Factbox: Debate on Bush-era tax cuts and economic growth

WASHINGTON (Reuters) - A highly-charged debate is brewing in the United States over individual income taxes -- all of which will jump next year without congressional action.

U.S. lawmakers are set to begin discussion on the taxes in September when lawmakers return from a break, although many believe divisions could push action back until after the November elections.

The biggest controversy is over whether historically low income tax rates for the wealthiest 2 percent of Americans should be extended.

President Barack Obama wants to extend lower rates enacted under former President George W. Bush for only lower and middle-class taxpayers, who comprise about 98 percent of the population.

In this group are individuals earning less than $200,000 per year and couples earning less than $250,000. Under Obama's plan, the top two tax rates would rise from 33 percent and 35 percent to 36 percent and 39.6 percent, respectively.

Below is a summary of the debate surrounding the issue:

CONTENTION: Republicans and business groups argue lifting the top two rates would derail the economic recovery.

FACTS: There is considerable debate on this contention, though several economists at top Wall Street banks say the recovery will probably not fall back into recession if Obama's plan wins the day.

But given the recent backslide in growth, many back waiting until the economy is on a firmer footing.

In an August poll of 53 economists conducted by The Wall Street Journal, 32 backed renewing all of the lower tax rates, 11 supported Obama's policy and three backed letting all the rates expire.

These limited tax increases would likely not stall the recovery, Citigroup chief U.S. economist Bob DiClemente said. But he added that given recent warnings about slowing growth by the Federal Reserve: "I'd be reluctant to go ahead with them at this time."

CONTENTION: Proponents of extending the lower tax rates for wealthier individuals say small business will be harmed under Obama's plan, which would slow economic growth.

FACTS: The congressional Joint Committee on Taxation estimates that about 3 percent of individual taxpayers with business income fit into the top two income rate tiers.

The same report found that half of small business income, estimated at about $1 trillion annually, comes from this elite group.

Included in this group, however, are firms that many would not consider "small." For example, hedge funds and law firms are organized in ways that technically put them in this category.

CONTENTION: There are more effective ways to stimulate the economy, where one can get a "bigger bang for the buck," than keeping taxes low for wealthier Americans, proponents of letting the top two tax rates rise say.

FACTS: Economists of all stripes agree high earners are less likely to spend extra cash than less well-off peers.

A January report by the Congressional Budget Office, seen as a neutral arbiter of budget matters, measured the impact of various measures to boost growth and employment.

It found that putting money in the hands of lower-income earners by boosting aid to the unemployed or lowering payroll taxes is a significantly more efficient way to stimulate growth compared to putting more funds in the hands of those already well-off.

"There are just better ways to use the money," said economist William Gale at the Brookings Institution.

Moody's Economy.com chief economist Mark Zandi, who advised Republican presidential candidate John McCain, backs this view but argues such programs could not make it through this Congress, which has fought bitterly to extend stimulus spending this year.

The influential Zandi advocates phasing out the low rates for high earners beginning in 2012, citing the fledgling recovery.

CONTENTION: We cannot afford to pay for the tax cuts given the widening debt and yearly budget deficits, expected at about $1.5 trillion this year, some deficit hawks say.

FACTS: Extending the tax cuts for the 98 percent of Americans in Obama's plan would cost $1.3 trillion over 10 years. Adding in the upper income groups would cost about $700 billion over the same period.

A key omission in the debate over what to do about the taxes is how extension of lower rates would be funded.

Under congressional budget rules, lawmakers can extend the lower rates for lower- and middle-class Americans without finding a separate revenue source.

The lower rates for the upper-income groups must be paid for under the same budget rules, although Congress could chose to waive the rules.