Bush tax cuts: Cutting through the noise

chart_bush_tax_cuts.top.gif By Jeanne Sahadi, senior writer


NEW YORK (CNNMoney.com) -- President Obama met on Tuesday morning with House and Senate leaders of both parties to begin to negotiate the terms of extending the Bush tax cuts.

No agreement was reached, but Obama said he appointed Treasury Secretary Tim Geithner and White House Budget Director Jacob Lew to start working with four appointed Republicans to work out a deal. "That process will begin right away," Obama said. "We agreed there must be some sensible common ground."

Both parties want to ensure that the tax cuts are preserved for lower- and middle-income families. But that's about the only thing they agree on at the moment.

To date, all the political jockeying and carefully worded answers to pointed questions have confused the issue for a lot of people. So we'll try to offer clarity on just what it is that's being debated and what's at stake.

What happens on Jan. 1 if Congress does nothing?

If no tax-cut extension is approved by Dec. 31, everyone's federal income and investment tax rates would go back up to where they were before the 2001 tax cuts were passed.

And if lawmakers again fail to extend them next year and make them retroactive to Jan. 1, your 2011 tax bill would increase.

If the tax cuts do expire and tax rates go up, you may notice the difference in your wallet as early as January, when your employer starts to withhold more taxes from your paycheck.

The Tax Policy Center estimates that a married couple with two kids under 13 and a household income of roughly $75,000 could end up paying about $2,600 more in federal income taxes next year than they would if the tax cuts were extended.

But the likelihood of all the tax cuts expiring isn't high, since both Democrats and Republicans agree on one thing: They want to extend the tax cuts at least on income below $200,000 for individuals ($250,000 for joint filers).

If Congress punts on any real decision about the Bush tax cuts, there are steps lawmakers or the IRS can take to prevent paychecks from shrinking in January, including passing a very temporary extension of the cuts into the early part of 2011 to buy lawmakers time to come to agreement on the issue.

What's the economic argument for extending the tax cuts?

Here's the main concern of many economists and lawmakers: If Americans' tax bills go up next year, they will have less money to spend and invest in the economy, and that could erase whatever economic ground has been recovered since the housing crisis sent the country into a tailspin.

If the tax cuts are extended, however, taxpayers won't really notice any change in their bottom line. So it's unlikely to create any new stimulus for the economy.

That's in part why some deficit hawks, like Diane Rogers of the Concord Coalition, say the Bush tax cuts should be compared to other types of tax cuts to see which offer the best chance of stimulating the economy to make sure the money is well spent.

Overall, extending the tax cuts may prove to be a mixed bag for the economy if they are extended permanently, according to an analysis by the Congressional Budget Office. In the short-run, making them permanent might help preserve the recovery, but may actually dampen economic growth in the long run because extending the cuts would add significantly to U.S. debt.

That's why many who don't want to let the tax cuts expire right away are only pushing for a one- to two-year extension.

What's the fight over the $250,000-plus crowd all about?

President Obama and many Democrats have said they want the Bush tax cuts to expire on income over $200,000 for individuals ($250,000 for couples).

Republicans want the tax cuts made permanent for everyone.

Their argument: wealthy taxpayers don't need the extra money, and if they get it they will probably save it and not spend it. That won't do much to help the economy. By contrast, they say, lower- and middle-income families are more strapped and would be more likely to spend any extra money from a tax cut.

If Obama gets his way, high-income households would see the top two income tax rates increase to 36% (from 33%) and 39.6% (from 35%). In addition, their investment tax rates would go up to 20% from 15%.

But high-income taxpayers would still benefit from the extension of tax cuts for the middle class. Among other things, that's because the changes made at the lower tax brackets would be preserved for everyone. Two examples: the creation of the 10% tax bracket and the reduced marriage penalty. The marriage penalty used to result in two-earner couples paying more than they would have as two single filers.

And, ironically, if the Bush tax cuts do expire for top earners, some might actually find themselves with a somewhat smaller tax bill next year.

Republicans and some Democrats say the cuts should also be extended for high earners, at least temporarily because the economy is too fragile to raise anyone's taxes.

Republicans also contend that small business job growth could be hurt because some business owners file at the top two tax rates and they, while a very small minority, generate a lot of small business income. The tax statistics aren't very clear, however, on the job creation potential among those who report small business income at the top two income tax rates.

What's at stake for the deficit?

The U.S. Treasury estimates the costs of making the tax cuts permanent for everyone is $3.7 trillion over 10 years.

Of that, $3 trillion accounts for the cost of extending them for the vast majority of Americans, as the president has proposed. The remaining $700 billion is the cost of extending them permanently for the high-income earners.

The cost would obviously be less if the cuts were extended for only one or two years, which is what many Capitol Hill watchers expect will happen in the end. There are no formal estimates for a short-term extension, but based on Treasury Department numbers, the cost is likely to range anywhere from $200 billion to $500 billion, depending on whose cuts are extended and for how long.

Those who support extending the tax cuts note that if the cuts expire and the economy suffers as a result, the deficit will get worse because the government will have to borrow more. To top of page

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