The uncertainty over tax rates, which had been hanging over the market all year, was lifted last night with the announcement that President Obama and Congressional Republicans agreed to extend the “Bush tax cuts” for all income levels for two years. According to the agreement, dividend and capital gains taxes will remain at their current level of 15%. The plan also includes a decrease in the payroll tax, an extension of unemployment benefits, tax cuts for business investment, and an estate tax rate of 35%, lower than the 55% rate scheduled to go into effect in 2011.
These substantial tax cuts should help the market in the short term, resolving uncertainty and perhaps increasing consumer spending. The market rose initially on the news. In the long term however, the tax cuts will be very costly. The plan adds as an estimated $900 billion to the deficit. This shows that despite the landslide GOP victory in November Washington does not seem serious yet about addressing the deficit.