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The Obama budget: What’s NOT in it for you

President Obama’s proposal for the fiscal year 2012 federal budget is just that: A proposal that would have to wind its way through a Republican-controlled House and a divided Senate to become law. So there’s no sense in panicking about what’s in it and what isn’t.

But here is why you need to pay attention: The wish list, released on Feb. 14, is indicative of the themes that will dominate the remainder of this presidential term and the 112th Congress. Individual taxpayers will find a tight budget. Retirees could get an extra break, and students may lose valuable subsidies.

Here’s a look at some of the key issues and specific proposals that will affect consumers.

Tax breaks and bumps. The Obama Administration’s plan includes a one-time payment of $250 to retirees. This was a move originally requested by the AARP to make up for the fact that there hasn’t been a cost of living increase for Social Security recipients for two years. The Democratic House already turned this down last year, but if it gets tucked into a much larger bill, it could make it through in 2011.

The White House plan also makes the “fix” for the alternative minimum tax permanent. That saves taxpayers who have big state tax bills along with large families from getting stuck by the AMT, which was intended to snag wealthy tax avoiders but instead penalizes those who have big writeoffs for state taxes or take personal exemptions for many children.

To pay for the first three years of the AMT fix, it attempts to revive the battle over tax cuts for the wealthy. The new budget blueprint would limit deductions for wealthy Americans (those earning more than $200,000 as individuals, $250,000 as couples) to 28 percent of their income. That would hit the home office deduction, charitable deductions and more. President Obama has proposed that before, and observers have suggested that Congress would be unlikely to go back in and start tinkering with income tax policy absent a complete tax overhaul drive.

Student loans could get pricier. The Obama budget takes a bite out of the benefits many graduate students receive. It would eliminate the federal subsidy which covers the 6.8 percent interest on those loans while the student is in school. Over a 10-year repayment plan, that would cost the typical graduate student roughly $2,314 in added interest for every year of graduate school, according to estimates calculated by Mark Kantrowitz, publisher of FinAid.org, a financial aid education web site. But that might be just the start of further cuts, says Kantrowitz.

Obama lays down a marker on Social Security cuts

Would he or wouldn’t he?

President Obama’s deficit commission endorsed cutting Social Security benefits last month, and many wondered whether the president would endorse those cuts in his State of the Union message this week. Instead, the president reiterated the traditional Democratic position on Social Security in his address that he staked out as a candidate in 2008:

“We must [strengthen Social Security] without putting at risk current retirees, the most vulnerable, or people with disabilities; without slashing benefits for future generations; and without subjecting Americans’ guaranteed retirement income to the whims of the stock market.”

That rhetoric differs significantly from the “everything on the table” messages emanating from the White House since the National Commission on Fiscal Responsibility and Reform issued its final report. Written by commission co-chairmen Alan Simpson and Erskine Bowles, the report recommended benefit cuts via a higher retirement age, lower annual cost-of-living adjustments (COLA) and a third, somewhat technical change in the way benefits are calculated.

What happened in the weeks since the release of the commission report? A coalition of traditional Social Security backers and Democratic lawmakers seem to have convinced the White House to back away from the Simpson-Bowles recommendations. Their case had two main points — both correct:

1. Cutting benefits is bad policy. That’s because Social Security has nothing to do with the federal deficit. The program ran a $2.5 trillion surplus in 2009, a number that will hit $3.8 trillion in 2020, according to the Economic Policy Institute. The surplus has been accumulating since implementation of the last Social Security reform measures in 1983, which were implemented for the purpose of building a cushion to fund the anticipated big wave of baby boomer retirements.

House panel opens tax reform talk: What do you think?

It’s opening day on what could be a long tax reform season, with the House Ways and Means Committee holding its first hearings on the topic on Thursday. The witness list is somewhat stacked with reform advocates –-  like Nina Olson, the national taxpayer advocate, and Kevin Hassett of the American Enterprise Institute –- and corporate types who are likely to say they’ve been beleaguered by tax complexity.

“It is clear that the tax code is too complex, too time-consuming and too costly,” said the committee chairman, Dave Camp, in announcing the hearing. The committee is encouraging anyone who wants to vent about the tax code to submit remarks through its website.

But we want to hear, too. Take our poll on key tax reform issues. And watch for President Obama’s state of the union speech on January 25. He’s expected to mention tax reform, but how heavily he hits that topic could provide clues to how long this “season” will last.

Does the tax code need to be reformed?

• Yes
• No
• It won't make much of a difference

Gridlock could gut stock returns

The widely anticipated gridlock that could stall Washington after the election isn’t so good for financial markets after all, says Sam Stovall, chief investment strategist for Standard & Poor’s Equity Research. The popular-with-strategists view, that a divided Congress would protect investors from having to swallow damaging legislation, is wrong: “History says the opposite is true: Gridlock is NOT good,” Stovall writes in his investment letter.

For more than 110 years, the average return when there was a Democratic president and a split Congress was not a return at all, but a loss of 3.7 percent. When both houses of Congress and the White House were all dominated by the same party, the average return was 7.6 percent. It seems that watching Washington bicker and stall doesn’t engender investor confidence.

Yet other historical indicators point to a good 2011 for stock market investors. The best year in the political cycle for investors is typically the third year of a president’s term: Prices have moved up in 94 percent of those years, averaging a 17 percent annual return. And “we’re in the sweet spot right now,” Stovall told Reuters. The best quarters in the stock market typically come in the fourth quarter of a mid-term election and the first two quarters of that post-election year. That all points to nice returns for the end of 2010 and 2011.

But maybe not for next week. Investors are widely expecting Republicans to win the House and pick up a few seats in the Senate, but not enough to gain them the majority there. If that happens, the old “buy the rumor, sell the news” homily could kick in, and the first market reaction to the election could be a disappointment.

Will Social Security be there for today’s young workers?

Social Security reform is a touchy subject these days for Thomas Brown and his grandparents.

“If I broach it with them, they are against any sort of legislation that would do anything to change Social Security,” says Brown (pictured below), a 28-year-old financial adviser with Pivot Point Advisors in Houston. “They depend on it, but when I look at my retirement plans, I don’t factor it in. The new way of thinking is that Social Security won’t be there — you have to plan for your own retirement.”

I write frequently about the future of Social Security, and pessimistic views like Brown’s always show up in the comments below my stories. Indeed, Gallup reports that six out of ten pre-retirement Americans don’t think Social Security will be able to pay them a benefit when they retire; those age 18-34 are even more pessimistic, with 76 percent saying they’ll get nothing from the system.

The doubts aren’t difficult to understand. “If you listen to any number of the news outlets, they’ll tell you the system is going broke,” says Brown. “Every year I get a mailing from Social Security detailing what I can expect in benefits, and they say themselves that it will be bankrupt around 2040 and that they are going to be paying out more than we’re paying in. So it’s not fear, it’s math.”

But Social Security isn’t going bankrupt — far from it. The system was intended — and has always been — a pay-as-you-go system, with taxes collected from workers used to pay current retirees. But Social Security also is sitting on a $2.5 trillion Social Security Trust Fund (SSTF) that has been stockpiled to fund the looming wave of baby boomer retirements; that fund is projected to be sufficient to pay benefits until about 2037.

Pessimism about Social Security among the young isn’t new. “It’s a very longstanding trend,” says Virginia Reno, vice president for income security at the National Academy of Social Insurance. “It was true in a survey we did in 1979, and another in 1991. There are good reasons — older Americans have given more thought to retirement resources. They have looked into it more.”

Then there’s that threatening annual benefit statement we all receive from Social Security. (You’re reading that carefully every year when it arrives in the mail — right?)

Social Security COLA complainers should settle down

Let the whining begin.

Seniors learned this morning that they won’t receive a Social Security cost-of-living adjustment (COLA) in 2011.

Seniors vote, and with the mid-term elections approaching fast, many will be furious with Washington, President Obama and other villains real and imagined. The whining was in high gear even before the official COLA news came this morning, with media cranking out stories bemoaning the second straight year without a benefit increase as an injustice to seniors and terrible news for the economy.

Sorry, but it just ain’t so. Social Security is a critical program that keeps millions of seniors out of poverty every year; its benefits should be protected from deficit cutters and beefed up in the years ahead. But there’s nothing inequitable about Social Security payments staying flat next year. That’s because seniors are still enjoying a huge 2009 Social Security raise that was based on an economic fluke.

Social Security has had an automatic annual COLA feature since 1975, which is determined by the third quarter Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). In the third quarter of 2008 — just before the economy crashed — the CPI-W spiked temporarily, the result of a big increase in energy prices.

The result was a whopping 5.8 percent boost in Social Security benefits for 2009 — a raise that was especially generous considering the near-absence of inflation in the post-crash economy. Seniors on Social Security or disability benefits also received a one-time payment of $250 under the 2009 stimulus.

Social Security payments can’t fall under federal law, so benefits were held level in 2010, and will continue that way until the CPI numbers exceed the 2008 CPI-W index level. Today’s final third quarter CPI report determines that payments will stay steady again in 2011.

Obama asks to extend education tax breaks: What’s at stake?

President Obama has asked Congress to renew the American Opportunity Tax Credit, which gives more than 12 million college students and their families tax breaks of up to $2,500 a year per student. Originally passed as part of the 2009 stimulus legislation, the credit is slated to expire at the end of this year. If it does, other credits and deductions would still be in place, but they would be less generous.

Here’s a quick guide to the credit as it stands now and what it could look like in 2011.

What is it? The American Opportunity Tax Credit essentially improves the existing Hope Scholarship, explains Mark Kantrowitz of Finaid.org. The Hope Scholarship offered $1,800 a year of tax credits for the first two years of post-high school education. The American Opportunity Tax Credit offers as much as $2,500 a year for four years, for a total of $10,000 per student.

And for low-income taxypayers, the American Opportunity Tax Credit is refundable, up to $1,000 a year. If your tax liability is less than the full $2,500 credit, you can get as much as $1,000 of it refunded to you. That’ll cover a few textbooks.

Who qualifies? Income limits are higher for the American Opportunity Tax Credit, too, says Bob Scharin, a senior tax analyst with Thomson Reuters. Single earners can claim the full credit as long as their income is below $80,000. (The income threshold is $160,000 for couples filing jointly.) It phases down until the credit disappears at $90,000 for single filers and $180,000 for joint filers.

The Hope credit limits were much lower — $50,000 to $60,000 for single filers and $100,000 to $120,000 for joint filers.

Does it matter who writes the college check? Even if Grandma pays the bill, Mom and Dad can still get the credit. They can also designate that the student take the credit on her taxes instead, if that’s more advantageous to the family. But they can’t transfer the refundable part of the credit. If parents don’t qualify for the refundable credit, the student can’t take it, says Kantrowitz.

Tax cuts: You could be a “millionaire”

Werner Renberg is a writer and author based in Chappaqua, N.Y. He is the author of four books, including All About Bond Funds: A Complete Guide for Today’s Investors. The opinions expressed are his own.

When President  Obama says that his proposed Fiscal 2011 budget would “give tax cuts to…98 to 97 percent of Americans” by permanently extending the expiring Bush tax cuts for them—but not for “the wealthiest 2 percent”—how does he split taxpayers into two classes? By drawing a line at “families earning more than $250,000 a year.”

In election campaign language, that becomes “folks who are already millionaires” and “folks” who are not. In the precise language of a tax return, it would mean:

1) Married individuals filing joint returns and surviving spouses face hikes in their marginal income tax rates—as well as in the rates on taxable dividends, long-term capital gains, and mutual fund capital gains distributions—if their adjusted gross income (AGI) tops $250,000. Single taxpayers’ rates go up if their AGI tops $200,000.

2) Other taxpayers continue to enjoy current rates until their AGI crosses the lines.  Congress is currently weighing the budget as well as bills to extend the tax cuts for everybody. It is also grappling with current law which would let everybody’s tax rates go up in 2011 if it does nothing.  Are all possible results of the president’s proposals clear to you?

One possibility may not be. For once in your life, maybe twice, you could be a “millionaire” as that word is understood in the election campaign—and be taxed as one—even though you don’t expect to earn enough to have filet mignon every night.

How?