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How Congress' tax-cut decision may affect economy

Associated Press | 11/30/2010, 7:51 p.m.

WASHINGTON — On this, economists agree: Extending tax cuts passed under President George W. Bush for low- and middle-income people would strengthen the weak economy.

The question is what to do about the highest-paid 3 percent of taxpayers. Should Congress let their tax cuts expire at year’s end as scheduled? Extend them for only a while? Or make them permanent?

It isn’t just a debate over how much money high-income Americans should get to keep. It’s about how much their tax cuts might aid the economy. And how much they’ll affect the budget deficit years from now.

But first, consider what would happen next year if Congress let the tax cuts for everyone expire as scheduled. According to Moody’s Analytics, the deficit would drop to $732 billion. That’s well below the $1.3 trillion deficit for the budget year that ended Sept. 30.

At the same time, the economy would suffer, Moody’s says: Growth would tail off to just 0.9 percent next year. That’s scarcely more than a recessionary pace. And unemployment would average 10.7 percent next year.

That’s because higher taxes would leave people with less money to spend. Businesses would be less inclined to hire. Economic growth would slide. Yet if Democrats and Republicans can’t reach a deal during the post-election lame-duck session that began this month, taxes will rise across the board in January.

Republicans triumphant in the mid-term elections insist that everyone, regardless of income, should continue to enjoy the taxcuts approved during George W. Bush’s presidency.

President Barack Obama wants to extend the tax cuts for individuals with taxable incomes below $200,000 a year and couples with incomes below $250,000. Taxable income is a taxpayer’s total income minus allowable deductions and exemptions.

Obama has long argued that income above those levels should be taxed at the higher rates that existed before 2001. Yet since his party suffered major losses in the elections, Obama has signaled a willingness to compromise. The White House has indicated he is open to a one- or two-year extension of the tax cuts but opposes a permanent extension for the highest earners.

Here’s how analysts think each of the three leading options would affect the economy next year:

Option One: Let the tax rates for the highest earners rise back to what they were before 2001, when the first round of Bush tax cuts was passed. But extend them permanently for everyone else. This is what Obama favors.

Moody’s Analytics says that under this scenario, the economy would grow 2.6 percent in 2011. That’s better than the scant 0.9 percent growth envisioned if everyone’s tax cuts expired.

Economists note that low- and middle-income people tend to spend more of their take-home pay than the highest-earners do. That’s especially true in a tough economy.

Still, unemployment would average 10 percent next year, up from the 9.7 percent estimated for this year. The jobless rate would tick up as growth weakened slightly next year.

This reflects the Republican argument that a tax increase for high-income taxpayers would hurt some small-business owners, making them less inclined to hire.