Does the Middle Class Need Tax Cuts?

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NEW YORK (MainStreet) — After months of heated debate in Washington, President Obama announced Monday that his administration has reached a tentative deal with the Republican leadership to extend Bush-era tax cuts for all Americans for two more years.

As part of the compromise, the administration agreed to propose extending tax cuts for households earning $250,000 or more a year while Republicans agreed to extend unemployment benefits for an additional 13 months. The plan would also reduce the Social Security tax for nearly all employees to 4.2% from the current 6.2% and lower the estate tax to 35% on properties worth more than $5 million.

Both parties agreed that tax cuts should be extended for middle-class households, but Republicans refused to approve a tax cut extension that did not also apply to the wealthiest households. Ultimately, it proved too politically unpalatable to let taxes go up on middle-class Americans when unemployment is still near 10%, which led the administration to this compromise.

"I'm not willing to let working families across this country become collateral damage for political warfare here in Washington," Obama said, according to the Associated Press.

Republicans have long argued that raising taxes on households earning $250,000 or more would hurt small businesses and potentially undermine economic recovery. Most Democrats, on the other hand, argue that extending tax cuts for this income group would help only a small percentage of businesses, while adding billions to the deficit. Moreover, Democrats noted that these households are also less likely than middle-class households to spend the money they save from the tax cuts, which would further weaken the economy.

With the compromise proposal set to go before Congress before the end of the year, MainStreet decided to take a look at the numbers. Would it really be the end of the world if tax cuts expired for middle-class Americans? Sure, all things being equal people would probably rather pay fewer taxes and have a little extra money to play with after each paycheck, but how much would the tax cuts really help average Americans compared to what they would cost our economy in the long run?

To extend tax cuts across the board for two years, as this plan proposes, we would add more than $500 billion to the national deficit in lost tax revenue. What would we get for this money? Not much, it turns out.

For starters, the effect on unemployment would be negligible. The Congressional Budget Office estimates that extending the tax cuts for just the middle class would only reduce the unemployment rate between 0.1% and 0.3% next year, and the effect if tax cuts are extended for wealthy Americans would do little more.

Meanwhile, the average American would not feel their wallets fatten up too much either.

The average American household earns just more than $52,000 a year, based on the most recent data from the U.S. Census Bureau, and according to the Tax Policy Center (run by the Urban Institute and Brookings Institution), these households would save an average of $1,180 in 2011 if the tax cuts are extended.

Obviously, $1,180 is nothing to sneeze at. For this amount of money, a family could pay for a year’s worth of cable or cell phone bills, get a roundtrip plane ticket to most destinations in Europe or pay for two months’ rent in most parts of the country (or about one month’s rent if you happen to live in, say, San Francisco or New York City.) But how much would you notice the difference from paycheck to paycheck? Distributed over 12 months, the tax cuts would yield only $98.33 in monthly savings for the average household.

By comparison, households earning $200,000-$500,000 would save nearly $7,500 in 2011, and those earning $1 million or more would save exponentially more, about $129,000. If that seems a bit uneven, that’s because it is. According to the Tax Policy Center, households in the $50,000-$75,000 income bracket will see after-tax savings increase by an average of 2.3% of their income, while households earning $1 million or more will see nearly triple the savings, or about 6.2%.

So what’s more important to you: saving about $1,000 a year on your paycheck while the rich save more than $100,000 or cutting hundreds of billions of dollars from our deficit to improve the long-term economic outlook of our country?

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