Three Solutions to Expiring Bush Tax Cuts

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As you may have heard, the Bush tax cuts are set to expire on December 31st and the executive and legislative branches have been floating ideas on how to best resolve them. Republicans want to extend the cuts for everyone, which will cost $3.7 trillion over 10 years, whereas Democrats only want to extend them for the those earning less than $200,000 ($250,000 for married filing jointly), which itself would cost $3 trillion over 10 years according to the Treasury Department.

The debate lies in whether we extend the Bush tax cuts for everyone or extend it for everyone except the “rich.”

I use quotations not to be quaint but I don’t like it when terms like “rich” or “poor” are assigned to numerical figures without context. $200,000 is certainly a vast sum of money to earn each year but to peg it as rich seems irresponsible. $200,000 in Manhattan or London is vastly different than $200,000 in an area with a lower cost of living. It also is used in a pejorative sense, sort of like when kids made fun of each other for being smart in school, it only promotes “classism” and puts a pitchfork in the hands of anyone earning less than the “rich.”

Bush Tax Cuts

The 2001 and 2003 bills signed by President Bush lowered taxes by creating 10, 15, 26, 28, 33, and 35% tax brackets. In 2000, the brackets were 15%, 28%, 31%, 36%, and 39.6% and each range was higher (single filer ranges below):

  • 15%: 0 – $26,250
  • 28%: $26,250 – $63,550
  • 31%: $63,550 – $132,600
  • 36%: $132,600 – 288,350
  • 39.6%: $288,350

In addition to those cuts, the child tax credit was increased from $500 to $1,000 and top long term capital gains and qualified dividend tax was reduced to 15% from 20%.

Extension Options

So the two options on the table, both of which are preferred over the default, are (it’s not strictly on party lines but here it is for simplicity):

  • Republicans: Extend tax cuts to everyone.
  • Democrats: Extend tax cuts for everyone except those earning $200,000 or more ($250,000 or more for married filing jointly).

The Republican argument is that extending tax cuts for everyone will stimulate the economy more so than any stimulus package. The counter-argument is that it won’t because people won’t see a difference if the cuts are extended (since it’s status quo) and that the high earners don’t need the tax cut as much as the government needs the revenue.

The argument for extending tax cuts for high earnings is that small businesses are included in that mix and increasing taxes on them would chop the legs out from under the recovery, as small business it the biggest engine of job growth. The argument against that idea is that stimulus is more helpful than a tax cut and that not as many small businesses are affected.

Who is right? Who knows. If it were up to me, I’d extend the cuts for everyone except high earners. Small businesses would learn to adapt their cash flow strategy so that they won’t pay as much in taxes (using loans to bridge expenses so they don’t have to carry income from year to year) and high earners are more upset with the idea than with actually being taxed more. The increase from 15% to 20% on long term capital gains will probably increase their tax burden more than rejiggering the tax brackets.

Final Comparison

In the first two cases, Congress needs to pass a law for those options to take effect. The default result is for the tax cuts to expire for all, which is a result that no party wants. The likelihood that it happens is very slim but given the contentious nature of Congress and the reality that this issue will be tackled after November mid-term elections makes it a little higher than people are comfortable with.

Cuts Extended Expire for Rich Expire for All
10% 10%
15% 15% 15%
25% 25% 28%
28% 28% 31%
33% 36% 36%
35% 39.6% 39.6%

This isn’t a perfectly fair comparison as the income ranges for the brackets would not be the same and other tax credits and deductions need to be considered, but for our purposes it’s good enough.

Hopefully I’ve done an adequate job of explaining the debate, a brief look at the alternatives and their arguments, and hopefully Congress will act before December 31st to get a resolution to this.

{ 56 comments, please add your thoughts now! }

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56 Responses to “Three Solutions to Expiring Bush Tax Cuts”

  1. Dylan says:

    Jim, if you don’t want to promote classism, you don’t even need to say “rich” at all. The tax code applies to dollars,, not people (with the exception of filing status). Since the first $200,000 earned is taxed the same regardless of class, the tax code is not being applied differently based on class. However, when people refer to cuts for the “rich” or poor,” it sounds as if they are, and politicians know it. In the end, it does not matter if you are “rich” or “poor,” but if you earn over certain dollar amounts in a year, you pay higher taxes on those last dollars. I think debate focus should be on that point; referring class is not only vague but also irrelevant.

    • I like this comment a lot. It seems like no one understands how marginal tax rates work.

      • Donald says:

        If they eliminate the temporary 10% bracket then taxable income under $8000 or so will be hit with an additional 5% tax. This means that probably most people who read this blog will pay an additional $400 per person.

  2. Jeff says:

    Jim, good article, but I don’t like your using the idea of a tax cut as “costing” the government. That implies that the money is property of the government and not of those who earned it. Since you usually post articles concerning property rights, this isn’t what I expected to read here.

  3. Frugal says:

    Perhaps too simple solution – extend them for shorter duration say 3 years, not for 10 years – see how economy is doing in next three years and decide

  4. tom says:

    I’m a fiscal conservative, but I don’t see how we can sustain any type of tax cut extension. We are running a $1 trillion deficit for the 2nd year in a row. SS will not have any type of COL increase (some say it’s already unsustainable), the new heath care bill is already starting to cost corporations and small businesses billion more and the Gov’t wants to keep on spending!

    If you cut taxes, you had better have a plan to cut an equal amount of entitlement programs or services.

    • Jim says:

      The part about politics that makes me laugh is how fiscal conservatives seem to lambaste any mention of tax extensions even though we’ve had these tax cuts for 9 years. Where were the complaints about deficits then? I’m not saying you are wrong on any point you made, it’s just that all this over the deficit at this point seems more like political posturing than anything else. Don’t you think?

      • tom says:

        I absolutely agree.

        Fiscal conservatives (both D & R) are complete hypocrites. For one thing our tax system is completely broken, so increasing or decreasing taxes won’t solve anything. At the same time, so are our entitlement programs. You go after those… it’s political suicide.

        The real test of entitlements will be when Gen Y starts to gain control and have real voice. We all know SS won’t be around when we retire, so Gen Y needs to unite and go after it with a huge ax. Jack up the retirement age, turn it into a low income program as opposed to everyone. Put retirement responsibility back on the worker, not the government.

        As for Medicare, I have no answer, it’s a complete cluster.

        I digress…

    • cubiclegeoff says:

      I see your point. However, the lack of a COL increase for SS is due to it being pegged to inflation, and has nothing to do with how much is in the trust. But ultimately you either raise taxes or cut programs, and both are generally unfavorable to most people when you get down to details.

      • daenyll says:

        It seems that to come near anything like true balance, both the unfavorable options of ending tax cuts and killing or trimming bulky programs will need to be done. It might be best to ramp into these options, but we cannot sustain the trillion dollar deficits in the budgets.

  5. FlyFisher says:

    “Small businesses would learn to adapt their cash flow strategy so that they won’t pay as much in taxes (using loans to bridge expenses so they don’t have to carry income from year to year) and high earners are more upset with the idea than with actually being taxed more.”

    Or small businesses might struggle, fail, or lay off workers in an already down economy. Hiking taxes on individuals who have to report all their small business income on their taxes but are paying this income out to employees is not going to help matters. The government should give individuals incentive to be entrepreneurial, not incentive to close shop.

    • cubiclegeoff says:

      I’m not convinced that the increase would be that much of an impact. If a business is on the edge, sure this could put them over, but there could be a variety of reasons why they’re there in the first place. An if tax rates are keeping people from be entrepreneurial, then they probably don’t have the spirit or the drive, or the idea that would make them successful.

    • Jim says:

      If they pay the income out to employees, they shouldn’t declare it as income on their tax returns. That’s an accounting problem, not a tax problem. If you know of people doing this, they need a better accountant because that small business isn’t claiming expenses properly.

    • freeby50 says:

      THe idea that the roll back of Bush tax cuts will hurt small business seems to be based on fundamental confusion over how taxes work.

      If you are a small business reporting your income on your taxes then you ONLY pay taxes on your PROFITs after the expenses are deducted.

      Lets say you are a restaurant owner who has $450k a year in sales at the restaurant. You then have costs of $200k to run your restaurant. That means you have a profit of $250k. You are taxed on the $250k not the $450k. If you have $250k of profit then thats $250k of margin. A married couple with $250k income would be paying about $55k of taxes today. If you raise their taxes 2% for the amount >$200k then they would be paying $1k more in taxes. SO they get to take home $194k after taxes instead of $195k after taxes. This will not break any business, theres no reason for this to cause them to lay anyone off.

      • Scott says:

        The only caveat to this is you are assuming we’re only talking about $250k guys.

        If you’re talking about someone making $500k, he’ll be paying 3% over $250k or $7,500 more annually. If you live in Cali or NY get hit with another $625 monthly bill, it will make you think differently and spend less or hire less. I’ve personally thought of laying off our home cleaning lady with all the crap hitting the fan. I’ve also kicked cable to the curb and stream tv & got Netflix to save about $70 / month.

        I fall below the $250k annually and all this discussion has made my life change, even if slightly, compound the tv (as many of my friends have) and you will lose jobs or not grow them at Time Warner, Cablevision, etc.

        Not to mention my cleaning lady buying less. I have a bigger plan of retiring sooner than later, all the talk just makes me speed the process and analyze everything.

        fyi, I’m on NetIQ too. I saw you there as well. You look like you’re doing well in the early retirement catagory…

        • Loren Chiyo says:

          I live in CA and am a small business owner and there have been years where our combined income would be $250K or over.

          This amount appears to be a lot of money, but then you figure in the balloon mortgages that people here usually hold in order to have some type of a work life balance where they do not have to commute 3-4 hours to work each day. We have friends who live in Riverside where property is cheap, but then they wake up at 3am to commute 1.5-2 hrs to work EVERY SINGLE DAY.

          We bought an expensive house not because it’s a mansion (it’s a 2 on a lot town house), but because of its location (close enough to work for a sane daily commute), which when added to the prop tax and general high cost of living and the 9.75% sales tax, sucks up that earning very quickly. People can say that we “chose” to live here, but then again there aren’t that many big employers in our niche industry, so we “chose” to live where the job is.

          I can definitely say that we’ve been making conscious decisions to cut back on business, because it becomes a law of diminishing returns. I’d rather have better work life balance and keep more of my hard earned dollars, then work like a dog and pay much more taxes. It’s people who are on the cusp of that $250K who are looking at this the closest.

          • Scott says:

            I hear ya on the work-life balance. We do not need to make more here in Cali and pay out 36%+10% fed & state.

            We look to better our personal capital in a shorter commute (20 miles each way for me is best case, Encino to East LA). I worked out a position that allows 6-3 hours to help on the commute and I don’t think I could get any better than this unless I could work out of the house…that’s the way my wife is moving although her commute is 8 miles and opposite of traffic.

            We all should focus on improving our personal life experience and focus on something other than money & taxes…

        • freeby50 says:

          Higher taxes might cut into the discretionary spending of high income individuals. Or more often it might just reduce the amount they invest or save.

          My point was that +2% marginal tax rate on high profit levels for small businesses is NOT going to cause a business to go under or make them lay off employees. The idea that the expiring tax cuts will “hurt” small business any more than anyone else is wrong.

          • Scott says:

            Probably right on not laying off; just will think twice or delay hiring more people or working the ones they have until they break.

            If you cut “some discretionary spending”, there will not be a need for products being made or services offered.

            My personal experience is we’ve cut back, even though we don’t need to. Psychological news blues do affect even the well to do (which I’m not)…

  6. zapeta says:

    I’d say extend for all but the rich, and for a shorter duration (5 years). We do have a huge national debt to consider, and with the fragile economy this isn’t the time to raise taxes across the board but maybe in a few years if the economy is better taxes should return to the pre-tax-cut levels.

    • cubiclegeoff says:

      I agree. Everyone is going to hate a tax increase, but we have a deficit and debt problem. And considering the huge rebound in luxury goods sales, I don’t think most of the wealthy will have too many problems.

  7. Seth says:

    I say everyone that has a job is rich and owes the government money. The government should take at least 50% from every wage earner no matter what they make. The government knows best what to do with our money and we have no business keeping it for ourselves.

  8. This statement, “Republicans want to extend the cuts for everyone, which will cost $3.7 trillion over 10 years” is factually false.

    Tax cuts mean the government is taking a pay cut. It doesn’t mean that government is paying out more. So it will not cost the government $3.7 trillion. It will mean the government *may* confiscate $3.7 trillion less from the people.

    I wrote *may* because keeping the taxes lower will help the economy rebound, so in actuality the government will most likely confiscate more money and not less by extending the tax cuts.

    The government needs to do what everyone of us has had to do during these rough economic times. Learn to live off of less. When my pay goes down, I spend less and not more. Obama and his ilk haven’t learned that one yet.

    Luckily, they are about to be taught a big lesson on this during the elections in November.

    • cubiclegeoff says:

      I’m not convinced that keeping taxes lower will help the economy rebound. There’s no evidence that it will occur.

      • Scott says:

        You are probably right. Lower income peeps will consume the same as before; higher will marginally spend less. I think the million $$ question is will they hire less?

        The bigger problem coming is how will we weane ones off unemployment payments. When this day comes, watch out…

        I can’t tell you how many times I’ve heard “I can sit on my tail and make more that the job offered”.

      • Unless you look at history as a guide. Then there is plenty of evidence.

        • cubiclegeoff says:

          Actually, there really isn’t much evidence of this.

          • Scott says:

            Probably not much evidence of either option that is conclusive…

            We all pay taxes in products we buy for various government oversight. I just think there should be a flat or VAT tax across the board instead of nickel & diming us on our income too.

            Simplify and get rid of the IRS & privatize the Postal Service.

  9. Santos says:

    I think that the mistake many make (including some of the posters here) is that they seem to think that poeple will act the way the government wants once the rates are increased (e.g. the rich will stop buying luxury goods to pay for the higher taxes because the government needs the money) The more likely scenario is that the rich will either look for strategies to shelter their income or simply lay off or not hire more employees (and continue buying their luxury goods and/or accumulate cash). The wealthy didn’t become wealthy by being dumb.

  10. TomM says:

    Guys, listen, the bottom line is that our government needs to learn to live within it means. You’re all mostly saying it’s ok to raise taxes because we have a deficit…..yeah, the government, once again, overspent and now we have to flip the bill. Sorry, I’m tired of this sort of thinking. We all have to live within our means in our personal lives, why shouldn’t the government have to do so? First, reduce the size of government, second, stop spending more than you take in, third, reduce taxes…you’ll take in more money…this has been proven time and time again yet government doesn’t like doing it, fourth, no new spending unless you can pay for it by cutting something else, etc., etc.,

    Until our government starts being fiscally responsible I’m not for going “back” to the old tax rates, or “raising” the tax rates. Show me you’re responsible with my money and then we’ll talk.

    • cubiclegeoff says:

      Reducing the size of government is a lot harder than it seems. If you ask people what to cut, generally they don’t like to cut anything that impacts them, which is most things in some way or another. Also, there’s no proof that lowering taxes raises revenue. There’s just no easy solution.

      • Scott says:

        The bigger the department, the more likely it touches us or ones we know. It’s a snowball rolling down a never-ending hill.

        We should go back to one income households and re-set the system…

    • billsnider says:

      I think your post is right on.

      Bill Snider

  11. Scott says:

    What happens when someone works 80 hrs / week? Do you adjust his $132k by the hours worked? What about the adjustment for inflation on incomes? Wouldn’t the numbers be more accurate? What about state taxes paid? What about cost of living in metropolitan cities vs. small towns? So complex a situation, no great answers…

  12. Peter says:

    What I dislike about these discussions is that there is hardly ever a discussion about cuts in spending, it’s always a discussion of how the government needs to raise taxes. Why? To pay for unstainable programs that do nothing or very little to actually help people. The spending and waste our government engages in has exploded the last few years, starting under Bush – but really going into turbo overdrive the last couple of years.

    I think that there should be some sort of a constitutional ammendment to say that government spending can only be a certain percentage of GDP, unless there are extreme circumstances (like a war) where it needs to be higher.

    I can’t think that raising taxes right now would be a good thing, unless you want to kill more jobs, and slow growth. 47 House Democrats don’t think it’s a good idea either, breaking ranks with Obama and party leaders, and have signed a letter to Pelosi saying as such.

  13. freeby50 says:

    Sometime you just have to put aside the BS and call things as they are. If you make over $250k a year (taxable income) then you are rich. Plain and simple. If you’re in the top 5% of the richest nation in the world then you are rich.

  14. Darin H says:

    A couple of points, first as pointed out above, a tax cut isn’t a ‘cost’, unless you commonly say stuff like “My spending went down because I got a raise” 🙂 . Second, assuming that people won’t change their behavior in response is completely shortsighted (and historically false; see the yacht luxury tax in the early 90s). Third, ask yourself why is Texas doing so well during this downturn (they added half of all the jobs added in the last year in the US) and Cali, Illinois and NY not? I’ll give you a hint, it has to do with taxes and regulations.

    • Borkley says:

      It has nothing to do with “taxes”. It’s because Texas is a right to work state. California is being crushed under the weight of public unions and their demands.

    • cubiclegeoff says:

      Texas also has an industry that’s always in demand, oil and natural gas. Unless an alternative becomes a major player, Texas will continue to have a strong economic base.

      • Scott says:

        Lived in TX for 8 years (until 3 yrs ago) and it really was not a bad place in my experience. The only thing that was negative was the property tax of about 2.25%, but I’m really reaching for something negative.

        In Dallas, roads are good, no income tax, pay comparable to any major city, not so much talk about government on the news unless its a scandal, low property cost & you can still afford to have land if you want it…

        We’ll probably move back after we get tired of So Cal (or lose a job)…

  15. freeby50 says:

    Darin, Unemployment in Texas is 8.3% which is the same as it is in New York. One big reason TX is doing better in the real estate market is that TX actually has tighter regulations on mortgages. It is the only state with Loan to value restrictions. People are not allowed to take money out in HELOCs or cash out refinances in TX if that drops their LTV below 80%. Plus of course if you never have a boom then there is no bust. If taxes and regulation are the answer then why is Nevada doing so poorly?

  16. Don C says:

    Tax cuts do not ‘cost’ the government. it just limits what they can spend in the future. Isn’t that a good idea?

    I think part of the problem is that $250k for a married family is too low. Increase that to to $500k and make the top rate applicable for those earning over say $2M. I think that is a fairer compromse.

    Just becasue we make close to what Obama says is ‘rich’, doesn’t mean we’re rich. It’s not that simple. Living in NY with a few kids and paying what we pay for housing since we live close to NYC, we have little left over for luxuries. An extra 2k in our pocket means a lot to us, and we get to decide how its spent. We earned it, we spend it as we see fit. Not on wasteful programs like funding a bug museums accross the country all in the name of ‘stimulus’.

    • Scott says:

      Agreed! My rent on a VERY modest home in Cali is $2,200 / month. We reduced our housing quality from TX when we paid $1,000 for our 50% larger home there. What’s bad is this is our 2nd largest additional expense. We pay about $25k in additional state tax annually here.

      People who live in these places should be looked at differently or as you say, raise what “rich” is.

      • Ryan says:

        I’d say if you can afford $2200/month, you’re living pretty well and making good money…

        • Scott says:

          Thanks Ryan for telling people what they can afford. Can I afford to buy a home here?…not as much as in TX. Making good money is apparently less than $250k to you as this is where we are.

          We live in the lower income areas in this neck of the woods…used to live in a much better area in TX.

          Answer me this, if you pay 10% of your income to the state, should you have to pay 3% more to the Feds? We’ll be in the 46% bracket soon if that is the case…not to mention sales, gas, and the multitudes of other ticky tac taxes we pay.

          • NateUVM says:

            I would say that maybe you should move back to Texas…?

            If you’re spending too much on housing, and you think your local taxes are too high… I mean, why AREN’T you moving? Why are you letting local issues cloud/influence your thoughts on a National issue?

            Your attacks on the proposed plans are about as fair as someone living in a low cost-of-living area, making only $125k and living in the lap of relative luxury, saying that all income over $130k should be taxed 75% as a solution.

            Perhaps a more measured, balanced approach is in order? One where we meet somewhere in the middle? Maybe one where most people, due to the state of the economy, get to keep their tax cuts in place, while, say, less than 2%, those making more than $250k*, go back to what they were paying 10 years ago?


  17. Scott says:

    Checked out your link & found some more on Mr. Orszag…he changed his tune since this 2/1/10 interview. He now says these should be extended as of Sept of this year.

    “The White House was blindsided Tuesday by former budget director Peter Orszag’s dramatic break with President Obama on tax policy.

    Orszag, in a column in The New York Times, called for all of the Bush-era tax cuts to be extended for two years, including rates for the wealthiest taxpayers, which the administration wants to phase-out for deficit reduction.”

    Question from your post link in Feb 2010…
    CHETRY: You also talk about letting taxes expire for families that make over $250,000. Some would argue that in some parts of the country that is middle class.

    ORSZAG: Well, I guess it’s not the parts of the country where I’ve been.

    I personally think everyone should revert back to the old tax rates and make it fair for everyone.

    I’m not in the 250k group, so I don’t have anything to gain. I just have a personal opinion on sense of fairness & my alarm is going off.

    You said those making 130k in most places are in relative wealth, so why not go after the “relativly wealthy”? I chose to live in Cali and since I’ve moved here, they’ve changed the game here too (too many to list). I still choose to live here until it doesn’t make sense for the additonal cost. When that day comes, I’ll go back and not sweat the taxes either way as I’ll likely have my wife stop working and we’ll drop considerably on the “wealthy” ladder.

    • NateUVM says:

      You’ve missed my point…twice.

      In the first case, I was making no statement to whether the non-partisan Mr. Orszag supported or derided the plans of the administration. Merely, to point out to those that say that a return to the original taxation of those making over $250k probably wouldn’t be the death knell to the economy that they profess. This, given the fact that we are talking about less than 2% of the populace having to a pay a little more on only the money they make OVER $250k.

      Second….the EXAMPLE about the person making $130k was NOT a statement of fact. It was an….example. Of how extreme positions aren’t always particularly good perspectives to appreciate when trying to come up with a solution. Given how partisan politics has become lately, the illustration was pointing out how the current administration’s solution, given our current economic state, is actually a fairly middle-of-the-road solution.

      Please try re-reading what I originally posted.

  18. don d says:

    Increases in the federal debt is running about 9 billion dollars/day.Raising taxes is just shopworn class warfare.

    • Scott says:

      But only 1.5%-2% of the vote lost to do it…not much loss for the gain in spending other people’s money…

      Sounds like a good investor class to me.

  19. Scott says:

    Here’s another spin…if you raise taxes on the “rich”, their “out of their own pocket” cost is less per additional employee as they would be taxed more if it was considered income.

    Hire someone to make their job easier and go on a long vacation…

  20. Scott says:

    I have an honest question.

    If my wife & I move to Mexico, do we get a check at the end of the year from the feds when we file our tax return?

    We’ll have interest income (appx. $5k), but no income from working…I’m assuming we would pay tax on the $5k & get back tax on the $10k standard deduction.

  21. Anonymous says:

    The one and only fair way to tax is to charge the smae percentage to all. Brackets are unfair. Less unfair would be to reverse the brackets so that the harder one works, the smaller percentage one pays.

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