Special Report No. 113
As the U.S. Senate votes on whether to make permanent only the estate 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. provisions of last year’s tax cut, a new report from the Tax Foundation calculates how much the eventual expiration of the entire tax cut would cost median-income families in each state.
“As important as permanent repeal of the death tax is,” commented John S. Barry, Tax Foundation Chief Economist and author of the new report, “it is really the eventual sunset of the tax cut’s other provisions that will come back to haunt typical American families.”
If Congress and the President do not act to make permanent the Bush tax cut, known formally as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), a family of four earning the median income can expect its federal income tax bill to increase by $2,681 between 2010 and 2011, a 48.8 percent increase. This will amount to 3.3 percent of the family’s adjusted gross income in that year and roughly equals what the average family of four spends on out-of-pocket health care costs each year.
Titled “The Effect of Temporary Tax Relief on a Typical American Family of Four,” the new Tax Foundation Special Report explains that the so-called Byrd Rule in the Senate is the reason that EGTRRA was enacted with an automatic expiration date at the end of 2010.
The report also details the impact the expiration will have on the nation’s median-income families, explaining why some states will fare so much worse upon expiration.
Some pundits consider it inevitable that the tax cut will eventually be made permanent, but Senate Majority Leader Tom Daschle has stated, “We will … never bring up the permanent tax cut the president has advocated. It is bad policy, it is wrong, and it compounds the budget disaster that our country currently faces.”
The major provisions of EGTRRA that affect average American families, all set to sunset after December 31, 2010, include:
- The creation of a new 10 percent 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. bracket, added to the existing bracket structure;
- A phased-in reduction of the remaining individual income tax rates over the next five years;
- A phased-in increase in the 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. from its previous level of $500 per child to $1,000 per child in 2010; and
- 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 phased in primarily between 2004 and 2010.
Due to EGTRRA’s doubling of the child tax credit, families with more than two children will experience an even greater increase in their taxes between 2010 and 2011 when the credit reverts from $1,000 per child to $500.
Because the median family income varies from state to state, the expiration of EGTRRA after 2010 will affect states differently. States with more low-income taxpayers will incur a disproportionately large increase in their federal income tax bill between 2010 and 2011. This is true for two primary reasons:
The absolute dollar amount of the federal standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. , personal exemption level, and child tax credit are standard across the country and across incomes. Therefore, these tax “benefits” will be of relatively greater value to families with lower incomes because they offset a greater percentage of their total taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. .
Secondly, federal tax rate brackets are standard across the country. Therefore, a family of four earning the median income in one state may be in a higher marginal tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat.
than a family of four earning the median income in another state.
Measured as a percentage increase in federal income taxes due, a typical family of four in Arkansas will be hit the hardest as their total federal income tax bill will increase by 102 percent between 2010 and 2011. The increase in five other states —Louisiana, Mississippi, Montana, New Mexico, and West Virginia—will exceed 80 percent.