To Extend or Not to Extend

09/03/2010

The tax cuts that were implemented during President Bush’s administration are set to expire at the end of this year.  The federal estate and generation-skipping transfer (GST) tax was revoked at the end of 2009 and is scheduled to be reinstated in 2011.

This means that taxes will be increased for everyone if Congress does nothing. 

So the question on everyone’s mind is, "will Congress extend or not extend …."

To me, Congress seems deeply divided and with the upcoming November elections, I only expect it to get worse.  Further, with our puttering economy, we seem to have a perfect storm for a knock-down drag-out battle over taxes.

A little history.

In 2001 and 2003, the Bush Administration and his Republican Congress made many income tax cuts and repealed the federal estate and GST for 2010. The income tax cuts along with the estate and GST tax repeal are set to “sunset” at the end of this year.  This generally means the tax cuts go back to what they were, meaning they will go up.

President Obama and many Congressional Democrats favor extending the income tax cuts for lower and middle-income taxpayers.  They also want to reinstate the estate and GST tax (generally at the levels that existed in 2009). 

Republicans, on the other hand, generally want to extend and/or make permanent the Bush income tax cuts for all taxpayers. They also want to eliminate the federal estate and GST tax altogether.

Because of our economic climate, the debate over income taxes has overshadowed the debate over estate and GST tax which has taken the back-burner.  Therefore, as I blogged before, I would not be surprised if the estate and GST tax end up getting reinstated to its 2001 levels.

Why do the parties differ so much?  It comes down to how they each believe taxes can stimulate the economy.  For the most part, Republicans think the best way to get the economy going again is to cut taxes, especially for the upper class, and ultimately cut the deficit with the rising revenues due to anticipated economic recovery.

Democrats counter that extending the tax cuts to high-income earners results in the equivalent of a $700 billion expenditure at a time when deficit spending needs to monitored and reduced.  They also argue that extending tax cuts for the “rich” would provide very little job creation in 2011.  Democrats offer as a solution with the small business jobs bill currently before the Senate, which contains both targeted tax cuts for small businesses and measures to improve their access to credit, both of which it is argued are far more powerful and cost-effective ways to stimulate economic growth and job creation.

But if we know anything, it is that the history is not as important as the politics … and the politics is getting ugly.

It reminds me of the Seinfeld episode when they talked about who has “the hand” in a relationship and how important it is to have the upper hand. 

Republicans believe they have the hand.  If they do nothing and/or resist Democratic proposals, they can say it was a failure of Democratic leadership that allowed the tax cuts to expire for everyone, including middle-class taxpayers.  Who cares about our country … right?  It’s all about the hand, and Republicans believe Democrats will come across as spiteful and partisan.

Democrats are no better. They believe they have the hand.  If they do nothing, the Bush tax cuts will sunset under provisions enacted by Republicans.  Therefore, they can’t be blamed, right?  Are they reading the polls?  Maybe they are, and that is why Democrats are appealing to their base by offering tax cuts for the middle class.

It looks like each side is waiting for the over to blink.  With the November elections looming, it will be difficult for any candidate to waffle on the tax debate, and incumbents in both parties may win or lose seats based on the position they take.

So what’s at stake? 

If Congress does nothing, President Bush’s tax cuts will expire and taxes on ordinary income, capital gains, dividends, gifts and estates will all increase. Qualified dividends, which are currently taxed at a maximum rate of 15 percent, will be taxed at ordinary income rates in 2011. Capital gains tax rates will rise from a top rate of 15 percent to a top rate of 20 percent. The top tax rates on ordinary income will rise from 33 percent to 36 percent and from 35 percent to 39.6 percent. Coupled with continued phase-outs of personal exemptions and itemized deductions, a taxpayer's effective tax rate could increase further. Both the estate tax and the generation skipping transfer (GST) tax will return in 2011 with a $1 million exclusion and a top rate of 55 percent. This is substantially less favorable than the 2009 maximum rate of 45 percent with a $3.5 million exclusion. In addition, the gift tax rate will rise from a maximum rate of 35 percent in 2010 to 55 percent in 2011.

And what will happen? 

Stay tuned ….

This could get more interesting than seeing my kids argue.