Bush Tax Cuts and Their Impact on the Economy

It would be impossible to ignore the current debate as to whether Congress should allow the ‘Bush Tax cuts’ to expire. Back when they were first introduced, as the Economic Growth and Tax Relief Reconciliation Act of 2001 and Jobs and Growth Tax Relief Reconciliation Act of 2003, the US treasury had a healthy surplus. Congress believed that the US economy would grow to almost $5.6 trillion in the next decade, which is currently not the case as the federal government has an estimated $1.34 trillion budget deficit (Manz 2002, pp. 13). The US has only recently emerged from the global financial crisis and while some economists would like to see the tax cuts extended so as to spur economic growth, other pundits warn that should the government extend all the tax cuts and take no further actions, then the federal government can expect the budget deficit to grow to unsustainable levels.

Atrends (2010) notes “the Economic Growth and Tax Relief Reconciliation Act of 2001 made numerous changes in the US Internal Revenue Code, lowering tax rates and simplifying retirement rules in the Individual retirement accounts, 401(k), 403(b) and pension plans.” The Jobs and Growth Tax Relief Reconciliation Act of 2003 accelerated credit increases and tax rate reductions passed in 2001. This allowed individuals to save more income from investments, such as reductions in rates charged on income from dividends and capital gains. The two mentioned tax cuts were designed to expire in December 2010, unless Congress reconsidered the option in accordance with sunset provisions.

The tax cuts are currently in effect for all income level groups, as the Bush administration set to increase income for all households. The purpose of the tax cuts was to allow individuals to spend more and increase demand for goods and services in the economy, ultimately leading to the creation of new jobs and thus revenues for the federal government, referred to as trickle down economics. Economists also hoped the Bush tax cuts would create the multiplier effect, whereby each dollar saved through the tax cuts would create more than a dollar in income levels, spurring economic growth.

The Bush tax cuts certainly had an early positive impact on the economy and new job creation, though critics argue as to whether their government could have implemented different policies to achieve the same results (Bischoff 2003). Democrats for one argued that the tax cuts would mostly favor the wealthy. It’s generally agreed that tax cuts increase disposable income for households, allowing them to spend more but the same cannot be said about the wealthy.

According to Democrats, the wealthy may not necessarily change their spending behavior and may in fact use the extra tax incentive to acquire more wealth for them, thus doing little to contribute towards economic growth. Democrats have argued that the cumulative costs from the budget cuts could have been used on projects such as infrastructure or training which could have led to the creation of more jobs and thus contributed to the growth of the economy, although results from past training programs have been mixed.

The economic recovery of the US will play a vital role in the forthcoming elections, which could be part of the reason everybody is keen on economic data such as monthly employment rates and oil prices. Fluctuations in energy prices have wiped out majority of the benefits derived from the tax cuts. A combination of major tax cuts and billions spent in wars in Iraq and Afghanistan have led to the significantly high budget deficit, while the government borrows more to sustain its expenditure needs. The recent global financial meltdown also contributed to the problems ailing the federal budget, for instance the government had to bail out bankrupt corporate using tax payer funds, accumulating a further $700 billion dent in the budget.

Should Congress allow the Bush tax cuts to expire, all American households can expect their rates of tax to increase. The current tax rate brackets of 10, 15, 25, 28, 33 and 35 percent will be replaced by five brackets of 15, 28, 31, 36 and 39.6 percent respectively. Chances of keeping the 10, 15, 25 and 28 percent tax brackets are looking ever slim, given the fragile economy. Investors can also expect an increase in capital gains and dividend taxes from a maximum of 15 percent to 20 percent tax on long term capital gains and as high as 39.6 percent on dividends unless Congress sets a ceiling rate. Currently, individuals in the low tax brackets do not pay tax from capital gains and dividends.

Most Americans are on the 15 or 25 percent tax bracket, according to the Wall Street Journal, and might see themselves parting with 28 percent of their incomes in tax obligations. Married couples who file their taxes jointly may expect to pay higher taxes and receive un-proportionately lower standard deductions. The child tax credit would be halved from $1,000 to $500, meaning that there will be lesser reprieve for these households (Gale 2010). If Congress allows the Bush tax cuts to expire, Americans can expect to feel the effects as soon as January 2011 when employers more taxes from paychecks.

The major argument for extending the Bush tax cuts is that the US economy is still recovering from a recession, and it would be too soon to increase taxes in the economy. Americans would have decreased disposable incomes, resulting into limited amounts available for consumption and investments in the economy, effects of which could wipe out most of the progress made in the economic recovery (Atrends 2010). On the other hand, broadening the tax cuts may not create stimulus for economic growth since most taxpayers will not notice adjustments in the end result. If Congress adopts to make the Bush tax cuts permanent, then they could help sustain the US economic recovery in the short term, but may reverse economic growth in the long term by adding to the already high federal debt levels.

Atrend (2010) notes “while majority of Democrats and Republicans agree on extending the tax cuts to households that earn less than $250,000 a year, most Republicans want to extend the tax cuts across the board for all households.” Democrats argue that extending the tax cuts to the wealthy would have no positive effect on economic growth since these wealthy households would probably save the money, rather than spend it

The US treasury, according to CNN, anticipates that it would cost the federal government almost $3.7 trillion to make the tax cuts permanent for al Americans, but these costs would obviously be lower if the tax cuts were extended temporarily (Sahadi 2010). A short term extension would cost between $200 billion and $500 billion, depending on the period of the extension as per Treasury Department estimates. Americans can therefore expect a tax extension for the middle and low income group earners, while the decision to extend it to high income households is debatable. One thing for sure is that taxes will eventually have to be raised so as to tackle the budget deficits.

References

Atrends, B., 2010. What Would Happen if the Bush Tax Cuts Expire. Wall Street Journal. Web.

Bischoff, B., 2003. “What the Bush Tax Cut Means for You”. smartmoney.com. Web.

Gale, W.G., 2010. Five myths about the Bush tax cuts. Washington Post. Web.

Manz, W.H., 2002. The Bush tax cut: a legislative history of the Economic. Growth and Tax Relief Reconciliation Act of 2001, Vol 1. Buffalo, NY: William S. Hein.

Sahadi, J., 2010. Bush tax cuts: What you need to know. CNNMoney.com. Web.