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The Tax Code’s Day of Reckoning: January 1, 2011

2 min readBy: Gerald Prante

Lawmakers this week agreed to extend the special lowered taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rates on capital gains and dividends until 2011. If their agreement becomes law, it may turn January 1, 2011 into what the Washington Post calls “The Day of Reckoning.” From yesterday’s Washington Post:

With this week’s hard-fought agreement on a $70 billion tax-cut extension, President Bush and congressional Republicans have effectively set a date for a fiscal day of reckoning for the next president and a future Congress: Jan. 1, 2011.

House and Senate negotiators reached agreement this week on legislation to extend the deep tax cuts on capital gains and dividends beyond their scheduled 2008 expiration date, through 2010. Final passage of the agreement must wait until Republican tax writers agree on a second tax bill that includes many of the tax breaks jettisoned from the measure on capital gains and dividends. If the deal wins congressional approval, every major tax cut passed in Bush’s first term will be set to expire on the same day five years from now.

Here’s a list compiled by Tax Foundation staff of major federal tax changes that will occur in 2011 if this package is enacted, on the unlikely assumption that everything else remains unchanged:

Individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rates go from 10%, 15%, 25%, 28%, 33%, and 35% to 15%, 28%, 31%, 36%, and 39.6%.

• Child credit falls from $1,000 per child to $500 per child.

Capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. rates would revert back to 10% and 20% (depending on AGI), while they are currently at 5% and 15%.

• Dividends would once again be taxed at the ordinary income rates (see above), while today they are currently at 5% and 15%.

• After being fully phased out for tax year 2010, the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. would be fully reinstated with a top rate of 60 percent and a $1 million exemption.

Of course, the best solution is for lawmakers to not focus solely on these expiring tax provisions, but rather to focus on fundamental tax reform, moving toward a tax code that’s less complex and less distortionary. The final report of the President’s tax reform panel last November is an excellent starting point.