The 1986 Tax Reform Act
Regarding the 1986 Tax Reform Act, even after the changes to Federal tax laws of the early 80’s, there were many that still thought the U.S. income tax needed to be revamped.
Numerous political leaders in both the Republican and Democrat parties became swayed by the post (‘82) recession boom that lowering marginal tax rates did result in returning strength in the economy.
At the same time, all of the tax law changes helped those who made policy realize just how complex the U.S. Tax system really was.
Also, significant attention on taxes and the oddities of the tax base during this time helped many better comprehend how the income tax was adversely affecting jobs, wages, and the overall economy.
"The taxpayer - that's someone who works for the federal government but doesn't have to take the civil service examination. ~Ronald Reagan (www.QuoteGarden.com)
There was suddenly broad appeal to policy makers that by lowering tax rates even more and by repealing particular provisions of the tax code that they could improve the income tax even more, and so the Tax Reform Act of 1986 was born.
The new 1986 Tax Reform Act had positive and negative effects. Personal and corporate tax rates were reduced from 50 to 28% and 50 to 35% respectively. There would now also be fewer tax brackets, along with increases in standard deduction and personal exemption amounts that were indexed for inflation, which resulted in the total elimination of any Federal income tax for millions of taxpayers. On the flip side, the Tax Reform Act created complex alternative minimum taxes that some say caused unnecessary and destructive economic issues.
The 1986 Tax Reform Act wasn’t really intended to reduce or increases tax revenues.
However, it did transfer portions of the tax burden from individual taxpayers to businesses, largely by increasing the tax on business capital structure.
Individual taxpayers were able to enjoy new deductions like state and local sales taxes and various interest deductions and they could now even eliminate income averaging. However, many thought the 1986 Tax Reform Act made business taxes significantly more complex, especially in the international arena.
Because a number of provisions of the Act went too far, the real estate market took a turn for the worse, which was not insignificant regarding the fall of the Savings and Loan institutions. In just over 20 years from ’64 to ’86 the top tax rate for individuals was reduced by 63%, from 91 down to 28.
More broadly, the 1986 Tax Reform Act was seen as one of the last great chapters of astonishing reductions to tax rates during this period.
Interestingly, in spite of these tax rate reductions, tax revenues rose because of the larger tax base - and because more high income taxpayers chose to receive taxable income.
While referred to as an income tax, for decades our Federal tax system was really a mix of consumption and income taxes and each of the major tax acts would move the balance one way or another. However, the ’86 Act weighed significantly heavier toward the income tax due to new constraints on IRA’s and mechanisms available for how the business world could use economic depreciation to reduce their tax burden based on capital investments.
While the Federal tax burden increased by .5% from 17.5 to 18 between ’86 and ’90, increased spending by the Federal Government created constant budget deficits, which resulted in pressure to now raise taxes. So Congress did exactly that in 1990 and the top tax rate went back up, this time from 28 to 31%.
Once President Clinton was in office, he lobbied for yet another major tax increase to help close the Federal deficit and in 1993 Congress raised the effective top ax rate to 39.6%.
The increase actually raised the top tax rate from 31 to 36% but then there was a 10% surcharge added on top of that.
So now the U.S. tax system was again trending in the other direction; from higher marginal tax rates to lower and back to higher again.
However, as we know, this latest (Clinton induced) trend did not last.
Source: U.S. Department of Treasury
Some people confuse the "Tax Reform Act of 1984" with the "Tax Reform Act of 1986" -- but the former was actually legislation enacted as part of what was actually called the "Deficit Reduction Act of 1984."
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