What Congress does—or doesn't do—about the Bush tax cuts and how it will affect you.

What Congress does—or doesn't do—about the Bush tax cuts and how it will affect you.

What Congress does—or doesn't do—about the Bush tax cuts and how it will affect you.

Moneybox
Commentary about business and finance.
Nov. 16 2010 5:43 PM

Cutting Through the Noise

What Congress does—or doesn't do—about the Bush tax cuts and how it will affect you.

1040 tax form.
Will Congress keep tax cuts for the "middle class"?

Some things never change. The current Republican leadership, like the Republican leadership of the early aughts, likes tax cuts—the broader the better. The current Democratic leadership, meanwhile, doesn't want to be accused of raising taxes. Welcome to the dying days of the 111th Congress, devoted to replaying the battles of the 107th and 108th.

The last big fight of this lame-duck session is over tax cuts passed in 2001 and 2003. Most Republicans would like to keep all of them. Most Democrats want to make the middle-class tax cuts—that's the term all sides are using for the parts of the law that affect individuals making less than $200,000 a year or families making less than $250,000—permanent. But they also want to let the breaks for the wealthiest 2 percent of Americans expire.

What is everyone bickering over? What does it mean for "middle-class Americans," the group every side is supposedly looking out for? Is Congress really raising taxes? Here, as a public service, are answers to these questions.

Last question first: Congress isn't really raising taxes. At least this Congress isn't. The 107th and 108th, back in the early aughts, passed this tax hike as part of a tax-cut bill. (Stay with me; it gets better.) Republicans wanted big, permanent tax cuts but lacked the votes to get them through the Senate. So they passed the two bills slashing taxes using the budget reconciliation process, which allows the party in power to avoid filibusters. Then they had to deal with something called the "Byrd rule," which lets senators block reconciliation legislation if it results in an increase in the deficit 10 years after its passage. Republicans handled that problem by simply writing an expiration date into the law: Jan. 1, 2011. The thinking was that no future Congress would dare allow taxes to go back up, and so these temporary cuts were really permanent.

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On Thursday, President Obama plans to start negotiations on a compromise—which should be interesting, given that Congress has only about 35 working days before the cuts expire altogether. The current betting is that Congress will agree to extend the cuts for a year or two, and then figure out its next move later.

Still, given Congress' ability to not get things done, it may be worth considering what happens if it cannot come to an agreement. Starting Jan. 1, just about every taxpayer would see higher rates. Right now, income tax rates fall on a sliding scale from 10 percent to 35 percent. That scale would shift, with new brackets starting at 15 percent and going up to 39.6 percent.

It is a little hard to parse out the effects for average families—this tax law was complicated, as is the tax code. But the easiest way to understand how, and how much, taxes will go up is to look at average effective tax rates, the percentage of income that families and individuals pay—including taxes, deductions, exemptions, and everything else. The Tax Policy Center estimates that, if the Bush cuts expire, a family in the lowest income quintile would pay 5.2 percent of its income in federal taxes, rather than 4.6 percent, for the 2011 tax year. For a family in the top 20 percent of income, the jump would be from 25 percent to 28.3 percent.

What does that actually translate into, in dollars and cents? Middle-income earners—making, say, $60,000 per year—taking standard deductions could see their income taxes increase about $900. A married couple with two children, filing jointly, would face a lower standard deduction, higher rates, and a halving of the child tax credit, from $1,000 to $500—all told, a tax bill increase of perhaps $4,600. The impact would be greatest on the very rich, who make a lot of their money from stocks and other investments and who benefited most from the Bush tax cuts in the first place. The tax on capital gains would rise, and dividends would return to being taxed like regular income. For someone making $500,000 a year, the increase could amount to $20,000, more if a higher portion of income came from investments.

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What broader economic impact might the increases in taxes have? Well, in the short term, higher tax rates on all income-earners would almost certainly slow down the economic recovery—particularly higher tax rates on poor or middle-income families. For that reason, economists, policy experts, and politicians are nearly unanimous in saying that taxes should not go up for "the middle class," by which they mean families making less than $250,000 a year. For the rich, there is less of a consensus. There is evidence that rich folks tended to save the dollars gained from lower tax rates under Bush, rather than spending them, leading some Obama advisers to argue that Congress could let the cuts expire without hurting the recovery.

But many others think the economy could use another year or two of recovery before Congress considers any tax hikes at all. Mark Zandi, chief economist for Moodys.com, for one, has said that the Bush tax cuts weren't very effective as stimulus—but he supports temporarily extending them because they're better than nothing.

In the long term, though, letting the Bush tax cuts expire may actually do a lot of good for the economy. In September, the Congressional Budget Office ran the numbers on the various options for the tax cuts. The CBO looked at four scenarios: making all the tax cuts permanent, making only the middle-class tax cuts permanent, letting all the tax cuts expire in two years, and letting only the tax cuts for the rich expire in two years. The CBO then calculated the effects of these options on the gross national product, both two years from now and 10 years from now. In the short term, letting the Bush tax cuts expire led to lower GNP, compared with keeping some or all of them. But, in the long run, letting all the cuts expire proved the best option.

Why? The country's yawning deficit and massive debt. There might be good reason to keep the tax cuts in place now. But in a few years, there will still be 14-trillion-plus reasons to let them go.

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