Read my lips. Presidential candidates often make tax promises they can't keep.
Democratic challenger Sen. John Kerry has looked directly into television cameras and told a national audience that if elected he would raise income taxes only on Americans making more than $200,000. He's also vowed to implement new tax cuts for 98% of U.S. families, while adding a host of social benefits and reducing the nation's record budget deficit.
President George W. Bush, meanwhile, has pushed to make permanent the major but temporary tax cuts from his first term -- on earnings, dividends and capital gains -- and to eliminate the estate, or inheritance, tax altogether. He has said he would hack away at the deficit as well and explore the idea of a simpler, streamlined tax code.
How seriously should taxpayers and investors view these election pledges?
"You have to dismiss a lot of it as rhetoric," said Bernard Baumohl, former
magazine senior economics reporter, director of the Economic Outlook Group and author of the new book
The Secrets of Economic Indicators
. "It just doesn't work like that in the real world."
Though the two major candidates' tax policies may be very different, whoever wins the election could be forced to abandon election tax promises posthaste, according to economists and tax experts. Keeping current tax cuts and adding new ones could meet strong resistance from Congress in the face of federal deficits.
The federal budget deficit hit its second record high -- in dollar terms -- under the Bush administration at $415 billion for fiscal year 2004, according to the Economic Policy Institute, an independent, nonprofit, nonpartisan think tank in Washington, D.C.
Bush inherited a record $230 billion surplus for the year 2000 from the Clinton administration. But the surplus turned to red ink as Bush grappled with a recession, the 9/11 terrorist attacks and the war in Iraq, and sought to stimulate the economy with sweeping income tax cuts.
"Taxes are out of whack," said Max B. Sawicky, an economist with the institute, who notes that taxes relative to gross domestic product haven't been this low since the 1950s. That means, he said, the nation is paying "Ozzie and Harriett"-era taxes to support a much bigger 2004 budget.
Both Bush and Kerry have indicated they would like to balance the budget in 10 years, but this is almost impossible, said Sawicky. It would mean that once defense, entitlement programs such as Social Security and Medicare and interest payments were paid, 89% of other federal programs, such as education, environment, housing and agriculture, would have to be cut.
"The reality is," Sawicky said, "that the federal government will need to accept a combination of moderate deficits, cuts in defense and entitlements, and tax increases, all options that no politician seems prepared to face today."
Despite Bush's fervor for tax cuts, some observers believe that if the president is re-elected, he'll be forced to beat a tax retreat just as Ronald Reagan and his father did before him.
Although cutting taxes to stimulate the economy was the cornerstone of Reagan's first term in office starting in 1980, ballooning deficits led his administration to raise taxes in his second term.
During the 1988 Republican Convention, George H.W. Bush uttered the famous promise: "Read my lips: No new taxes." Within two years, however, he had agreed to a 5-cent increase in gas taxes. At first he first refused to call it a tax, but later did, apologizing during his losing campaign against Bill Clinton.
"They came to grips with the fact that supply-side economics doesn't work all that well," said Baumohl. Supply-side economics focuses on tax reductions, especially among the wealthy, to increase investments and stimulate the economy.
The current Bush in the White House has drawn a similar line in the sand, however, promising in 2002 that "not over my dead body will they raise your taxes."
To some economists, Bush seems remarkably stubborn in pushing for more tax cuts despite growing budget deficits.
Budget deficits, of course, force the government to pay more in interest payments on the additional debt borrowed by the Treasury to finance the budget. That debt can dampen economic activity by competing with private enterprise for investor dollars and raising interest rates.
"The President doesn't seem constrained at all," says Sawicky. "I don't know how he thinks about it in his head."
Kerry, on the other hand, seems to understand the need for a balance, he said. "There's much more chance of fiscal discipline under Kerry."
The two candidates offer voters sharply contrasting views on taxation, whether or not their specific campaign promises come to pass.
Here's what each has to say on major tax issues:
Since he entered office, Bush has succeeded in passing two major tax reform acts, one in 2001 and one in 2003, that lowered individual income tax rates. The reforms also increased the child tax credit and minimized the marriage penalty. The acts reduced taxes for all taxpayers, but particularly for the wealthy.
At the start of 2001, taxpayers in the top two tax brackets were paying maximum tax rates of 35.5% and 39.1%. Today, the top tax brackets are 33% and 35%.
"If you look at it from 10,000 feet, wealthy people are doing very, very well," said Tom Ochsenschlager, vice president of taxation for the nonprofit American Institute of Certified Public Accountants.
Kerry, however, has set his sights on raising taxes for Americans earning more than $200,000 annually and vowed to roll back the two top income tax rates back to their previous levels. He wants to use that money to help pay for social services, such as better health care programs.
If Kerry wins the election, taxpayers with earnings near the $200,000 range might want to take some precautions this year. "Don't defer you bonus until next year," advised Ochsenschlager. "If you want to wear a belt and suspenders, take your bonus this year."
Dividends and Capital Gains
A major goal of Bush's tax reforms was to lower taxes that investors pay, on the dividends they receive from securities, and on capital gains when they sell their investments at a profit.
The 2003 act reduced dividends, a company's distribution of earning to shareholders, from a taxpayer's highest earned income rate to 15% for higher-income taxpayers and to 5% for those in the two lowest tax brackets.
It also lowered the taxes on gains of securities held long term, or more than one year. The tax was reduced from 20% to 15% for those in the top four tax brackets and from 10% to 5% for investors in the two lowest tax brackets.
In 2008, both the lower 5% dividends rate and capital gains rate will drop to zero.
But these tax breaks are temporary, and they revert to their pretax act rates in 2009, unless new legislation passes.
Bush has promised to extend these investment tax benefits if elected to a second term.
Kerry, however, has been silent on the subject of capital gains, according to Ochsenschlager of the CPA institute. He speculates that Kerry is probably planning to reverse the reductions as part of his pledge to raise taxes on the wealthy, "but hasn't spelled it out in the campaign."
A Kerry win could be a boost for municipal bond securities, said Thomas Doerflinger, an investment research senior U.S. equity strategist with Swiss financial services company
. Municipal bonds, which generally give off income that is free of federal taxes and exempt from state and local taxes in the state of issue, have long been popular with investors seeking tax-free income.
If Kerry prevails in the election, investors should consider taking some capital gains this year, rather than postponing them until 2005, advised Carol Ferguson, a manager with the CPA institute.
Under the 2001 act, the estate tax is gradually being phased out until it disappears for one year in 2010, then returns in 2011 on estates of $1 million or more. In this year and next, the tax applies to estates larger than $1.5 million.
Bush would like to eliminate the estate tax altogether. Kerry favors taxes on the largest estates.
Alternative Minimum Tax
The AMT, was intended to ensure that the wealthiest taxpayers paid income tax even if they took numerous tax breaks. But in recent years the AMT -- which is not adjusted for inflation -- has swept up many middle-class families and is accounting for an increasingly larger share of tax revenues.
Both Bush and Kerry have said they would consider a bipartisan approach to reforming the AMT.
If the newly elected president is compelled to raise taxes, taxpayers should have some warning, said Ferguson. Tax hikes usually take effect on the date of enactment or the date of introduction to Congress, she said, while tax decreases can be retroactive: "It's very easy for them to send you more money in the mail."
Directly and indirectly, the contrasting tax policies of the two candidates are of great import to taxpayers and investors. But in the end, reality, not rhetoric, may turn the tide in setting the agenda of the next four years.
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