To extend or not extend the Bush tax cuts? That question is at the heart of the debate between Democrats and Republicans on Capitol Hill, as lawmakers line up to let the tax cuts expire, make them permanent, or do a little mix and match.
Most Republicans, who have traditionally advocated for lower taxes, say that letting Bush's tax cuts expire amounts to a tax increase -- the last thing a country should do in the middle of a recession. Democrats counter that with the federal deficit at a record high, the country cannot afford to take more money out of the treasury, especially to finance lower taxes for the wealthiest Americans.
The most likely scenario is one President Barack Obama and most Democrats in Congress prefer -- keeping the current income tax rates for lower- and-middle-income earners, but raising the rate for the wealthiest Americans -- namely individuals making more than $200,000 a year and families making $250,000 or more. Many of the other cuts would remain under this scenario.
But Congress must act soon to prevent any of the Bush tax cuts from ending and there's no guarantee it will pass a bill before next year's expiration date. To help you understand what's at stake, we've put together a Bush Tax Cut Primer below.
But first, a little background.
In June 2001, Congress passed a large package of tax cuts that President George W. Bush pitched on the presidential campaign trail. Not only did the legislation reduce income taxes for nearly all Americans, it sent $300 or $600 rebate checks to every taxpayer. The legislation also phased out the estate tax, reduced the "marriage penalty" for couples filing jointly, increased the threshold for the Alternative Minimum Tax (AMT), and raised the child tax credit that parents could claim on their annual returns.
The most unusual aspect of the 2001 package was that the cuts were temporary, with some reductions phasing in as late as 2006, and all of them expiring by the end of 2010. Not only did the bill stipulate that some of the cuts would be good for only a year or two, it also left the task of ending or extending tax relief to whomever followed Bush in the White House.
Despite the $1.35 trillion price tag, which some Democrats complained was too expensive, Bush and Congress would go on to pass five more tax-cut packages over the next seven years, with the biggest breaks coming in 2003. In that bill, Congress trimmed taxes on capital gains and dividends; accelerated most of the 2001 cuts that were scheduled to be phased in; temporarily erased the "marriage penalty" for couples filing jointly; again increased the child tax credit; and made another AMT fix. That price tag in 2003: $330 billion.
Subsequent years saw more fixes to the AMT and extensions for the marriage penalty break, capital gains and dividend cuts, and other targeted measures, which were all originally short-term fixes. All together, the Bush tax cuts cost just north of $2 trillion.
Unless Congress acts this year, all of the tax cuts mentioned above will expire as the legislation originally called for. Here's what that would look like:
-- Some taxpayers in the 10 percent bracket would go to the 15 percent bracket;
-- The 25 percent bracket would go to 28 percent;
-- The 28 percent bracket would become 31 percent;
-- The 33 percent bracket would go to 36 percent; and
-- People in the highest bracket -- 35 percent -- would see their rate go up to 39.6 percent.
Obama and most Democrats in Congress want to let the rate cuts for the two highest income brackets expire and go back to their previous, higher levels, but leave unchanged the income tax rates for other Americans.
In 2001, estates worth more than $675,000 were taxed at the 55 percent rate. Over the years, the threshold rose to $3.5 million, and estates worth more than that were taxed at the 45 percent rate. This year, the estate tax rate is zero. But starting in 2011, it would return to 55 percent with a $1 million exemption. Most Democrats say they'd like to see estates taxed at the 2009 level of 45 percent, but there is not yet a consensus about the exemption amount. A smaller number of Democrats, led by Sen. Blanche Lincoln (D-Ark.), have advocated a $5 million exemption and a 35 percent rate.
Before 2001, married couples that combined their income and filed a joint return were taxed at a higher rate than if they filed separately. They also did worse when it came to calculating deductions, tax bracket eligibility and credits. The tax cut packages during the Bush years eliminated most of those inequities, but they will return full force without congressional action.
Capital Gains and Dividends
The 2003 tax cuts reduced levies on capital gains and dividends to 15 percent or 5 percent based on a person's income. More cuts zeroed out dividend taxes entirely for some earners. Capital gains rates will return to 20 percent in 2011 without action, while the tax on dividends will go back to marginal rates.
Alternative Minimum Tax
It may come as a surprise that the United States has two parallel tax systems -- one for high earners and one for middle- and low-income Americans. The dual tax system was developed about 40 years ago to prevent wealthier Americans from zeroing out their taxable income with clever deductions and accounting tricks.
Currently, the AMT, which includes different and less generous tax breaks, applies to families making more than $70,000 and individuals making more than $46,000 annually, but in 2011 those numbers would revert to 2001 ranges. That means millions of Americans -- families making $45,000 or more and individuals making at least $33,750 -- would be hit with the higher tax.
Child Tax Credit
In 2010, most families got a $1,000 tax credit for each child. In 2011, the credit would drop to $500 per child.
In general, Democrats say they want to extend nine-tenths of these tax cuts. President Obama's budget blueprint extended the tax cuts for all but the top income brackets, and the Senate Budget Committee endorsed a similar proposal.
But Congress needs to move on a bill (as yet unwritten) and pass it before the end of the year to make those promises a reality. Is it possible? As Sen. Richard Durbin (D-Ill.) the Democrats' second-ranking senator, told Politics Daily this week, "We know the direction we want to go in, but we're not there yet."