Expect to have a little more money in your pocket once the president and congressional Democrats and Republicans complete their wrestling match over a proposed tax cut. Yes, there will be a tax cut, and it should be positive for investing, spending and the economy.
If you're doing estate planning, wait as long as possible before making any big decisions, because significant change may be on the way.
The Federal Reserve is still expected to do the "heavy lifting" with interest rate cuts designed to revive an economy teetering on the brink of recession. However, a significant tax cut approved by midsummer could add a half-percent to the nation's gross domestic product. If — and this is a big if — all seems solid on the rate and tax fronts, our economy could be back on track sometime this fall.
"A reduction in tax withholding means people will have more money and will boost the economy by spending more," believes David Blitzer, chief investment strategist with Standard & Poor's. "This will be an 'aggravation and anxiety' economy the first half of the year, but I expect improvement in the second half."
Even Fed chief Alan Greenspan isn't pooh-poohing a tax cut anymore, though for now it's still a discussion point with a myriad of political implications.
Under President Bush's tax relief proposal, the tax for a couple with two children and $60,000 in income would decrease 28 percent from $4,945 to $3,545. Of course, a lot depends not only on the size of reductions but on whether they're fully enacted for the 2001 tax year.
"While the momentum for a tax cut isn't as strong as it was a month ago, I think we'll get a tax cut bill enacted this summer," predicted Greg Valliere, chief strategist with the Charles SchwabWashington research group. "It will likely be a $1.6 trillion bill, about half of which will go to pay for tax rate reductions that take effect immediately or even retroactively to Jan. 1, 2001."
Democrats should win some of the "rich-versus-poor" arguments, so benefits will likely be tilted toward working families. Bush would replace current tax rates of 15, 28, 31, 36 and 39.6 with a structure of 10, 15, 25 and 33 percent. While it's unlikely he'll prevail in cutting the 39.6 percent bracket to 33 percent, it may be reduced to 37 or 36 percent. He should succeed in getting the 15 percent bracket sliced to 10 percent.
"There will most likely be new savings incentives in the form of increased contributions to Roth IRAs and 401(k) plans, while the marriage penalty will be reduced by reinstating the 10 percent deduction for two-earner couples," Valliere added. "An increase in the child credit from $500 to $1,000 is also expected."
But don't expect to see a lowering of the capital gains tax from 20 percent to 15 percent, since that measure seems to lack political backers. Meanwhile, the alternative minimum tax, a shadow tax that targets some taxpayers when they rack up a lot of deductions, will be reined in through changes in its preference items.
Here's what's likely for the estate tax:
The momentum for abolishing what Bush calls the "death tax" has slowed because it's too emotional an issue, yet reform is likely.
The top estate tax rate, now as high as 55 percent, could be decreased to 40 percent or less.
The exclusion from estate tax, currently topping out at $1 million per estate in 2006, could be boosted to $3 million or $4 million.
There will be a dramatic increase in the exemption for family-owned businesses, especially farms.
"The stock market will benefit over time from the proposals to increase annual deductions for the 401(k) and IRA," added Marshall Acuff, investment strategist with Salomon Smith Barney. "While Democrats may emphasize the lower tax brackets in their proposals, under both plans the consumer will be helped."
But investors must still pay close attention to expectations for earnings growth, which are near their lowest levels in 20 years, Acuff believes. Individual companies may still be doing more downgrading of earnings forecasts. There are also concerns about how the combined impact of tax cuts and rate cuts will affect the overall economy.
"You could be adding too much strength to an economy that may already have some resilience in it," warned Diane Swonk, chief economist with Bank One in Chicago. "You could see a situation a year from now with the Fed doing another 180-degree turn and increasing rates, which would not be good for investors."
Swonk is convinced we're moving out of the worst quarter of the year in what will turn out to be an overall good economic year.
"Since consumer spending represents 68 percent of gross domestic product, a tax cut will be positive," concluded Jack Shaughnessy, chief investment strategist with Advest Group in Boston, who expects the stock market to revive in the second half of the year. "What I'd really like to see is reduction in taxes for corporations, translating into more cash flow, capital spending and improved earnings, with less need to lay off workers."
Andrew Leckey answers questions only through the column. Address questions to Andrew Leckey, "Successful Investing," 98 Henry St., Dept. 183, Brooklyn, NY 11201, or by e-mail at email@example.com.