Bush tax cut dithering might lead to shrinking paychecks

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The clock is ticking on the Bush tax cuts, and the likelihood that a vote to extend them will happen before November is not looking good. Why the urgency? Because the Internal Revenue Service needs lead time to create, publish, and distribute tax tables for the first payroll of 2011.

Absent a vote, the current rates will expire for all taxpayers. A Treasury spokesperson, Sandra Salstrom, told reporters that if no agreement is reached by mid-November, her department will have to decide how to proceed. Chances are tax tables will be developed based on the pre-Bush tax cut rates, and later replaced with new tax tables.

With only a few months before the possibly higher tax rates kick in, employers would be wise to explain to employees what might be coming and why, so they can brace for lower paychecks.

What’s the debate?

The Obama administration wants the current tax rates – the Bush tax cuts – to expire for the top 2 or 3 percent of earners. That is, individuals who make at least $200,000 or families who earn at least $250,000.  

Most Democrats want the same plan. Many, however, are supporting a temporary extension of all tax cuts, probably for 12 or 24 months, to give the economy time to pull out of the recession. Most Republicans also want to see tax cuts extended for all taxpayers, for a 12- or 24-month period. They say raising taxes during a recession doesn’t make sense.

If all the tax cuts expire, which they will if Congress does not vote otherwise, tax rates will return to June 2001 levels. They are:

  • 10 percent will increase to 15 percent
  • 15 percent will increase to 28 percent
  • 25 percent will increase to 31 percent
  • 28 percent will increase to 36 percent
  • 35 percent will increase to 39.6 percent

What will happen in January if an agreement isn’t reached in time to issue tax tables?

“It could be a paycheck or two until the new tables are implemented,” Scott Mezistrano, senior manager of government relations at the American Payroll Association in Washington, told Bloomberg.com.

While that doesn’t sound too bad, it has repercussions for consumers, for employers, and for the economy in general:

  • The wasted taxpayer dollars to distribute tax tables that might only be useful for one or two pay periods, and then the need to do it all over again.
  • The impact on households that can’t afford to have additional money withheld from their paychecks, even temporarily.
  • The headaches it will cause for every employer or payroll processor that will first have to over-withhold federal taxes, then refund the extra money once Congress makes a decision and the IRS distributes new tax tables. Furthermore, the extra workload likely will come during January or February, when payroll-related work already is multiplied.

Consumer confidence

Bloomberg.com reported that in September, consumer confidence dropped from 68.9 percent in August to 66.6 percent a month later. The biggest decrease was in households with income of at least $75,000, where sentiments about the overall prospects of the economy are dwindling. In lower income groups, consumer confidence somewhat increased.

The drop in confidence among higher income taxpayers might be because they are expecting to see their taxes go up, according to Chris Lowe, chief economist for FTN Financial in New York. Lower income taxpayers are not expecting it, might not be prepared, and a bigger tax bite will come as a painful surprise.  

Consumer spending accounts for 70 percent of American economic activity, according to Bloomberg.com. Even a small dip in after-tax income could seriously depress spending.  With many lower- and middle-income taxpayers barely scraping by, two reduced paychecks can leave them in financial trouble.

Alec Phillips, a Washington-based economist for Goldman Sachs Group, Inc., predicts that with the election in November and Thanksgiving holidays for Congress, there will be no vote until December. Bloomberg.com quoted him as saying the delay “would have a significant impact on low- to middle-income people. To the extent they don’t have the access to credit that they had a few years ago, then the cash flow disruption would have a pretty big impact” on spending.

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