September 24, 2004

TAX CUT EXTENSION SOARS THROUGH CONGRESS

On September 23, 2004 Congress passed pre-election legislation extending President Bush's tax cuts from his first term in office through the remainder of the decade. Both the House and Senate passed the bill by wide margins, 339-65 and 92-3. The White House says the bill, designed to spur economic growth by making Bush's popular tax cuts permanent and therefore increase savings, will bring $148.9 billion in tax relief to middle-class Americans, married couples, and parents as well as to corporations through tax credits. The provisions in the bill include extension of the $1000 child tax credit and the marriage penalty fix and expansion of the 10% tax bracket and alternative minimum tax (AMT) until 2010. The bill also reintroduces the corporate Research and Development tax credit along with 22 other corporate tax exemptions and gave exemptions to the combat pay of soldiers in Iraq and Afghanistan . To better understand the impact of these taxes, here's a look at each one individually.

Child Tax Credit [i]

The child tax credit was passed in 1997 as a $500 per child, refundable tax credit for qualified parents. For parents to qualify, their children had to be their dependents and be under 17. In 2001, President Bush signed into law a bill that would gradually enlarge the credit to $1000. In 2003, a bill passed that immediately increased the child tax credit to $1000. Today's legislation extends this increased amount until 2009 and applies a more generous formula to allow more workers to claim the credit as a refund. The Heritage Foundation estimates that the new child tax credit extension will bring tax relief to the parents of 47 million children for the next six years.

Marriage Penalty Fix [ii]

The marriage penalty was first rectified in 2001 with the Economic Growth and Tax Reduction Reconciliation Act. Prior to 2001, married couples who both worked and filed a joint tax return encountered an increase in taxable income when they got married. This was because their deduction as joint-filers, $7600, was less than if it had filed by two single individuals, each with a deduction of $4550. To make marriage more beneficial financially, the act gave married couples who both work a further 10% deduction for their taxes. Most politicians and analysts agree that this measure will positively affect low to medium-income homes, where the majority of homes have two earners. It has been extended until 2008.

10% Tax Bracket

Created by the Economic Growth and Tax Reduction Reconciliation Act in 2001, this tax bracket offers the lowest marginal rate out of any tax bracket. For earners in this bracket the first $6000 of taxable income for single filers is taxed at a reduced rate, from 15% to 10%. For joint filers the amount is $12000 and for the heads of household it is $10000. Bush's expansion of this tax bracket means tax relief is open to more tax payers than ever before and will be so until 2010.

Alternative Minimum Tax (AMT) [iii]

Congress introduced the AMT in 1969 in an attempt to stop rich taxpayers from avoiding tax by over-using deductions. The AMT has a lower rate than the traditional tax structure but it allows virtually no deductions. Since it was designed to make high-income earners pay more in taxes, those who qualify for the AMT are forced to pay that tax structure amount even if it exceeds traditional tax structures. Traditionally, few taxpayers have been affected by it, only 2.5 million in 2002. However, the combination of President Bush's tax cuts (which reduces taxes under the traditional system) and the fact that the AMT is not indexed to inflation means that it will affect far more people in the future.

The Bush administration's tax plan provides relief to the increasing number of Americans who are subject to the AMT and indexes the AMT to inflation. AMT exemptions for individuals will stay at $40,250, rather than fall to $33,750. For families the rate will stay at $58,000 instead of falling to $45,000. For those families who are subject to the AMT and are eligible for the child tax credit, the tax credit can now be applied to AMT eligibility, taking most of these tax payers out of the alternative minimum tax structure.

Corporate Taxes [iv]

The new tax cuts also benefit American corporations by giving them tax credits. Corporate provisions like wind energy credits and research and development credits give American corporations more incentives to develop new technologies and generally try to make corporate America more versatile in the global economy. All together the 23 provisions will cost $12.97 billion, the most costly of which is the Research and Development one costing roughly $7.5 billion itself.

The Bush Administration and many members of Congress believe that these tax provisions will be beneficial to America . The White House estimates that the tax provisions will affect around 94 million Americans from the lower, middle, and upper-classes and bring the total amount of Bush-era tax relief to $1.9 trillion. Bush's opposition in the presidential campaign supported a majority of the President's bill and voted for it in the Senate. John Kerry, despite criticism of the corporate provisions, backs the majority of the $149 billion tax breaks where they apply to lower and middle-class earners. Other Congressmen and some economists, however, disagree.

One of the three dissenting Senators, Lincoln Chafee (R. R.I.), issued a statement expressing dissatisfaction with the way his colleagues voted after the Senate session had adjourned. The Senator said, “I for one am very reluctant to saddle future generations with a bill for this ruinous policy.” The tax issue is especially murky because of its timing just before the election. Many Democrats, although opposed in principle, were fearful of political retribution if they did not vote for the tax cut. Rep. Jim McCrery ( R. La. ) captured the spirit of the day when he said, “Anyone voting ‘no' is voting for a tax increase for the American people, especially on the middle-class. That's the bottom line on this bill.”

Critics of the tax breaks say that Bush's tax relief plans are shortsighted and will contribute to an already growing public debt accumulated by three years of federal deficits. The Congressional Budget Office predicts that the national debt will rise from $4.3 trillion today to $8 trillion in 2014 with the tax cuts in place.

Economists further warn that Bush's emphasis on lowering taxes is the wrong answer to a more pressing problem. Bush's answer to looming federal deficits in the face of tax cuts is to cut federal spending at the same time, but the three largest portions of the federal budget, national defense, entitlement for Social Security (expected to increase as Baby Boomers retire), and interest on the debt are untouchable in the current political climate. Reductions in entitlement owed to Social Security benefactors and the success of Medicare and Social Security privatization in Bush's “ownership society” plan will play a large part in how tax cuts affect the American economy. [v]

Balanced budgets and privatization will have to remain platform pieces for the time-being. After the election, however, the winners of the congressional and presidential races must effectively address federal fiscal policy and deal with annual budget shortfalls and the march of the Baby Boomers toward retirement. If we head towards the “ownership society,” tax cuts are a step in the right direction but they must be accompanied by more fundamental changes in federal spending.

[i] Rea S. Hederman, Jr., “One Cheer for the Tax Extender Package,” WedMemo (The Brookings Institute: 23 Sept. 2004 ), #572, Available Online at http://www.heritage.org.

[ii] Rea S. Hederman, Jr., “One Cheer for the Tax Extender Package,” WedMemo (The Brookings Institute: 23 Sept. 2004 ), #572, Available Online at http://www.heritage.org.

[iii] “A Flood of Red Ink – America 's Deficits,” The Economist ( 8 Nov. 2003 ).

[iv] Martin Crutsinger, “Congress Sends Bush Tax Cut Bill, Victory,” Associated Press Online ( 24 Sept. 2004 ), Available Online at http://www.ap.org.

[v] Michael Sivy , “What the Election Really Means to You,” Money (October, 2004), 122.