House, Senate Reach a Deal on Tax Cuts

House and Senate negotiators on Wednesday agreed to a $350-billion plan to cut taxes and provide aid to financially struggling states, capping months of debate over how much to scale back President Bush’s more ambitious plan to spur economic growth.

The bill’s costliest and most controversial element is a plan to slash taxes on dividends and capital gains -- a compromise reached after President Bush abandoned his push to eliminate, not just reduce, taxes on dividend income.

But even for taxpayers with no investment income, the measure promises a quick infusion of cash.

Cuts in income-tax rates now scheduled for 2006 would occur immediately, and could be reflected in reduced payroll withholding as early as July 1. Some 25 million low- and middle-income families with children could receive refund checks of up to $400 a child as early as this summer. Married couples would get a larger standard deduction when they file their 2003 tax returns.

The compromise bill is expected to clear the House and Senate and go to the White House for Bush’s signature before week’s end. Overall, it calls for roughly $315 billion in tax cuts, $20 billion in aid to states and about $15 billion in refunds for low-income families with children.

Of the aid to states, California would get an estimated $2.5 billion of the total.

The tax cuts are less than half the $725 billion Bush proposed in January when he unveiled his plan to help the nation’s sluggish economy. But amid congressional concern about the mounting federal deficit -- as well as the war with Iraq -- it quickly became clear that he would have to settle for less.

Wednesday’s deal was struck after Vice President Dick Cheney came to the Capitol for an afternoon of hard bargaining -- a kind of shuttle diplomacy among Republican factions warring over the size and details of the tax cut. His active role was a sign of how urgently the administration wanted Congress to finish the bill this week, before lawmakers begin a weeklong Memorial Day recess.

Timing of congressional action on the tax-cut bill is economically and politically important to Bush. The longer it takes to get the money it provides flowing to consumers, businesses and beleaguered state governments, the less likely the economy will have significantly improved as the 2004 election draws near.

Precise estimates of the impact of the whole bill on particular families remained uncertain because of details still in flux. But changes in the tax brackets alone would save a single filer with $65,000 in annual income $741 in federal income tax. The dividend change would save a taxpayer in the 33% bracket $180 for every $1,000 in dividend income earned. Changes to the tax rates for capital gains -- profits from the sale of stocks, real estate and other assets -- would save investors roughly $5 for every $100 in gains.

While most of the tax cuts would take effect retroactively to Jan. 1, 2003, they would not stay on the books for nearly as long as the 11 years Bush proposed. To keep down the bill’s total cost, most of its provisions would be only temporary.

Precise expiration dates were still being calculated Wednesday, but the tax cut on investment income would likely last until 2008. Meanwhile, tax credits for families with children, tax relief for married couples and new incentives for businesses to invest and expand would probably last no more than two years. The accelerated income tax rate cuts would expire in 2011.

Critics denounced the temporary nature of many of the tax cuts as illusory, arguing most, if not all, would be extended. They derided the cutoff dates as gimmicks designed to obscure the bill’s true long-term drain on the deficit-ridden federal budget.

“We know that the price tag is fake because the backroom negotiators are intent on putting an artificial ‘sunset’ on the tax cuts, an expiration date that they know is not real but makes it appear as if a tax cut does less damage to our fiscal situation,” said Rep. Charles Rangel (D-N.Y.).

Final details were still being worked out overnight, but GOP House and Senate leaders voiced confidence that they could pass the bill as early as today. They also acknowledged that many Republicans are bound to be disappointed that the tax cut is so much less than the original Bush plan.

“Obviously, we’re disappointed we couldn’t get more,” said John Feehery, spokesman for House Speaker J. Dennis Hastert (R-Ill.). “But you’ve got to look at the big picture. If the Democrats were in control, we’d be raising taxes.”

The compromise was crafted to resolve differences between versions of the bill passed recently by the House and Senate. Although both bills had similar provisions on individual income tax breaks, they differed in other important respects.

The House bill would have cut taxes $550 billion over 11 years and called for reducing -- not ending -- the dividend and capital gains taxes. The Senate bill was a $350-billion package that would have eliminated dividend taxes for three years. It included some $90 billion in tax increases to hold down its cost.

The White House initially favored the Senate dividend-tax provision because it embraced the principle of repeal. But administration officials concluded that a bill would pass this week only if they backed down on insisting that the dividend tax be eliminated.

Late Tuesday, negotiators agreed to a compromise $383-billion tax cut package that was based on the House approach of cutting dividend and capital gains taxes. But that deal broke down because it exceeded the $350-billion benchmark several pivotal senators said was the most they would support.

“I have to stick to my guns,” said Sen. George Voinovich (R-Ohio), who was among the holdouts.

House Ways and Means Committee Chairman Bill Thomas (R-Bakersfield) refused to accept Senate proposals that would have held down the cost of the bill by including offsetting tax increases targeted at businesses and Americans living abroad.

The impasse was broken, with Cheney’s help, with the agreement to keep the cost of the bill to $350 billion not through tax increases but by making the cuts last for shorter periods than the initial compromise proposed.

Almost unchanged was a Senate proposal to provide $20 billion in aid to states, most of which are struggling to balance their budgets. Half the money would be earmarked to increase the federal share of Medicaid, the federal-state health program for the poor. The other half would go to states as unrestricted grants for other social services.

Taxpayers would feel the most immediate impact from provisions that accelerate income tax rate reductions set to take effect 2006 under the Bush-backed law passed in 2001. Under the new bill, income tax rates would drop from 27%, 30%, 35% and 38.6% now to 25%, 28%, 33% and 35%, effective last Jan. 1.

The increase in the per-child tax credit from $600 to $1,000 goes only to taxpayers who meet current income guidelines. Under these rules, married couples qualify for the full credit if they earn less than $110,000 a year; individuals earning less than $75,000 qualify.

To pump money into the economy quickly, the Treasury Department is expected to send out checks before the end of the year, based on estimates from 2002 returns. Although the increase in the child credit is set only for 2003 and ‘04, the bill’s proponents say they expect Congress would renew the higher tax break before it expires.

The compromise also promises two years of tax relief to married couples, who often suffer from the “marriage penalty” -- a quirk in the tax code that means couples end up paying more to the government than if they filed separately. The bill tries to reduce that inequity by, among other things, increasing the standard deduction allowed for married couples.

The dividend provision would eliminate the current discrepancy in the tax treatment of different kinds of investment income. Now, dividends are taxed like ordinary income, at rates of up to 38.6%. Capital gains are taxed at a rate of 20% for most taxpayers and 10% for lower income people.

Under the compromise, both dividends and capital gains would be taxed at 15% for most taxpayers, 5% for lower income people -- but only through 2007. In 2008, the 5% rate would drop to zero. That gives Bush a symbolic victory by having the dividend tax eliminated for a small group of taxpayers. But even that victory would be short lived: The current tax rates would be reinstated in 2009.

As with the child credits, however, the bill’s proponents anticipate the cuts would be extended.

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Times staff writer Kathy M. Kristof in Los Angeles contributed to this report.