Your money: Washington's solution

The government has produced a massive tax cut and financial sector rescue plan to restore the flow of credit. But some say taxpayer dollars are being wasted.

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By David Goldman, CNNMoney.com staff writer

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NEW YORK (CNNMoney.com) -- Borrowing and spending are the lifeblood of the economy, but both have tightened up dramatically in recent months.

As banks and consumers hoarded cash, consumer spending, which accounts for 70% of the nation's gross domestic product, sharply declined.

While bank-to-bank lending rates have fallen, those institutions remain wary of lending to each other. That, in turn, makes them wary of lending to consumers. Lenders have reportedly turned down requests for auto and home loans even for borrowers with decent credit.

Lawmakers agree that a restoration of consumer confidence and the credit market is crucial to an economic recovery, but the government's solutions have been criticized for feeding more irresponsible decisions.

Here's a look at what the government is doing and who is being helped.

What's being done

To boost spending, the $787 billion stimulus bill enacted last month includes $212 billion in tax cuts, the bulk of which is the $116 billion Making Work Pay tax credit.

Making Work Pay is a refundable tax break for individuals worth 6.2% of earnings up to $400 per person ($800 for joint filers). For most working individuals, the credit will be paid over time at roughly $15 per period, assuming 26 pay periods in a year.

Other tax cuts include $40.5 billion to extend, increase and make partially tax deductible unemployment insurance benefits. The bill also includes $20 billion to increase food stamp benefits by nearly 14%, a $70 billion exemption from the Alternative Minimum Tax for middle-income families and a $14.2 billion program to send one-time payments of $250 to those who are retired, disabled or otherwise can't work.

To boost lending, the government has unveiled countless programs. By far the most well-known is the $700 billion Troubled Asset Relief Program, most of which so far has gone to shoring up banks' capital positions. The government hopes that banks will use the money to regain steady footing and resume their lending practices.

The Obama administration also unveiled its $1 trillion Consumer and Business Lending Initiative, formerly known as TALF. The program will provide financing to private investors to buy up consumer-loan-backed securities, which are bundles of loans that are then divided up and sold to investors like stocks. By creating a market for these now largely unwanted securities, which banks use to finance their lending, the government hopes that banks will start issuing new loans and interest rates for consumers will go down.

Other initiatives include a plan to support private investors' purchases of toxic assets, and a $1.5 trillion program to guarantee certain kinds of corporate debt for up to 10 years.

Who's being helped

Roughly 97% of U.S. households could see tax savings as a result of the stimulus plan, with average savings totaling $1,179, according to the Tax Policy Center. But how much a household actually gets depends on income, marital status and whether a filer has children. The savings range from a few hundred dollars to several thousand.

For Making Work Pay, the full credit would be paid to workers making $75,000 or less ($150,000 per couple) before taxes. A partial credit would be paid to those making above those amounts but no more than $100,000 ($200,000 for couples). Even very low-income families who don't make enough to owe income tax would be able to claim it, but in such cases, workers will need to file their 2009 tax returns to do so.

In terms of the financial sector rescue, the government hopes that when the credit starts flowing, the lending and borrowing cycle will restore the economy to a healthy state and secure consumers' ability to secure loans for college, cars and homes. Increased lending would also help businesses finance their payrolls.

What are the risks

The large hike in tax breaks have greatly increased the expected budget deficit to $1.75 trillion for the current fiscal year, which ends Sept. 30. The Obama administration has stated that it is committed to halving the current deficit level in four years, and some experts say higher taxes will be required to do that.

Furthermore, many cities and states currently face steep budget shortfalls, and many have no option but to raise taxes in the near-term, which may mute some of the impact of the Obama tax cuts.

Despite government initiatives, banks thus far have been reluctant to increase their lending. Some experts say the government will have a hard time getting banks to lend in the current market without forcing them. As many banks' situations just continue to worsen, many analysts worry the government's capital investments in banks are becoming a "black hole" for taxpayer dollars.

Others say nationalization, or a government takeover, of a bank is imminent, which could set a bad precedent. Detractors argue that nationalization interferes with business' ability to innovate and grow - or fail if necessary.

Banks may continue to make unscrupulous business decisions, if they believe they'll get a government bailout if the decisions go sour. To top of page

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