Kiplinger Connection
The Economy • Energy • Taxes

The Economy: Inflation is in check, interest rates hold.
Energy: Oil will continue a slow downward spiral.
Taxes: The new housing law may hurt some.

The Economy
With the economy expected to grow 1.5% this year and next, businesses and consumers stung by gas prices, real estate, and credit woes must wonder:
Where is the growth coming from? Weakness seems to be nearly everywhere.
Exports, federal spending, and rebate check shopping are feeding GDP gains. The weak dollar helped boost exports by a bit more than 9% in the second quarter. Federal spending ... up nearly 7%. Consumer spending ... a better than expected 1.5%.
What’s not rising is business spending on new equipment ... down 3.4%.

One sweet note for everyone: Inflation is in check. Although energy and food prices have soared, underlying inflation ... measured using GDP figures and the best available gauge of price pressures in the economy ... rose just 2.1% in the last quarter. That’s close to the Federal Reserve’s long-term goal of 2%.
When the Fed met Aug. 5, it kept interest rates steady.
Monthly job losses should taper off into the fall, maybe even reverse, with tiny monthly gains in employment. For the year ... a net loss of 500,000.

Energy
Seeds of a recovery lie in easing oil prices, a trend we expect to continue.
By year-end, look for oil prices at about $110 a barrel. Come 2009 ... averaging at or near the $100 mark, though there’ll be plenty of ups and downs.
That’ll take close to 40¢ a gallon off gasoline pump prices by late December, putting the national average at about $3.50. In 2009, we see a further decline and an average for the year of roughly $3.40, 20¢ less than the average this year.
Figure on paying about 50¢ less for a gallon of diesel by New Year’s. The 2009 yearly average should run near $4.15 a gallon, 15¢ below this year.
It’ll take longer for users of heating oil to enjoy any downward movement. Retail customers will have to pony up about $4.50 a gallon by December. Next year, however, the average for the year will be 15¢ a gallon or so lower than in 2008.
Consumers will put the savings into dining out, shopping, and home repairs, while firms will ponder adding workers and investing in new plants and equipment.

There’s no magic in the oil price decline:
There are no shortages. And demand is softening. Oil producers are watching anxiously as individuals and firms permanently adopt energy saving measures. Drivers who converted to hybrid cars, for example,
won’t return to gas-guzzling SUVs and pickup trucks. The drop in gasoline prices may spur a bit more driving, but not enough to return pump prices to previous peaks.

Warnings about running out of oil are overdone.
Oil production will likely rise 10% by 2018, though it will be pricey. Even as older wells in the U.S., Europe, and elsewhere fade, new technologies will open production from huge reserves off Brazil’s coast ... potentially 50 billion barrels of oil. With other likely bonanzas ... in the Arctic and off the U.S. and West African coasts ... increases in oil supply will outpace demand, despite continued rapid growth in emerging economies.
Moreover, increased conservation and alternative fuels will play a key role. Doomsday forecasts made a decade ago underestimated the impact they’d have.

Taxes
The new housing law is chock-full of tax breaks for homeowners.
Property taxes can be deducted in 2008, even if you don’t itemize. The one-year-only break is capped at $1,000 for couples and $500 for singles.
A tax credit for first-time home buyers is also included in the bill. The credit, which is in effect an interest free loan of up to $7500, is phased out for high-income taxpayers and must be paid back over 15 years beginning in 2010.
Some taxes were raised to help offset the cost of these and other credits ... about $12.4 billion over 10 years. One change for some taxpayers restricts a break on the sale of a second house that has been converted into a primary residence. Conversions after 2008 won’t be eligible for a 100% tax free profit on selling.

Tightening the rules on car donation deductions is paying off handsomely.
Write-offs dropped 80% in 2005, the first year that tougher rules applied. Taxpayers claimed $470 million on 300,000 returns reporting vehicle donations. That’s down from $2.5 billion on 900,000 returns a year earlier under the old rules.

Upper-incomers are bearing a record share of the U.S. income tax burden.
The top 1% of filers paid 39.9% of all federal income taxes for 2006, up half a point from 2005. That group reported 22% of adjusted gross income. The top 5% of earners paid 60.1%. The lowest-earning 50% paid just 2.99% of taxes.