The consequences of allowing the Bush tax cuts to lapse

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This fall, if lawmakers can’t stop arguing long enough to pass new tax legislation, Americans will be facing the highest tax hikes ever beginning January 1, 2011. That is the date that the tax cuts enacted in 2001 and 2003 under the Bush administration will expire.

The imminent expiration on tax cuts has sparked off a debate among economists over whether to extend them, and if so, to whom. Obama has declared his intention to let the tax cuts expire for the wealthiest brackets, while extending them for individuals who earn up to $200,000 a year and families whose income is $250,000 or less. Secretary of the Treasury Timothy Geithner made a speech on Wednesday in which he insisted on the necessity of removing tax cuts for the wealthy, and David Stockman, director of the Office of Management and Budget under President Ronald Reagan, wrote an op-ed in the New York Times on Sunday lambasting Republicans for even considering extending tax cuts. On the other side, Arthur Laffer published a column in the Wall Street Journal insisting that tax cuts for the wealthy increase government revenue.

The debate that has erupted in Congress has taken on a different tone, with politicians trying to juggle the necessity of passing legislation with a desire to get reelected. Taxes will certainly be a major issue in the midterm elections. As the New York Times put it:

the tax fight will serve as a proxy for the bigger political clashes of the year, including the size of government and the best way of handling the tepid economic recovery.

Obama has made it clear that he intends to let the Bush tax cuts expire for the wealthy, but Republicans want the tax cuts to be extended across the board. Compromise is difficult when politicians are catering to their constituents, especially on this issue, since there is not a single constituency that is hoping for higher taxes. But that is exactly what will happen if Congress cannot work through the gridlock and put new tax legislation in place before January 1: married or single, multibillionaire or starving artist trying to pay off student loans, everyone will be paying higher taxes.

The Bush tax cuts gave breaks to investors and small businesses intended to encourage people to reinvest in the economy, thereby creating more jobs and boosting the economy. He cut income taxes across the board as “a matter of fairness.”

As the expiration date looms, some of the debate is still uselessly focused on whether the tax cuts should have been implemented in the first place. As Alan S. Blinder wrote in The Washington Post, “we can’t undo the past.” It doesn’t matter whether the tax cuts were a good idea or a bad idea; the fact is, they’re about to expire, and the political establishment needs to decide what to do with them, given the present economic situation — another issue that no one seems to be able to agree on.

When the Bush tax cuts expire, personal income tax will increase by three to five percent for all tax brackets. Married couples lose a number of benefits. Bush’s tax cuts increased the standard deduction for couples that filed jointly, making it double the standard deduction for someone filing as single. Couples filing jointly will only be entitled to half the standard deduction they received last year. The nonrefundable child tax credit will be halved, decreasing from $1000 to $500, and the credit for dependent care, which families with children to receive a credit for the money they spend on child care in order to work, will disappear entirely. Itemized deductions will phase out, which will primarily affect wealthier taxpayers.

Taxes on capital gains will increase, and dividends will once again be taxed at the same rate as income. The estate tax, which lapsed in 2010, will also return, jumping back up to 55%; the Wall Street Journal has even gone so far as to suggest that allowing the estate tax to return is Congress “incentivizing death” by making it beneficial for wealthy people with large estates to croak before January 1 in order to spare their relatives and heirs the high cost of the estate tax.

Small businesses, beneficiaries of Bush’s tax cuts, will have to pay more as a variety of tax cuts expire. For instance, the amount of equipment purchases that they can expense will substantially decrease.

Students, and families putting children through college, will be particularly hard hit. The tuition and fees tax deduction will be eliminated, as will the American Opportunity Credit, a credit for families supporting full time college students. Some scholarships will now be taxable, and employer assistance for education will end. The number of families eligible for the student loan interest deduction will decrease. Computers and equipment will no longer be considered a qualified higher education expense. The maximum contribution from education IRAs, otherwise known as Coverdell education savings accounts, will decrease, as will the number of things that are considered qualified education expenses.

A number of credits for energy efficient appliances and vehicles will be eliminated.

This will mean the expiration of the Making Work Pay Credit, as well as the Earned Income Tax Credit, aimed at helping to lift families, especially families with children, out of poverty.

These tax hikes will come at the same time that many of the taxes included in the new health care bill kick in.

A full list of the tax provisions set to expire on December 31, 2010 can be found on the website for the Tax Policy center.

The bottom line is that our tax code is a messy patchwork. Congress may not be able to attempt an overhaul of our tax code in the last few months of the year, but without new legislation that either extends the Bush tax cuts or replaces them with some new policy, 2011 is likely to be a miserable year for taxpayers.

GEITHNER ON TAXES

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