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– January 15, 2016
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Monetary Policy
Growth expectations shift downward.
On Dec. 16, 2015, the Federal Open Market Committee raised its target for the federal funds rate to a range of 0.25 percent to 0.5 percent, an increase of 25 basis points. It was the first step since June 2006 to move the target rate higher and was widely anticipated.

Along with the rate increase, Federal Reserve policy makers also updated the central bank’s economic forecast. The latest projected range for longer-run real GDP growth was substantially lower, at 1.8 percent to 2.2 percent, than the 2.3 percent to 2.6 percent expectation in 2012. That drop of about 0.5 percent points is a major shift down in growth expectations.

A similar drop occurred in the outlook for the longer-run unemployment rate. In the earlier projections, the rate was 5.2 percent to 6 percent. In the latest projections, it was 4.8 percent to 5 percent. The outlook for longer-run inflation remained at 2 percent.

Finally, and most important in our view, was the drop in the longer-run fed funds target rate. In the earlier projections, the consensus range was 4 percent to 4.5 percent. In the latest update, the range stood at 3.25 percent to 3.5 percent, a drop of 75 to 100 basis points. A basis point is one one-hundredth of a percentage point.

This long-run target is important because it is the one element in the projections the Fed has control over. Aiming too low could eventually lead to higher inflation. Aiming too high could trigger a new recession. Looking at the past, some suggest that Fed policy makers were at least partly responsible for triggering some recessions by raising the fed funds rate too high. The good news is that the current rate-setting committee has repeatedly indicated that it will be deliberate in its decision making – balancing an emphasis on incoming data with the need to act preemptively and balancing the dual mandates of maximum employment with stable prices.


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Tax Policy
Making tax breaks permanent could cost $680 billion over 10 years.

In December, Congress passed (and President Barack Obama signed) the Protecting Americans from Tax Hikes, or PATH, act. The law clarifies several important provisions of the federal tax code and is expected to reduce revenue by about $680 billion over 10 years ($830 billion when interest is included) by making several “tax extenders” permanent or extending them for several years. Tax extenders are special credits or deductions added over the years that are subject to annual renewal.

There is something for everyone in the measure. Several provisions help low- and middle-income families pay for college. Businesses get tax breaks, and the act includes special rules that help nonprofit organizations. However, notably missing from the law are any offsetting spending cuts or revenue raisers, so while helping many families, it will widen the U.S. budget deficit.

We look here at the tax extenders most likely to affect you. Estimates for the 10-year cost are from the Committee for a Responsible Federal Budget (crfb.org), a bipartisan, nonprofit watchdog group in Washington.

Charitable distributions from individual retirement accounts, or IRAs: PATH makes permanent a rule that lets people who are at least 70½ years old donate up to $100,000 a year from an IRA without being taxed on the distribution. Estimated 10-year cost: $9 billion.

State and local sales tax deductions: PATH makes permanent a rule that lets taxpayers deduct either state income taxes or total sales taxes paid. This can be particularly important for people who itemize deductions in states with no income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) or that only tax income from interest and dividends (New Hampshire and Tennessee). Estimated cost: $42 billion.

American opportunity tax credit: This gives qualified taxpayers a credit of up to $2,500 a year for certain higher education expenses. PATH has made this credit permanent, a big help for low- and middle-income families with children attending college. Estimated cost: $80 billion.

Child tax credit: Another bonus for low- and middle-income families, this provides a $1,000 tax credit for each qualifying dependent child in a household. The law also modifies the earnings threshold for low-income households, making it more generous to those families. Estimated cost: $88 billion.

Mortgage insurance premiums: PATH extends for 2015 and 2016 the tax deduction for homeowners who pay for private mortgage insurance. Estimated cost: $2.3 billion.

529 plans: A notable change for 529 plans, the most common college savings plans, is the ability to use proceeds for computers and related college expenses. Estimated cost: $53 million.

Research and experimentation tax credit: Although it’s not likely to affect your personal finances, one of the largest provisions made permanent is a credit for business spending on research and development. Estimated cost: $113 billion.

The majority of the provisions were made permanent, with a 10-year revenue loss of $562 billion. The bulk of the remainder, $74 billion, were extended until 2019. Only $49 billion of the revenue loss will come from changes that are effective for two years.

Next/Previous Section:
1.Overview

2. Economy

3. Inflation

4. Policy

5. Investing

6. Pulling It All Together/Appendix

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