Flip on the television, and you'll probably hear the talking heads chatter about the Bush tax cuts, which are set to expire in December 2012. What are these tax cuts, exactly? What will happen if they expire?
What are the Bush Tax Cuts?
"Bush tax cuts" is a catch-all term that describes temporary tax reductions passed in 2001 and 2003. These tax cuts are set to expire at the end of 2012. If they expire, many middle-class and upper-class Americans will see increases in their tax bill.
What's at Stake?
Between $3 trillion to $3.7 trillion dollars. That's "trillion" with a "t," or $3,000,000,000,000 dollars.
People Who Favor Extending the Tax Cuts Say ...
There's the obvious point that no one enjoys paying taxes, but in addition, many experts fear that the tax cut expiration will reduce consumer spending, which will hurt the recovering economy.
People Who Favor Letting the Tax Cuts Expire Say ...
On the other hand, the U.S. has a huge federal deficit, and many experts argue that the tax cut expiration will generate the revenue needed to pay off our mounting national debt.
The federal deficit passed $1 trillion in 2009 and hasn’t dipped below that number since.
The Fine Print
There's an intense political debate about who should benefit from an extended tax cut. President Obama proposed extending the tax cuts only for households that make less than $250,000 a year, arguing that wealthy households can afford to pay higher taxes. The increased tax revenue, he and his supporters argue, can be used to repay the national debt.
But his opponents argue that many small businesses are taxed at the household level. (Businesses that are organized as an LLC or an S-Corporation are taxed as if they were a household.)
Letting the tax cuts expire will harm those small businesses, some people argue. If a small business winds up needing to pay an extra $35,000 a year in taxes, for instance – poof! – there goes someone’s job.
They also note that America already has a progressive tax code that charges a higher tax rate on upper-income dollars. (This is also known as a "marginal" tax rate.)
Read more: Why the rich should budget, too.
In theory, Congress can create a tax reform agreement this year, which would put to rest the thorny issue of what happens to the tax cuts in December. But there seems to be a slim chance of Congress passing a major tax reform bill the summer before a Presidential election.
Automatic spending cuts totaling $1.2 trillion over the span of the next 10 years are expected to provide some relief for the national budget. Those spending cuts are scheduled to begin at the end of 2012.
If Congress repeals those spending cuts, and also extends the tax cuts, the U.S. debt will hover around $900 billion or more for the next decade, according to Congressional Budget Office estimates.
How Can I Prepare?
Be aware that if the tax cuts expire, your tax bill might go up. If you're living at the margins of your budget, this might make things a little tougher.
Take another look at your budget to find ways to reduce your spending and set aside a little more money for your tax bill. In the worst-case scenario, you'll be prepared if your tax rates increase. And in the best-case scenario, your tax bill will stay the same or decrease, and you'll be left with extra savings that you can apply to your debt, put aside for retirement, or spend on your child's tuition bill.