Tax Debate to Dominate in Coming Week

The debate to extend the Bush tax cuts likely will gain momentum, after a weaker-than-expected November jobs report disappointed hopes for a quicker recovery.
By Shanthi Bharatwaj ,

NEW YORK (

TheStreet

-- The debate to extend the Bush tax cuts likely will gain momentum in the coming week, after a weaker-than-expected November jobs report on Friday dashed hopes for a quicker economic recovery.

Headlines out of Europe will also continue to get attention amid hopes that the European Central Bank will be able to contain the debt crisis on the Continent.

Jeffrey Kleintop of LPL Financial expects the tone of the markets to be slightly negative in the days ahead. "Next week the data fades and the pendulum will swing back to headlines. The headlines are not going to be as favorable," he said.

"There will be continued division within Congress over tax cuts. I don't think that will get resolved in the coming week ... maybe two weeks later but not in the coming week. The eurozone issues will crop up again with questions about what is next for Portugal and Spain."

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Kleintop, however, says investors could look forward to plenty of action in the subsequent week. "The markets could give back some of the strength we saw this week. It could be a good buying opportunity for investors ahead of the following week when we have Chinese manufacturing data, a

possible decision on tax cuts and the meeting of the

Fed

, which I think is looking for something to prove after being challenged in the last month," he said.

The Fed's quantitative easing move received widespread criticism last month, as it was seen as an attempt to artificially depress the dollar to boost exports. The central bank was also accused of "exporting" inflation to emerging markets.

Stocks got off to a strong start in December as a wave of better-than-expected economic reports offset concerns on the sovereign debt crisis in the eurozone. Expectations for a stronger recovery were tempered somewhat on Friday, after the Labor Department said the

economy added only 39,000 jobs in November, far fewer than the 140,000 economists were expecting.

With unemployment inching higher to 9.8%, Congress is under pressure to resolve uncertainties on taxes and to reauthorize extended unemployment benefits that expired in November.

Earlier in the week, President Obama appointed Treasury Secretary Timothy Geithner and budgets director Jack Lew to work with both parties in Congress to resolve the issue.

If the Bush tax cuts expire, individuals will be forced to pay higher taxes on their incomes as tax brackets move up. Capital gains taxes will rise from 15% to 20% and qualified dividends will be taxed at the ordinary income bracket. Married couples will pay higher taxes; H&R Block estimates that a couple earning $80,000 a year could see an additional $221 withheld from its bimonthly paycheck.

On Thursday, House Democrats approved legislation that would extend current tax rates to households with incomes up to $250,000 while allowing taxes on higher earnings to rise. The vote was considered symbolic and unlikely to get passed in the Senate.

Indeed, on Saturday, the

Senate defeated that bill and a similar one

. Later, President Obama

said he would to work to hash out a deal with Republicans by the end of the year

.

Republicans wish to extend the Bush tax cuts across the board permanently, while the Obama administration is willing to negotiate only a temporary extension of tax cuts for the wealthy.

The markets will also follow the current debate in Congress to reauthorize the extended unemployment benefits program that expired at the end of November.

Congress expanded unemployment insurance benefits by creating Emergency Unemployment Compensation (EUC) and 100% federal funding of Extended Benefits (EB). Those programs provide unemployment insurance benefits after a worker exhausts state benefits, helping when it takes longer to find a job. Those extensions began to expire Nov. 30.

The Labor Department estimates that 2 million Americans will lose aid by the end of the year if Congress does not act.

On Thursday the White House Council of Economic Advisers said in a report that failure to extend the program could cost 600,000 jobs in 2011 because of a drop in consumption.

"For the last half-century, Congress has consistently extended unemployment benefits when economic circumstances were serious enough to make finding a job difficult," the report said. "Given the current labor market conditions, failing to continue the extensions now would be unprecedented."

Analysts expect an adverse effect on the holiday shopping season and retailers if the benefits expire. Investors will be following retail stocks, including

Amazon

(AMZN) - Get Report

,

Wal-Mart

(WMT) - Get Report

,

Target

(TGT) - Get Report

and

Macy's

(M) - Get Report

closely for any news that will affect the holiday shopping season, which so far has been strong.

News out of Europe will continue to be monitored even as concerns on the crisis showed signs of abating recently. Chris Low, economist at FTN Financial, said investors in the U.S. cannot ignore problems in Europe even though economic reports in the U.S. show signs of recovery.

"The thing about Europe is this isn't really a European crisis," Low said. "It is the continuation of the ongoing credit crisis. We can shrug off the problems outside the U.S. if we manage to tame those problems here. Two things need to happen

in the U.S. economy. One, jobs have to improve. And two, credit growth has to stabilize. There is not enough investment nor enough spending. The securitization market needs to come back. Fixing private sector credit also will allow the government to back off their own borrowing a bit."

Art Hogan of Jefferies does not expect the Fed to make any changes to its plans in the next meeting. "QE2 is already in place. It does not have to be readdressed," said Hogan, adding that the weak jobs report probably meant that the Fed had a good justification for going ahead with quantitative easing.

Initial weekly jobless claims, which are scheduled for release on Thursday, would be the biggest economic report to watch out for in the coming week. Jobless claims are expected to drop to 430,000 in the week ended Dec. 4, according to consensus estimates from Briefing.com.

The University of Michigan consumer sentiment index on Friday will be the other noteworthy report. Consumer sentiment is expected to climb to 72.5 in December from 71.6 in November.

Other reports next week include consumer credit data on Tuesday, mortgage applications on Wednesday, the wholesale inventories report on Thursday and the trade balance report on Friday.

--Written by Shanthi Bharatwaj in New York

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