- Bargaineering - http://www.bargaineering.com/articles -

Three Solutions to Expiring Bush Tax Cuts

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 [3]. In 2000, the brackets were 15%, 28%, 31%, 36%, and 39.6% and each range was higher (single filer ranges below):

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):

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.