Millions of Americans now receiving their $10.25 individual weekly windfall from President Obama‘s “Making Work Pay” tax credit may be in for a disagreeable surprise next spring.

The government may want some of that money back.

The tax credit is supposed to provide up to $400 to individuals and up to $800 to married couples as part of the economic recovery act voted into law last February.  Workers began receiving the tax credit in paychecks they received after April 1, when employers were required to implement the new tax tables.

Revised withholding tables issued by the IRS extract less from individual paychecks for the tax credit.  The $10.25 individual weekly rate is based on the 39 remaining weeks in 2009.  It’s a simple change, for people who have one job.

There are, however, circumstances that will cause millions of taxpayers to get much more spendable cash than they are entitled to, and Uncle Sam will want this extra funding repaid at tax time.

The IRS is aware of the problems the tax tables will cause many consumers, but is keeping quiet.  I suppose the IRS is hoping many of the over-receivers will be expecting a refund, and will not complain because their refund will be smaller.  The average refund was just below $2,700 for 2008 income.

Taxpayers who plan their withholding close to their expected obligation might be in for a surprise. 

The revised tax tables credit workers with 6.2 percent of their earned income, up to a $400 maximum for individuals and up to $800 for married couples filing jointly.  Ineligible are individuals grossing over $95,000 and couples taking in more than $190,000.

The tax credit was designed specifically to help boost the economy by collecting less from workers and thereby giving more money to consumers. 

In his appraisal of his first 100 days in office, President Obama praised the tax credit as one of his achievements, promoting that 95 percent of working families will qualify for it in the next two years.

The tax tables don’t take into account several common categories of taxpayers:

• A worker with two jobs will receive a potential $400 increase in the take-home pay at each job, up to $800, but is only eligible for a maximum credit of $400. The excess must be repaid at tax filing time, either through a smaller refund or paying in cash.
• Married couples filing jointly are eligible for an $800 credit. If both spouses work, the new withholding tables give them each $600 (total $1200), and the excess $400 must be repaid. The IRS recognized the problem and adjusted the withholding tables, but the fix was imperfect.

Note: Fifty-five percent (33 million) of married couples have both spouses working for a paycheck.

• A college student with a job making $10,000 will receive $400 that must be returned if the student is listed as a dependent on their parent’s tax return.

Fifty million retirees face even bigger potential headaches.

For people who receive Social Security, Supplemental Security Income, Railroad Retirement benefits or Veteran’s Disability benefits, the Social Security Administration is sending out $250 payments in May as part of the economic stimulus package.  These payments are meant to provide a boost for people who don’t qualify for the tax credit.

Several retiree categories will face potential problems from the new tax tables.

• Retirees who have earned income and Social Security will receive the $400 benefit in their paychecks and the one-time $250 payment in their Social Security check. They must pay back the $250 when they file their tax return.
• Retirees who have federal income taxes withheld from pension benefits will receive the $400 benefit due to the new tax tables, but since pension benefits are not earned income, they don’t qualify for the tax credit and it will have to be returned.
• Retirees with working spouses who are having taxes withheld at the married rate will receive an excess of $400 through the working spouses paycheck that must be returned.

Treasury Secretary Timothy Geithner said in March that both Treasury and IRS understood the concerns and were “exploring ways to mitigate that effect.”  No news since.

Don’t be caught in the repay surprise:

• Check all federal withholding amounts with those received before April 1. Include all paychecks (you and spouse), Social Security and Pension payments. Multiply that difference by the number of remaining paychecks and payments for 2009.
• Check federal withholding for children with earned income. Calculate any overage and have them readjust their federal withholding amounts.
• Change of federal withholding rates and additional taxes to be withheld may be requested on Form W-4 available from employers and the IRS.
• The IRS and many private tax preparers have a calculator on their Web site to help taxpayers figure withholding.

Remember, the maximum benefit is $400 per worker, $800 per married couple.  If one spouse receives only Social Security benefits, their benefit is $250 for a total of $650.

If you did not have earned income, you are not eligible for the $400 recovery tax credit.

IRS website calculator and W-4 form

“Attention Pensioners: Pensioners do not qualify for the Making Work Pay credit, unless they receive earned income.  However, the new withholding tables apply to all taxpayers, including pensioners.  The IRS has a withholding calculator pensioners and others can use to make sure enough tax is being withheld from their pay.  Adjustments to withholding can be made by filing Form W-4P, Withholding Certificate for Pension or Annuity Payments.” 

IRS withholding calculator

Another calculator

OK, simple enough, but Daschle disclosed to the Senate Finance committee that he used it about 80% for personal use and didn’t disclose it or pay taxes on the personal transportation benefit.

He discovered it himself when he found out he was the president’s pick, filed amended tax returns and paid the back taxes and interest before the Senate Finance committee hearings.

“Under Section 132 of the Internal Revenue Code, the value of transportation services provided for personal use must be included in income.” 

Now here’s the complication and the lines between business and personal cross.  What if the Daschles were going to an invited business affair in the car?  Is the transportation personal, or business?  Is the transportation to do business considered business?  My transportation expenses to my first job are not deductible as business expenses, only my transportation expenses to my second job, and not from there to home.

So what if the Daschles were going out to a personal dinner in the car, and Tom’s cell phone rang from a business contact.  Would the ride suddenly transport into a business expense for as long as the conversation lasted?

Lawyers face this dilemma all the time.  They may go out to a business lunch to discuss a legal issue, and the lunch is a business expense.  What if they start talking about the Super Bowl during dessert and coffee?  Do they divide up the check accounting-wise to business and personal?  What portion of the waiter’s tip goes to business?

Members of the committee staff from both parties have been examining a number of other issues, including Tom Daschle’s relationship with EduCap, a student loan company.

Members have been asking if Tom Daschle should have been registered as a lobbyist as well while working at the law firm Alston & Bird, where the firm was registered as a lobbyist for EduCap and as well as health care companies.

In his financial disclosure report, Mr. Daschle said he received compensation for providing “policy advice” to EduCap. The exact amount was not disclosed, but it was more than $5,000.

EduCap reports to the Internal Revenue Service that it does business as the Catherine B. Reynolds Foundation and is the principal underwriter of the annual meetings held by the American Academy of Achievement, which has, on several occasions, honored Mr. Daschle.

In its report, the Senate Finance Committee said its staff was still reviewing “whether travel and entertainment services provided to the Daschles by EduCap Inc., Catherine B. Reynolds Foundation” and the Academy of Achievement “should be reported as income.”

Enough to give you a headache?

I’m certainly not saying the Senate Finance committee is wrong or accusatory in their findings.  Certainly, taxes and business dealings are the easiest to find, and we certainly want our top government officials as clean as possible.

The IRS relies on estimates with as much backup as possible for credibility in estimates like that.  I suppose Tom could have kept a detailed log (maybe on his Blackberry) of travel and entertainment purposes with dates and times, or written a personal check at the end of each trip in which part of the ride was personal.   Please!!

There are lots gray areas in income tax collection, and if Tom Daschle is under scrutiny, other officials including the president are faced with the same daily dilemmas.  That’s why they all have aides to take care of the minutia.  And if they don’t, they can help the employment problem by hiring one.

I would hope the Finance Committee will soon confirm Tom Daschle and other presidential choices while still doing their jobs.  I know I would feel more comfortable if Tom Daschle were putting his full attention to improving our health care, and the president was able to concentrate fully on fixing the economy.

When questioned about the delay to confirm Tom Daschle, a spokeswoman for the Finance Committee, said, “There’s been a lot on the committee’s docket.” 

No wonder.

Political analysts and reporters keep talking about “trickle-up” and “trickle-down” economics.  What do these terms mean?  Personally, I’m interested only in “trickle to my pocket.”  But as far as taxes are concerned, I pay what the government says to pay.  They decide how to apply the money. 

The current administration largely uses supply-side economics.  In a phrase, money is applied to the top level of the economy, with the hope placed in the fairness of industry controllers that it will trickle down to the worker class.

Supply-side economics as an economic definition is a macroeconomic philosophy that holds that:

1.      Lowering income taxes and capital gains tax rates will encourage the wealthy to invest in stock market companies.  Wealthy would describe people in the higher tax brackets, who would benefit most from these tax breaks by gaining more disposable income.

2.      These investments made by the wealthy (if they make the investments) will encourage businesses to expand and produce an increased supply of goods and services at lower prices. 

3.      That expansion in turn, will result in economic growth, increasing employment, disposable income for more workers, and demand for these goods.

Supply-siders feel that in a high tax rate environment, lowering taxes to the right level can raise revenue by causing faster economic growth.

This philosophy is also referred to as “trickle-down economics.” 

·        Proponents argue economic growth will flow downward from top to bottom, indirectly benefiting those workers who do not directly benefit from the tax changes. 

·        Opponents argue that “trickle-down” policies, if they work at all, provide a very slim benefit by the time they reach the worker, due to the benefits taken out at every level.

Advocates of the trickle-down effect believe that a free market, unrestrained by heavy taxation, regulation and other forms of government controls, will cause an increase in wealth for society as a whole, part of which will “trickle down” benefits from the wealthy to the worker class, increasing their standard of living.

Increasing taxes reduces trade between businesses and discourages investment like an international trade barrier or tariff, meant for that purpose.

Nixonomics

In 1971, Republican President Richard Nixon ended the the U.S. Gold standard, where the value of the U.S. dollar was pinned to the fixed value of gold.  Almost immediately,commodity prices such as oil and gold, spiked up. Actually, the value of commodities remained constant while the dollar was devalued. 

As a result, the stock market lost half of its value between the market peak of 1972 and its bottom in 1982, with investors seeking better returns in commodities and real estate. 

Decreasing market investment caused companies to cut back, increasing unemployment. Unions influenced business owners to keep raising prices, fearing more wage hikes, causing inflation.  Nixon refused to cut taxes since he said the incentive to invest in the market was zero.  The result was a stagnant economy with high inflation, better known as stagflation.

Wage and price controls were put into effect, but interest rates were allowed to run free.  The result was rapidly rising interest rates and tight credit.  Inflation caused wage earners to creep into ever higher tax brackets, losing wage increases to taxes.  The number of households able to afford mortgages diminished.

This was an example of supply-side economics gone bad.  High taxes, high inflation and uncontrolled interest rates in a free market economy caused the economy to grind to a halt.

Reaganomics

Skip ahead to 1981 when Republican Ronald Reagan became President.  Unemployment was at 7.5% and inflation was at 13.5%. 

Federal Reserve chairman Paul Volcker squeezed inflation from the economic system, by raising the federal funds rate to 20%, forcing the prime interest rate up to 21.5%.  This extremely tight monetary policy intentionally plunged the U.S. economy into a deep recession and wiped inflationary psychology and expectations out of the system.

Economist Robert Mundell convinced the President to reduce upper bracket and capital gains taxes to increase national output and tax revenue, and that would bring inflation under control.

The ensuing tax cuts, reducing taxes by $749 billion over five years, drew the country out of recession, and the tax receipt level quickly returned, then surpassed previous levels.

This was an example of supply-side and trickle-down economics that worked.  After the economy was intentionally put into a coma, it was restored to health with lower unemployment levels and higher wages, as well as lower prices for consumers.

There are arguments whether the tax cuts actually paid for themselves in the Reagan era.  Take away natural increases due to inflation, increased FICA taxes and corporate taxes, tax revenue in constant dollars decreased by $2.77 billion in that time period.  And recouping $746 billion is not bad.  But one thing is clear, that Reaganomics dramatically reversed the American economic decline of the 1970s.

Trickle-down supply-side economics is the model cherished by the Republican Party.

Shortcomings

The supply-side of the argument has its shortcomings.  The conditions must be correct and  the trickle-down stream must be entirely without blockages in order to work:

1.      Taxes must be high enough that economic expansion is currently stifled.

2.      The lowering of taxes must be noticeable enough to the wealthy that they will consider investing the extra money and not save it or spend it only on personal consumption.

3.      The stock market must be attractive enough for the wealthy to consider investment there, as opposed to, for example, foreign investments, commodities (like oil), or real estate.

4.      Stock market companies who receive the investment must, in turn, invest in expansion and increased employment, with the goal of increased production and lowering prices of their products.

5.      The demand for the products must increase as production increases so the company still makes at least the same profit as before the expansion.

The economy must continue to expand, with people buying an increasing number of the lower cost product. 

Supply-side economics proposes that production or supply is the key to economic prosperity and that consumption or demand is secondary. 

In other words, supply will influence demand.

Bush-onomics

Skip ahead again to 2001, with our current President George W. Bush. 

Bush inherited an unsteady economy from Democratic President Bill Clinton.  Over the three quarters prior to March 31, 2001, the economy grew only at a 1.1% annualized rate.  Much of this was credited to the bursting of the the dot-com bubble.

With threats of impending recession from Federal Reserve Chairman Alan Greenspan, Bush argued with Congress for a $1.35 trillion tax cut over ten years to stimulate the economy and create jobs.  It was approved.

The early 2000s recession (which was not technically a recession) following the 1990s boom was not as bad as was predicted, but was still characterized by outsourcing followed by large layoffs, and recovery without strong employment growth. 

Despite the resultant effects of the 2001 9/11 attacks, President Bush managed to keep the country out of recession.

Large numbers of economists were against the tax cuts, saying they will fail as a stimulus and “will worsen the long-term budget outlook … [and] generate further inequalities in after-tax income.”  The President claimed the tax cuts paid for themselves through economic growth, but it took them until FY2006 to surpass the 2000 level and will take until 2011 to recover all the funds advanced. 

Economist Arthur Laffer stood alone in stating that the tax cuts were “what was right,” because after the 9/11 attacks and threats of recession, the President “needed to stimulate the economy and spend for defense.”

Side note: Even with the tendency of the business cycle to produce periodic recessions,  under Bush’s administration the length of time between recessions has extended to a record-breaking 17 years of sustained growth, in employment, personal income and Gross Domestic Product (GDP).  In addition, there were decreases in the government deficit for years 2005, 2006, and 2007.  Deficits however, still add to the public debt. 

The previous record between recessions was 11 years, 1958 – 1969. 

The supply-side economics of the Bush administration shows that he acted prior to a recession taking hold. 

1.      Taxes were not stifling to business investors, even though the economy was struggling.

2.      Tax cuts issued up to 2003 resulted in a 20% increase in income of the top 1% income households. 

3.      The stock market received a great deal of investment, rising  nearly 32% from January 2001 (10,686) to October 2007 (14,093). 

4.      Production expanded, reducing unemployment from a high of 6.3% in 2003 to 4.4% in March 2007, with an average of 5.2%.

This was an example of supply-side and trickle-down economics that worked for seven years, prior to the ‘economic downturn.’  The President executed a preemptive strike and kept the nation out of recession for most of his two terms in office. 

Recession of 2008

The economic downturn is a harsh reality of economic cycles.  It is now up to our President elect to lead us back to prosperity.

This recession, started by the bursting of the U.S. housing bubble, leaves businesses with their expansions hanging like a stone around their necks with no customers and sharply reduced stock value. 

But that is the subject of another post.