Back in the good 'ole days of budget surpluses (i.e., 2001 and 2003), the Bush administration was concerned that if surpluses grew too large, they would stifle the economy's growth. In an effort to reduce the surpluses, Congress enacted significant tax cuts for all tax brackets that would be effective until the end of 2010.
Given the continually fragile state of the economy and enormous budget deficits, should the tax cuts be extended or should they be permitted to expire? The answer to that question is very complicated and requires a little background information.
From the most simplistic point of view, most economists advocate that in order to restart the economy, we need to stimulate consumption, which should cause employers to hire additional workers, which should reduce unemployment, which should further stimulate consumption, and so on and so forth. Because of this generally accepted premise, the issue at the heart of the debate surrounding the Bush tax cuts is whether the cuts will efficiently stimulate consumption and aid the economic recovery.
Even if the tax cuts do effectively add to the economic recovery, they will very likely continue to add to the budget deficit over the next 10 years to the tune of $3.7 trillion, according to the nonpartisan Tax Policy Center. Although Republicans may argue that the costs of the tax cuts will be netted out by increases in taxable earnings, there is little evidence to suggest that this will occur, at least in the short-term.
Surprisingly, many Democrats and Republicans agree that the tax cuts should be extended, at least temporarily, for 97% of Americans, i.e., all but the top two tax brackets. In terms of income, this means the cuts will be extended for those individuals that make less than $200,000 per year and those families that make less than $250,000.
Republicans argue that the cuts should be extended to all tax brackets because of the tenuous economic recovery and because of a possible "double dip," — a worsening of the economy caused by too little consumption. They argue that increasing the tax rates on the wealthy will discourage business owners from hiring new employees or reinvesting profits in their businesses. A relatively small group of Democrats also support this premise.
Democrats contend that the taxpayers in the top two tax brackets will not allow increases in their tax liabilities to affect personal spending, business spending, or hiring new personnel. They claim that business owners will hire additional employees if it is a good idea, regardless. Democrats also claim that the wealthy are much more likely to simply save their money than spend it, but that those lower-income taxpayers are much more likely to spend the money and increase consumption immediately.
According to the Tax Policy Center, if the tax cuts are allowed to lapse for the top two tax brackets, it will shave $700 billion off the budget deficits over the next 10 years. However, if all the cuts are extended, the majority of that $700 billion will go to the wealthiest 1/10 of 1% of Americans, who earn more than $7 million per year, on average, and will result in an average tax savings of $3 million over a 10-year period for those taxpayers.
Although many Democrats and Republicans do think the tax cuts should be at least partially extended, there are those that think the cuts should be allowed to lapse completely, including former Federal Reserve Chairman Alan Greenspan. During an Interview on NBC's Meet the Press, Greenspan said: "[t]he problem we've gotten into in recent years is spending programs with borrowed money, tax cuts with borrowed money, and at the end of the day, that proves disastrous."
Because this is an election year, members of Congress are loathe to increase taxes on constituents and may not act until after the November elections, at the earliest, and possibly not until next year. If the tax cuts are allowed to expire, taxpayers in most tax brackets will see a 3% to 5% increase in their tax liabilities. The marriage penalty will return, meaning the standard deduction for married couples will be less than the standard deduction for two unmarried people. The child tax credit will be reduced from $1,000 to $500. The long-term capital gains tax will increase from a maximum of 15% to 20%. Qualified dividend plans, which are now taxed at 15%, will be taxed at the same marginal rate as the taxpayer.
What do you think? Do you support allowing the cuts to expire? Why or why not?
This is a guest post by Steve Cook. Steve is an associate with a Phoenix, AZ-area law firm that specializes in taxation. He is also a bit of an economics, web design, and software engineering nerd. Read more articles from Steve's firm:
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