The weather in State College and all of Centre County is turning colder as we head into the Christmas season. On the day that I write this, the high is 26 degrees and going outside leaves a chill in your bones.
The chill in the air in Washington, D.C., comes in the form of a tax deal that President Obama has worked out with the Republican Congress. It is still in the works and will probably be altered in various ways to try to make everyone happy (if ever there was an impossible task). There are many partisan articles out there either focusing on the salvation of the tax-cut deal or warning of the ways the tax-cut deal will end the world as we know it. The reality is somewhere in between.
Why do we need a tax deal in the first place? Let’s start at the beginning. The Bush tax cuts were established in 2001 and set to expire at the end of this calendar year, ushering in higher federal income tax rates across the board. For now, the income tax rates are 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. The lowest earners are taxed at 10 percent while the highest are taxed at 35 percent.
If the Bush cuts expire, the old rates come into play. The lowest—10 percent—tax rate disappears, replaced by 15 percent. Two higher federal tax brackets—36 percent and 39.6 percent—are created for the highest earning taxpayers.
In addition to increasing taxes on income, allowing the tax cuts to expire would reinstate the federal estate taxes that were slowly dwindling over the years due to the same tax cut. In fact, 2010 heralded a full repeal of the estate tax for this calendar year. The restoration of the federal estate tax effective Jan. 1, 2011 at 55 percent for estates over $1 million led many reporters to joke that the estate tax was “returning from the dead.”
This $1 million mark hits many estates that, to many, are not considered wealthy, but comprise homes, IRAs or small businesses that add up. Both Democrats and Republicans want to avoid the older estate rules. The rumor is that they are gunning for an estate tax of 45 percent on estates over $3.5 million to be put into effect starting in 2011. Because the economy is slowing and unemployment remains high in the U.S., the government does not want to penalize the American public with higher tax rates right now, even though as a country we are carrying an enormous deficit.
Another advantage of the proposed tax deal for workers is the payroll tax holiday, a one-year cut that shaves two percentage points off the Social Security tax. The 6.2 percent will decrease to 4.4 percent on employees, lowering the Social Security contribution but keeping the Medicare portion of FICA intact. This will lead to higher take-home pay across the board that can be vital to a slow growth economy. For example, a family earning $70,000 would see $1,400 more in their paychecks with this plan. That’s $1,400 that could translate to greater spending on goods and services.
The tax deal is criticized as a benefit for the rich. The fact is that high-income earners pay the majority of the taxes in the United States, so any tax break will benefit them more. The top five percent of taxpayers—those with adjusted gross income over $159,619—pay a whopping 50 percent of all taxes. What’s being lost in all the rhetoric is that the extension of the 10 percent federal income-tax rate will greatly benefit the lowest-income families. In addition, the child tax-credit provision and the tuition tax credit would continue to help lower- and middle-class families into 2011 with the tax deal.
What of the critique that the government can ill afford to let go of tax revenue for Social Security when it already is in bad financial shape to pay for the aging baby boomers’ benefits? The payroll tax holiday is estimated to cost $120 billion. A few billion here and a few billion there, and pretty soon we are talking real money. In reality, increased demand for goods and services that will hopefully result from the tax holiday may help the government and the economy’s overall picture. Tax cuts stimulate the economy, while tax increases can dampen the economic picture, something we can ill afford to have in the present environment.
What will be the final outcome of the proposal? It seems definitive that at least a portion of the proposal will pass and that taxes will be lowered at least for the next year or two. But that still leaves us with an enormous challenge: making the deficit disappear.
