Retrospectives on the Tax Reform Act of 1986

Last Friday saw the 25 year anniversary of the Tax Reform Act of 1986. This act was the most recent tax simplification bill, and passed with the sponsorship of both parties. The bill reduced top marginal tax rates from 50% to 28% and consolidated tax brackets by weeding out deductions and exemptions from the tax code. Here are a few retrospectives on the bill.

Martin Feldstein:

The Tax Reform Act of 1986, enacted 25 years ago last Friday, showed how a tax reform that includes lower rates can change incentives in a way that grows the tax base and produces extra revenue…

Taxpayers who faced a marginal tax rate of 50% in 1985 had a marginal tax rate of just 28% after 1986, implying that their marginal net-of-tax share rose to 72% from 50%, an increase of 44%. For this group, the average taxable income rose between 1985 and 1988 by 45%, suggesting that each 1% rise in the marginal net-of-tax rate led to about a 1% rise in taxable income.

This dramatic increase in taxable income reflected three favorable effects of the lower marginal tax rates. The greater net reward for extra effort and extra risk-taking led to increases in earnings, in entrepreneurial activity, in the expansion of small businesses, etc. Lower marginal tax rates also caused individuals to shift some of their compensation from untaxed fringe benefits and other perquisites to taxable earnings. Taxpayers also reduced spending on tax-deductible forms of consumption.

Howard Gleckman:

Tax reform will make nearly everyone mad. Big-bucks subsidies will be slashed or killed. Political demagoguery will run wild. The Reagan Administration saw that reform would only work if it began with a very specific plan that the White House owned. And President Reagan eventually became its best salesman. My Tax Policy Center colleague Gene Steuerle—who helped write TRA 86—always says the secret to success in Washington is writing the first draft. Put it this way: President Obama’s health reform strategy, which left the dirty work to Congress, is not the way to go.

Gene Steuerle:

In a recent testimony and a Tax Notes article, I outlined ten steps that increased the chances of reform in 1986 and for the most part are repeatable today. These include; seize today’s, not yesterday’s opportunities; rely on principles like equal justice under the law to determine what should be done; make reform comprehensive, in part, because the political cost is likely to be the same in any case; shift the burden of proof to those opposing the better system; form liberal-conservative coalitions in areas where both sides can gain something; plan strategies in advance for how to best present the proposals and their effects to the public; empower nonpartisan staffs like Treasury’s Office of Tax Policy and the Joint Committee on Taxation (who really assembled the ’86 reform); establish leadership on a variety of fronts; insure accountability so that very specific political leaders bear a significant cost if reform fails; and empower someone to run with the ball and strategize on how to make reform happen.

Lee Burman:

And it’s easy to get excited about the possibility of a Tax Reform Act of 2014. Tax reform is even more necessary now than it was in 1986. Everyone agrees that the tax system is complex, unfair, and inefficient. And it doesn’t come close to raising enough revenue to pay for the government, whose needs will only grow as the baby boomers retire and health care costs continue to rise. There are lots of tax reform plans out there, including the ones produced by theBipartisan Policy Center (my favorite since I helped write it), the Bowles-Simpson panel, and an excellent report commissioned by President Bush. There’s even an action-forcing event in 2012 when the Bush tax cuts are scheduled to expire. Rather than extending what everyone agrees is a deeply dysfunctional tax code, why not remake it to meet the needs of 21st century America?

Overall, the lesson from 1986 is that tax reform can be both popular and economically efficient. Yet tax simplification is a process that needs to be renewed every generation. The twenty five years since 1986 have seen a wave of new deductions that have led to increases in marginal tax rates while larger portions of income are sheltered from taxation through economically wasteful carveouts. We are long overdue for another tax simplification process — perhaps like the one that the Bowles-Simpson committee has recommended. One hopes that President Obama and Congressional Democrats can take the lead, as President Reagan once did, in helping to broker a bipartisan tax agreement that will lower tax rates and broaden the tax base.