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Economic Forecasts

Time to Tackle the Budget Deficit

Bipartisan ideas are credible, but are Americans ready for such strong medicine?

Economists and policy wonks have long warned that the burgeoning U.S. budget deficit poses a serious threat to our fiscal health. But a tax deal debated at press time could add as much as $900 billion to the tally.

The deal would extend the Bush tax cuts for two years, including an extension of the top 15% rate on capital gains and dividends. Social Security payroll taxes would be trimmed for one year and unemployment benefits extended for 13 months.

Ironically, Washington is also looking seriously at proposals from a bipartisan commission, appointed by President Obama, aimed at cutting the deficit by nearly $4 trillion over the next decade. The plan would simplify the tax code, replacing six brackets that rise as high as 35% with three -- as low as 8%, 14% and 23%, depending on tax breaks sacrificed. The changes would hit Americans in all walks of life right in the wallet:

Homeowners. The home-mortgage-interest deduction would disappear, to be replaced by a 12% tax credit on the interest paid on mortgages up to $500,000. There would be no tax break for interest paid on second-home loans or home-equity lines of credit. Under current law, homeowners can deduct interest on mortgages of up to $1 million on first and second homes, plus interest on up to $100,000 in home-equity debt. Now, someone in the 25% tax bracket with $10,000 in mortgage interest can deduct $10,000, for a savings of $2,500. Under this proposal, the break would be worth just $1,200.

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Retirees. The President's commission would gradually increase the age at which workers can claim Social Security benefits (to 64 for early retirees and to 69 for full benefits) by 2075, with some exceptions for workers in physically demanding occupations. The plan would also increase the amount of income subject to the Social Security tax. A new benefit formula would slow future growth, especially for high earners. (For more on Social Security, see You'll Still Get Social Security.) Medicare enrollees would face higher out-of-pocket costs but get more protection from catastrophic expenses.

Investors. Capital gains and dividends would be taxed at the same rates as ordinary income. An alternative proposal would exclude some capital gains and dividends -- say, 20% -- from taxation. Interest on newly issued state and municipal bonds, which is now exempt, would be taxed.

Employees. Tax breaks on employer-paid health insurance would be trimmed over time, until such benefits are fully taxable in 2038. The plan would consolidate the alphabet soup of tax-advantaged retirement plans, capping annual contributions from both employers and employees at $20,000 or 20% of income, whichever is lower. The top limit now is $49,000.

Students. Subsidies for Stafford loans would end, so interest would accrue while students are still in school.

Drivers. Gasoline taxes would increase 15 cents per gallon by 2015 to pay for roads and other infrastructure.