How Budget Plan Would Affect Consumers

The Bush Administration’s budget plan, if enacted as proposed, could have a significant pocketbook impact for many American families. The government, in an effort to spur savings and long-term economic growth, said it wants to give savers, home buyers and investors a tax break.

It would do this by cutting capital gains tax rates, allowing penalty-free withdrawals from retirement accounts for certain home purchases and launching a so-called family savings account.

There is serious doubt whether the Administration’s plans have a chance of getting through Congress, since similar proposals have previously been shot down. But if they did pass, how would they work and how would they affect consumers? Here are the answers to some basic questions.

What cuts are proposed for capital gains?

The Administration has set up a three-tiered plan for capital gains taxes. If an investment--including stocks, bonds and real estate--were held for three years or more, investors would be allowed to “exclude” 30% of the gain from taxes. That would effectively lower the tax rate on the gain to 19.6% for those in the top bracket of 28%.

If the asset were held for only two years, the exclusion would be 20%--which equates to a 22.4% marginal rate for those in the highest tax bracket. The exclusion would fall to 10% for those holding the asset for only one year, a 25.2% effective rate. Investments held for less than a year would continue to be taxed at today’s rates.

What breaks are planned for home buyers?

Those who have not owned a home for at least three years would be able to withdraw up to $10,000 from their Individual Retirement Accounts for a down payment without triggering tax penalties. Currently, investors face a 10% tax penalty on withdrawals from retirement plans if they are under the age of 59 1/2. They also must include the withdrawn amount in taxable income for that year, which also increases their tax liability.

Under this proposal, the 10% penalty would be waived, although taxable income would rise based on the amount withdrawn. The one caveat is the house could not cost more than 110% of the median home price in the area.

What is the “family savings” plan?

This plan would essentially create a sister for Individual Retirement Accounts that could be used by higher-income individuals. Those earning no more than $60,000 annually and couples with combined income of $120,000 or less would be able to contribute $2,500 individually ($5,000 for a couple) to Family Savings Accounts. Contributions would not be tax-deductible. But if the money were held in the account for more than seven years, the earnings on the account would accrue tax-free.

Investors would get their tax breaks at the back end of the deal instead of getting upfront deductions like those offered on IRAs.

On the other hand, money in a Family Savings Account could be withdrawn prior to retirement. But if it were taken out in less than three years, investors would pay a penalty tax of 10% on the withdrawal. Between three and seven years, withdrawals would not be penalized but would be taxable.

Currently, contributions to IRA accounts are tax-deductible for individuals earning less than $35,000 ($50,000 if married, filing jointly) and for those who do not participate in another qualified retirement plan. Interest accruals on IRAs are also tax deferred--in other words, you don’t pay until you take the money out. However, if contributors take their money out before age 59 1/2, they must pay a 10% tax penalty.

With the family savings account, contributions and interest accruals are tax-free when withdrawn.

When would these proposals go into effect if passed by Congress?

According to the budget proposal, the family savings account and breaks for home buyers would be effective as of Jan. 1, 1991. The capital gains proposal would go into effect in a staggered fashion over the next three years.

However, there are serious questions about whether any of these plans will pass muster in Congress. Congress has rejected similar--in some cases, identical--plans in previous sessions, complaining that they favored the wealthy. Those concerns could derail these programs once again.

Moreover, all the proposals would cost the government money. And with deficits still running at record levels, that’s tremendously unpopular.