Tuesday, November 02, 2010

What Will Happen To Expiring Bush Tax Cuts

Under President Bush, Congress enacted a series of tax cuts in 2001 and adjusted in 2003. Those tax cuts expire after December 31 of this year and the rates will revert to those in effect prior to 2001. That means significant and hefty tax hikes for all Americans.

Congress has not acted to sort out this mess and it will be left to the lame duck session to deal with the issue. At stake are hundreds of billions of dollars - both in terms of tax revenues and in income that taxpayers can hold on to.

The Times sets out a bunch of possible outcomes, but emphasizes that the tax cuts are costing the government hundreds of billions, rather than noting that the tax cuts put more money into the pockets of the taxpayers.

Of the possible outcomes, the most likely to occur is the punt - the lame duck Congress will simply extend the status quo (rates in effect for tax year 2009) for another year or two. I don't seem them making a quantitative and qualitative change to the tax structure.

What would potentially make quite a bit of sense is one that addresses both the AMT and tax rates for high income taxpayers. A new bracket could be created for taxpayers at a 45% rate (or 40% depending on the income threshold, which could be anywhere from $1.5 million to $5 million) - and no deductions, credits, or exemptions. For taxpayers now making $250,000 to that $1.5 million (or up to $5 million), they would see limited deductions, credits, and exemptions and a 35% rate. Keeping the other rates and income levels as they are would provide stability for tax planners, begin the institution of tax simplification that makes it easier to comply with the tax code, and improves compliance.

In other words, one possible implementation could be a 40% rate from $1.5 million to $5 million; 45% for $5 million or more, both subject to no credits, deductions, exemptions, and no AMT. Or, it could be 45% from $1.5 million and limited credits, deductions, and exemptions for taxpayers making up to $5 million.

At the same time, the dual nature of the AMT could be eliminated in one fell swoop as the tax systems are rolled into one method that eliminates needless complexity and annual battles in Congress to adjust the AMT for inflation. Currently, the top tax rate is 35% on incomes over $373,650 with multiple credits, deductions, and exemptions that serve to reduce the effective tax rate significantly.

This simplification and clarity on high income taxpayers could lead the way to simplification at the lower tax brackets. Since it would eliminate the complexity in calculating tax due, compliance would increase and tax avoidance would be reduced - both serving to increase tax revenues without having to adjust rates further.

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