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Tax Cuts Will Likely Stall GROWTH Act

As the investment community applauds the two-year extension of the 15% Federal tax rate on dividends and capital gains through 2010, which President Bush signed into law via the Tax Relief Extension Act of 2005 last Wednesday, Washington-watchers say it might be a while before investors can expect any further tax breaks.

And that means the progress on tax bills tailored to the mutual fund industry, such as the Generating Retirement Ownership Through Long-Term Holding (GROWTH) Act, might be stunted.

That bill, known inside the Beltway as HR 2121, would call for all taxes on mutual fund earnings to be deferred until a shareholder cashes out. Any dividends that are reinvested would likewise be tax deferrered according to the proposed bill, introduced by U.S. Representatives Paul Ryan (R-Wisc.) and William Jefferson (D-La.) last May.

The Investment Company Institute has championed the bill since its introduction, but also conceded it might be a two-year work in progress.

Others say it might be longer.

"The entire industry would clearly love to see the GROWTH Act pass," said Geoff Bobroff, president of Bobroff Consulting in East Greenwich, R.I. "But [it] is troubled because it tends to focus on one industry, and most tax legislation does not benefit a single provider. I think it's the right answer [for investors], but I don't know what the impetus would be to get Congress to support it."

One reason is that 60% of the 91 million Americans who invest in mutual funds do so through tax-sheltered accounts, such as 401(k) plans, and therefore are not affected by taxes on dividends and mutual funds - at least not now.

Another reason is the increasing Federal deficit, which is now estimated to be $371 billion, or $2,700 per tax return, according to the Washington-based Tax Foundation, a non-partisan research group.

"There's a great pressure in all of these tax bills to create an off-setting revenue source," said Neils Holch, executive director for the Coalition of Mutual Fund Investors, also based in Washington. "I think the focus right now is on extending current provisions on things slated to expire. I don't know if there's much money in the budget to do anything much more than that," Holch said.

But that doesn't mean that the recent extension is the end of investor-friendly tax-cuts forever.

In fact, if there is a lesson to be learned from the recent extension of the law capping taxes on capital gains and dividends, it's that politicians are increasingly aware of a relatively new electorate: the individual investor.

"Things like this that might not have passed 10 or 15 years ago are able to pass now," Holch said. A big part of the credit for this increased power goes to mutual funds. Whereas, in the past, investing in stocks and bonds was only for the wealthy, mutual funds and 401(k) plans gave the middle class access to well-respected money managers, new capital markets and a reason to think of themselves not just as income-earners, but as investors, Holch said.

And, as the recent extensions show, politicians know that once a tax break hits the books - even one written as a temporary reduction with a so-called sunset date - it's awfully hard to take it back.

However, it's also hard to justify new breaks when there's no easy way to make up the lost revenue, said Merideth Dodson, director of domestic campaigns for RESULTS, the Washington-based not-for-profit aimed toward ending hunger. In fact, Dodson argued, cuts like these don't lift the economy, but widen the gap between rich and poor.

"To have a 15% rate on taxation on what I consider unearned income when a teacher is paying a higher rate on earned income just to make ends meet is just not right," Dodson said.

But such an "us-against-them" mentality poses no serious political threat to the passage of the GROWTH Act, according to Max B. Sawicky, an economist with the Economic Policy Institute, a not-for-profit, non-partisan policy think tank.

"People are not so concerned when [other] people get a tax cut. They think it's a freebie, and there's not much outrage," Sawicky said. "The GROWTH Act will pass."

Opponents of the recent extension, and other tax cuts that target investors, say that such breaks only amplify the Federal deficit, and result in service cuts for those who need them.

"Every dollar of spending claims a tax dollar sooner or later, whether it's another [type of] tax or [to pay for] debt services. When you cut taxes without cutting spending, you're not cutting taxes broadly, you're shifting taxes to younger people," Sawicky said.