Even if Bush Cuts are Extended, Taxes are Rising Next Year

Congress and the administration have been arguing for months over extension of the Bush tax cuts: Should we extend them for everyone or only for the poorest 98.3 percent of Americans (which would also maintain some tax cuts for the rich)? Disagreement revolves around roughly $68 billion: the cost of covering the last 1.7 percent vs. the government pulling that much money out of the private sector and squelching economic recovery. But nobody’s talking about the nearly $80 billion hit that expiration of the 2009 stimulus bill will inflict.

The stimulus bill (the American Recovery and Reinvestment Tax Act of 2009) provided $287 billion in tax cuts for 2009 and 2010 but most provisions expire at the end of this year. (Congress extended some of the business tax cuts during the summer.) The big kahuna is the Making Work Pay credit—nearly $60 billion a year going to most workers—but partial exemption of unemployment compensation, expansion of EITC and education credits, and greater refundability of the child credit deliver nearly $20 billion more. Taxes will jump for more than 95 percent of Americans when those cuts evaporate come January.

Why does a $68 billion tax increase on wealthy taxpayers throw Congress into total gridlock but no one mentions a tax hike almost 20 percent bigger? Partly it’s that the stimulus was designed as temporary; Congress may have made the Bush tax cuts temporary to avoid a filibuster but proponents always meant them to last forever. However, it’s also a triumph of politics over economics: stimulus is a dirty word in Washington these days, even though most economists agree that the economy still needs a strong boost. And maybe “economist” is a dirty word too.

Arguably taking $80 billion away from all but the richest Americans would hurt spending more than pulling $68 billion out of fat wallets. Low- and moderate-income households save less of their income than do wealthier people, so raising their taxes causes a bigger drop in consumer demand.

Deficit hawks worried about running up more red ink should oppose extending either set of tax cuts. But people worried about what a tax rise will do to the economy should quit fretting about higher taxes on the rich and focus on the other 98 percent of Americans.

While it’s still possible that Congress will act to extend some of the tax breaks we’ve received during our nation’s Great Recession, it’s not likely. Which means that no matter what happens with the Bush tax cuts, if you make less than $150,000 (the income above which the Making Work Pay credit didn’t apply) you’ll be paying more in taxes next year.

What’s a taxpayer to do?

After the issue of the Bush tax cuts is resolved, I’ll be writing more about year-end tax planning. But in general, when faced with higher taxes, the correct strategy is normally to move as much income as possible into the the year with lower taxes (in this case, 2010) and move as many deductions as possible into the year with the higher taxes (2011).

How do you shift income? Depending on your profession, it might be tough. If you’re expecting a year-end bonus, you could try to get the boss to pay it this year rather than next. If you’re self employed, you could try to collect outstanding invoices this year rather than next.

When it comes to deductions, you can try to put off paying for deductible expenses (for example, medical bills) until next year when they might do you more good.

Again, these tax increases aren’t yet set in stone, nor are they huge – so doing nothing, especially at this point, isn’t a foolish strategy. As more information comes in, more advice will be going out – stay tuned.