additions to a shareholder's basis that would reduce capital gains when the stock is sold.

Details aside, the concept of eliminating the tax on dividends is popular with those who would reap the benefits.

"As someone who has always owned "boring' utility stocks and other similar dividend-paying type stocks, I would really welcome this particular tax break," said Pitzy Pierce-Hurwitz, 42, of St. Petersburg.

Opponents complain that most of the benefits would go to high-income taxpayers, with the biggest beneficiaries being corporate titans such as Bill Gates. Dividends are reported on 87 percent of returns with $200,000 or more in income, but only 20 percent of those with less than $75,000. Excluding them from tax is projected to produce $20-billion in savings for investors this year.

"The president's proposal on tax-free dividends is a slap in the face to American working men and women," said John Avery, 49, of St. Petersburg. "I pay income tax on my Social Security and Medicare taxes as well as sales taxes and every other tax and fee imposed by multiple layers of government. Income earned from investments should be taxed at the same rate as income earned from labor."

One possibility is a congressional compromise, giving Bush only part of what he wants.

"We might end up with a return to a dividend exclusion of some dividend dollar amount like we had until 1986 as a compromise," said Luscombe at CCH.

If dividends do become tax free, dividend-paying stocks obviously would become more attractive to investors. Retirement accounts would be less attractive since withdrawals are taxable under current rules. Both tax-free dividends and the proposed savings accounts would have an edge over other tax-favored investments such as municipal bonds, which might have to pay higher interest rates to compete for investor dollars.

"A lot of these proposals sound simple on their face, but when you look under them, there's a lot of complexity, and it can have a big effect on the way people invest and also on the institutions that rely on funds for financing," said analyst Seidel at RIA.

Foot on the accelerator

The part of the tax package that appears to have the most support in Congress is acceleration of these previously adopted tax breaks:

Expansion of the 10 percent bracket. The 10 percent rate now applies to the first $6,000 of taxable income for singles and $12,000 for married couples filing jointly. (Taxable income is what is left after subtracting personal exemptions and deductions.) Anyone with income over the current limits would benefit from raising the limits to $7,000 for singles and $14,000 for married couples. Total savings in 2003: $5-billion.

Reduction in tax rates for higher brackets. The upper tax brackets, which for 2002 are 27, 30, 35 and 38.6 percent, would be reduced to 25, 28, 33 and 35 percent. This would benefit singles with taxable income greater than $28,400 and married couples with taxable income greater than $47,450. Total savings in 2003: $29-billion.

Marriage penalty relief. The marriage penalty is the extra tax that two-income couples pay that they would not pay if they were allowed to file as singles. This proposal tackles two of the biggest causes of the marriage penalty by expanding the 15 percent tax bracket and increasing the standard deduction to twice the deduction for singles. All married couples who take the standard deduction would benefit from the latter. The bracket expansion would benefit those who have taxable income greater than $47,450. Although only two-income couples are penalized by the current tax law, one-income couples also would benefit from the proposed changes. Total savings in 2003: $19-billion.

Child credit increase. Bush wants to raise the credit from $600 to $1,000 for each child under 17 and mail out advance checks this summer based on this year's returns. The parents who qualify for the benefits would save $16-billion in 2003.

In addition, to make taxpayers get the full benefit of the new credits, Bush wants to change the rules for the Alternative Minimum Tax. Cost this year: $8-billion.

"It would help to prevent an AMT explosion," said Seidel at RIA. "Acceleration of tax rate cuts without any change to alternative minimum tax would mean a lot of people would lose the benefit of the rate cuts."

The big winners in this section are families with children and married couples. Marriage penalty relief may be the most popular of the proposals.

"I've never understood why the marriage penalty was not phased out years ago," said Scott Stewart, 52, of St. Petersburg. "Certainly, it should have been, and it's about time."

Clearwater financial planner Ray Ferrara predicted any tax savings will be quickly spent.

"I don't think people would use it to bolster their savings," he said. "Most Americans, given an $1,100 tax reprieve, would end up spending the money or using it to reduce debt."

-- Helen Huntley can be reached at huntley@sptimes.com or (727) 893-8230.

Highlights of President Bush's proposals to change tax laws

Accelerate to 2003 tax breaks already approved for later years:

Reduction in tax rates

Expansion of 10 percent tax bracket

Reduction of marriage penalty through expansion of 15 percent tax bracket and increase in standard deduction

Increase in Child Tax Credit from $600 to $1,000

Eliminate tax on stock dividends

Increase immediate deduction for small business investment from $25,000 to $75,000

Increase exemption from Alternative Minimum Tax so fewer taxpayers are affected

Create Retirement Savings Account with rules similar to current Roth IRA, with $7,500 annual limit on contributions. No deduction for contributions. Withdrawals tax free after age 58.

Create Lifetime Savings Account available to anyone of any age to save for any purpose. Similar to Retirement Savings Account, with $7,500 annual limit on contributions, but no restrictions on tax free withdrawals.

Create Employer Retirement Savings Account as a replacement for 401(k), 403(b) and other employer-sponsored plans; simplified rules.

Create Personal Re-Employment Accounts of up to $3,000 that unemployed workers could use for job training and job hunting expenses.

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