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The Unkindest Cuts

4 min readBy: Gerald Prante

This article appeared in the New York Post on August, 22, 2010.

Perhaps the biggest issue going into the fall’s midterm elections is the elimination, extension or modification of the so-called Bush 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. cuts. It affects our wallets, of course, but also our nation’s financial future, as government debt continues to expand to immense proportions While the argument is sometimes framed as tax cuts for the rich, the truth is if Congress does nothing before January, virtually all Americans’ paychecks would shrink.

The tax cuts passed under the Bush administration, mostly enacted in 2001 and 2003, substantially lowered what every taxpayer, poor and rich, owes each year. Among the dozen major tax changes, the single biggest provision was a new 10% bracket for the first several thousand dollars we earn, which benefited all taxpayers, including low-income households who also received bigger refundable credits. Middle-income households got marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. relief, and when the per-child tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. doubled from $500 to $1,000, they got most of the benefit.

High-income households got their full itemized deductions back and 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. relief, and investors got a lower rate on capital gains and dividends. Across the board, the marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s on wages fell from 28%, 31%, 36% and 39.6% to 25%, 28%, 33%, and 35%. In short, virtually every American’s paycheck got bigger.

If the tax cuts were to fully expire, New Yorkers would be among the hardest hit, since their incomes are higher. For example, the average middle-income family in Carolyn Maloney’s congressional district (NY-14) would face income taxes that are $3,066 higher.

The tax cuts were all temporary because Republicans could not get enough Democratic votes to gain a 60-vote Senate majority. Without that supermajority, no bill can pass if it adds to the deficit for more than 10 years. Well, the 10 years have passed, and it’s a different world. Instead of budget surpluses on the horizon, a looming fiscal cliff is much closer than anyone would have thought possible. Extending the Bush tax cuts in full for another 10 years would add an estimated $3 trillion to the national debt. That is on top of the $8 trillion that is already set to be added to the debt under the president’s proposed budget for 2011-20.

Tax cuts from the Bush years aren’t the only tax laws set to expire on Dec. 31. President Obama’s stimulus bill included temporary tax credits for higher education, more refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). s for low-income households, and a new “making work pay” tax credit worth $400 per worker – those are expiring, too.

So what can we expect Washington to do before Jan. 1?

There is a chance that Congress will take no action and allow all of the tax cuts to expire. Most experts were shocked in 2009 when Congress did nothing to stop a scheduled repeal of the estate tax, so a similar scenario could play out this fall. And full expiration has academic support from renowned economists Alan Blinder and Alan Greenspan, who say a commitment to fiscal responsibility is worth any short-term economic harm.

But that is not the Democrats’ plan. Instead, they propose extending about 80% of the Bush tax cuts. Only high-income taxpayers, defined as single people earning more than $200,000 and couples earning more than $250,000, will see their paychecks shrink in January. That threshold was set by then-candidate Obama on the 2008 campaign trail.

High-income people will lose many of their tax cuts under the Democrats’ plan: they’ll lose a large fraction of their itemized deductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s including charitable gifts and mortgage interest. Their tax rate on qualified dividends and long-term capital gains will go from 15% to 20%, and the top two wage tax rates will return to 36% and 39.6% from their current levels of 33% and 35%. According to the administration, these restored higher tax levels would raise about $630 billion over 10 years, which is about only one-fifth of the $3 trillion price tag for making all the tax cuts permanent. In his budget, President Obama proposed cutting back further on the itemized deductions of high-income taxpayers, but Congress has ignored that idea for the second year in a row.

On the other end of the policy option spectrum is full extension of the tax cuts, which most Republicans favor. With a weak recovery faltering, they argue, higher tax rates on everyone would be disastrous, and even if limited to high-income people, the job-creating business sector would suffer. As for the benefit of deficit reduction cited by Blinder and Greenspan, Republicans scoff, predicting that government would just spend the additional revenue instead of paying down debt.

And the fate of the Bush tax cuts is not the only uncertainty. What will Congress do about the tax credits in the stimulus bill, worth about $70 billion per year? President Obama proposes extending all of them at least one year and some permanently. But when House Democrats recently publicized a tax plan officially scored by the Joint Committee on Taxation, none of the major Obama stimulus credits were included.

Over the next four months, Congress will be making the first of what will be many major decisions over the next decade concerning the future of US fiscal policy. So when the champagne corks pop 130 days from now on New Year’s Day, what tax rates will each of us be paying?

Gerald Prante is senior economist at the Tax Foundation, a nonprofit, nonpartisan research and educational organization that monitors fiscal policy.