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Extending the Bush tax cuts strictly a short-term fix

President Obama and Republican leaders recently agreed to extend, for two years, tax cuts that were set to expire at the end of this month. The agreement would lower payroll taxes, continue jobless benefits for the long-term unemployed, incentivize business investments and create a plan to reinstate the estate tax. Timothy Rupert, a professor of accounting at Northeastern University and expert in tax code changes, explains what this means for taxpayers and the federal budget.

With the budget deficit skyrocketing, how can we possibly afford this?

At a cost of almost $900 billion, a number of people (including fiscal conservatives) are asking that question, because the bill provides tax relief but doesn’t provide for any revenue increases or cost reductions to pay for the cuts. Others wonder whether we can afford not to act now. If the provisions were allowed to expire, it would result in a significant tax increase and as the economy begins to show some signs of recovering, I think many people are worried that a tax increase might seriously damage the recovery.

How will this affect long-term economic and gross domestic product (GDP) growth in 2011?

The bill is predicted to help economic and GDP growth in the short term, but It’s not clear that it will have much of an impact on long-term economic and GDP growth. The bill basically extends the benefits to which most taxpayers have already become accustomed, so it’s not likely to have a big impact on their behavior.

There are a few new provisions that might have a positive effect in the short term (for example, a provision to allow businesses to expense all of the cost of machinery and equipment in 2011). But most maintain the status quo, and based on some recent comments from advisors to the Obama administration, it sounds as if they don’t expect it to have long-term positive effects. They actually plan to use that as a reason to eliminate the provisions the next time that they are up for extension.

While some tax benefits to low- and moderate- income families were extended, the wealthiest seem to be reaping the most here. Is this tax cut going mean the rich getting richer?

The tax act extends significant benefits for low- and middle-income families that should reduce their tax bills considerably, including the extension of some key credits for low-income taxpayers and the inclusion of an alternative minimum tax “patch” for middle-income taxpayers. And this act adds a new temporary reduction in Social Security taxes, which should help low- and middle-income taxpayers substantially by reducing the tax by two percentage points for 2011. That said, there are still substantial tax benefits for the high-income taxpayers, especially reductions in the tax rates for interest income and dividends, so it’s going to be difficult for our elected officials to convince us that these breaks are benefitting everyone equally.

Was this package the best approach in helping to ease taxpayers’ fears about a still unstable economy and to help the unemployed?

I don’t believe anyone would agree that this legislation is the best policy. However, it might be the best approach that is feasible right now. Remember that the expiration of the Bush tax cuts at the end of 2010 was not a surprise. They have been scheduled to end for several years, but Congress has been unable to come to any agreement on what should be done. To the extent that this bill represents Congress actually taking some action with respect to the tax policy, it is at least resolving some of the uncertainty about our tax system for the short term. The question is whether they can arrive at compromises that will create some certainty for the longer term.

Recently, a presidential commission released a report about ways to address our long-term deficit, including recommendations for major changes to our tax code. Will this most recent legislation help or hurt those efforts?

The directions offered by the commission would result in major tax policy changes that would most likely require a great deal of compromise on the part of both parties. Given the difficulty of arriving at a compromise on this legislation and the backlash within the Democratic Party, the possibility that both parties will be able to arrive at a compromise for longer-term changes seems pretty small at this time. It seems likely that it will be several more years before any major tax policy decisions are made.

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