Like HowStuffWorks on Facebook!

How the Bush-Era Tax Cuts Work

The 2001 and 2003 Tax Laws

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was signed on Memorial Day in 2001. Business activity reached a peak in the United States in March 2001, two months before the first tax cuts were made [source: CNN Money]. However, few predicted the oncoming recession that would shrink the economy over eight months in 2001, and no one foresaw the devastating 9/11 attacks that would slow recovery even further. As Congress drafted the law, the Congressional Budget Office was predicting $5.6 trillion budget surplus over the next ten years [source: Kessler].

With ample money in the coffers, Congress proposed widespread tax relief. The 2001 tax law called for rate cuts in every tax bracket and the creation of a new 10 percent tax bracket for the lowest earning households, those making zero to $12,000 in taxable income. Beforehand, the lowest rate had been 15 percent.

As it was written, the 2001 law called for rate reductions to occur in stages over several years. For example, the highest tax rate in 2000 was 39.6 percent for the top-earning households. The 2001 law lowered the rate to 35 percent, but not until 2006. Until then, it would be lowered incrementally over each tax year. The same was true with the 28 percent, 31 percent and 36 percent tax brackets, which were each scheduled to lower by three points by 2006, but in small increments [source: Gale and Harris].

After the 2001 cuts passed, reality hit. The country was in far worse economic shape than Congress had believed. This prompted calls for even more tax cuts to spur investment and job growth. Congress responded with the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). The 2003 law accelerated many of the rate changes in the 2001 law, to be phased in over a number of years.

The biggest tax cuts in the 2003 law applied to dividends and long-term capital gains. Dividends used to be taxed at the same rate as normal earned income. The 2003 law taxed dividends at a flat 15 percent across all tax brackets. As for income earned from selling investments -- stocks, bonds, investment real estate -- the rate fell from 20 percent to 15 percent for those in higher tax brackets, and from 10 percent to 5 percent (and to zero by 2009) for those in the 15 percent tax bracket and below [source: Gale and Harris].