Bush Tax Cuts for Beginners

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Election season is upon us and the political parties are taking each other to task. At the forefront of many voters’ and politicians’ minds are the Bush tax cuts and whether they should be renewed past their current expiration date of Jan. 1, 2011. Since the legislation and debate surrounding the issue is fairly complicated, MainStreet is here to explain what the hoopla is all about.

Back in 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act, a sweeping piece of tax reform that, contrary to popular belief, lowered taxes for almost all Americans. Of course, the nation wasn’t burdened by a  $1.34 trillion deficit at that time, so an across-the-board decrease seemed reasonable, if not necessary. The U.S Treasury at that time was enjoying a surplus that economists had projected to continue through 2011. To prevent the tax cuts from affecting the nation’s deficit beyond this projected surplus, most provisions were designed to “sunset” out , or expire, over time.

To keep these cuts in effect, certain stipulations were extended or adjusted through a second major piece of legislation signed in 2003. Here are the nuts and bolts to what the tax reforms meant for regular Americans.

  • Before the Economic Growth and Tax Relief Reconciliation Act, the American tax system had five tax brackets depending on the amount of income you earned annually. The more money you made, the higher percentage of it had to go back to the federal government. That rule still applies. However, the Bush tax cuts meant the creation of a sixth income tax bracket for single filers with taxable income up to $6,000, joint filers up to $12,000 and heads of households up to $10,000. The new bracket enabled the five pre-existing ones to be lowered in varying increments to 10%, 25%, 28%, 33% and 35%. Should the cuts expire entirely, the income tax brackets would revert to the five-tiered system of 15%, 28%, 31%, 36% and 39.6%.
  • Taxes on capital gains, which means profits made from stocks, bonds and other capital investments were reduced from 10%, and 20% to 5% and 15%, depending on the filer’s tax bracket. If the tax cuts expire, the maximum taxes on gains would return to 20%. Taxes on dividends, the earnings that a corporation pays out to its shareholders, could soar much higher. Currently, a 0% rate applies to this type of investments. However, should the cuts expire, rates would return to up to 39.6%, as divedends would revert back to being taxed as ordinary income.
  • The standard deduction for joint filers was increased under the 2001 law. The increase in standard deductions, coupled with the changes in the income tax bracket, were designed to prevent couples from incurring marriage penalties, or paying more together than they would separately. These penalties would be reinstated should the cuts expire.
  • A number of tax credits were instituted. Some of these rebates were extended under separate legislation, such as the adoption tax credit, which now lasts until 2012 under the new health care reform. However, the popular child tax credit, which entitles families to receive an annual rebate of $1,000 per child, would be reduced by half should the cuts expire completely.
  • The number of standard personal exemptions and rate of itemized deductions that could be claimed on tax returns were increased. The argument that the Bush tax cuts benefit the wealthy stems, in part, from this particular stipulation as higher-income households (those making $170,000 or more) were eligible for more of these rebates.
  • The estate tax, a tax on the total value of the money and property of a person who died, was initially lowered from 55% to 50% in 2002, with an additional 1% reduction each year until 2007, when the top estate tax rate became 45%. A major point of contention between both parties, the political wrangling allowed the tax to expire completely in 2009. If the tax cuts were allowed to sunset, the federal estate tax would revert back to the rate it was that year, 45% with the $3.5 million per-person exemption

The tax cuts might seem favorable on face value. No one wants to pay higher taxes, after all. The problem is we can’t afford a permanent extension. The Treasury Department estimates that even temporarily extending the tax cuts would cost the federal government roughly $200 billion in fiscal 2011 and $260 billion in 2012. This debt could accumulate to trillions during the next decade.

To save some money, President Obama proposed Congress keep the six tax brackets (and the lower rates on dividends and capital investments) and extend the cuts to everyone except those with incomes greater than $250,000. While it looks as if this particular proposal may pass pending further compromise, it is being met with opposition from Republicans who believe the tax cuts should be extended, albeit temporarily, for all.

Their argument is two-fold: Higher taxes on the income brackets inadvertently penalize small businesses, who generate a high percentage of jobs for the low-to middle-income families the president is trying to spare. Second, electing to forgo a tax break for high-income families prevents these individuals from spending the money they would save, which would in turn bolster the already flailing economy.

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