Extend or Expire?
Charles Enis, associate professor of accounting at the Penn State Smeal College of Business, sat down to discuss the fate of the Bush-era tax cuts. He addresses the pros and cons of extending the cuts and letting them expire, as well as the consequences for small businesses and taxpayers.
Should Congress extend the Bush-era tax cuts or let them expire? Why or why not?
Well, in my opinion, Congress has a good opportunity here to improve the transparency of the tax codes. For example, if they let the tax cuts expire for the upper income categories, the maximum statutory rate will rise from 35 percent to 39.6 percent. I would say let that happen, but to counter that, fix permanently or get rid of the alternative minimum tax (AMT).
Additionally, part of the Bush tax cuts was to repeal Section 68 of the code, in which high-income taxpayers lose a certain portion of their itemized deductions. This is, in effect, a tax. When you take away deductions, it detracts from the transparency of the code. It was repealed gradually and done away with finally in 2010, but the phase out of itemized deductions and exemption allowances comes back full force in 2011 if the Bush tax cuts are not extended.
The phasing out of itemized deductions and exemption allowances let that go away. They should extend the repeal advantage. In other words, you’re going to have a higher marginal tax rate, but you’re going to do away with a lot of these unobtrusive hidden-type taxes, which I think would be a great opportunity.
If you’re going to go and say to the wealthy people, we’re going to let your tax rates go up as high as 39.6 percent, then I think you should also tell these people that they no longer have to worry about their itemized deductions, exemption allowances, and the AMT.
Can you explain the AMT?
The version of the AMT that we have today was instituted in the Reform Act of 1986. It was designed to make wealthy people, who escaped taxes using tax loopholes, pay something in tax. However, the AMT was not adjusted for inflation, so it captures many middle-income taxpayers who are probably not using tax loopholes to avoid paying taxes.
This is the way the AMT works: You calculate the AMT and the regular tax. Taxpayers pay the greater of the two. So, if the government doesn’t fix the AMT, it’s going to dwarf the regular tax whether the cuts are extended or not.
I think the debate over whether the tax cuts are extended or not is very important. It’s so important that it’s detracting from this problem of the AMT that really hasn’t received the attention it deserves.
What are some of the pros and cons of extending the tax cuts? Letting them expire?
If we allow the tax cuts to expire and the tax rates go up, this could mean trouble for the economic recovery. Right now, you have some policy-makers declaring the recession is over, but try telling that to someone who’s out of work. That’s the problem—jobs. You can say the recession is over but that doesn’t help all those people who are out of work. Will higher tax rates hinder these people from getting back into the workforce? Possibly.
On the other hand, there are those who want to let the tax rates increase. We have a huge budget deficit. We need the tax dollars to pay down the deficit. There are a lot of people arguing that the Bush tax cuts favor the wealthy and that it’s really not a fair distribution of the tax burden.
By making the tax cuts expire, you may create a perception that the tax code is fair and may get additional revenues to pay down the deficit. On the other hand, by keeping the tax cuts, you may be able to have a quicker economic growth and be able to get people back to work.
What are the consequences for small businesses and employers if the tax cuts expire or extend?
If the tax cuts expire, the tax rates go up. Where that’s going to hurt a lot of businesses is the combined federal tax and state and local taxes. When the federal government cuts taxes, the state and local governments usually look at it as an opportunity to raise taxes. A lot of them did. If the tax rates go up, are the state and local governments going to forego raising their rates simply because federal rates are increasing? Not likely.
This is going to be a tax burden. There are the federal income taxes and in Pennsylvania, there’s the Pennsylvania income tax. You’ve got the township earned income tax, the payroll taxes, FICA taxes, etc. You put all that together and that’s a lot of taxes.
Many small business owners are in the tax brackets that are going to be impacted by the increase in tax rates. The idea here is if you’re a small business owner and you’ve got a budget, the more cash that goes one place, leaves less cash somewhere else.
Fast-forward to Jan. 1, 2011, and the Bush-era tax cuts are not extended? Can you give us an idea of what 2011 and beyond is going to look like?
Then the issue becomes, what will be the tax policy in 2011? Will they do nothing? Will they go and pass something entirely different? Maybe pass a tax law that has higher rates but not as high as those in the law that expired. Could they extend the tax cuts retroactively to the beginning of the year?
What about the nuts-and-bolts administrative material like printing the tax forms? How are you going to print a tax form, instructions and booklets, and all the literature the IRS comes up with, not knowing what the law is going to be by April 15. What about the software makers? I imagine the people who work for these software companies are going to have several versions ready to go depending on what happens.
We are quickly approaching the deadline to extend the tax cuts, and with mid-term elections looming, it’s possible that Congress will not vote on the cuts until late this year, if at all. What are the implications of a delayed vote for businesses and taxpayers?
If it comes down to a deadline like that and Congress is still gridlocked, I think they might come to a compromise and extend the cuts for one more year and worry about it later. Then, we’re going to be in the same boat as we are with the AMT every year. Will they extend it or let it expire?
There’s so much uncertainty and lack of transparency with the tax code. I think if they’re going to do any more tinkering with extensions along the way, they need to improve the transparency and predictability. Take some extenders and get rid of them for good or keep them around.
Charles Enis, associate professor of accounting at the Penn State Smeal College of Business, is an expert on tax and other policy issues. His research has been published in such leading journals as The Accounting Review, Advances in Taxation, The Journal of American Taxation Association, and the Journal of Economics and Business. Enis holds two bachelor’s degrees, his C.P.A., his master’s degree and Ph.D. from the University of Maryland.