Economic Recovery Tax Act of 1981

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Economic Recovery Tax Act of 1981
Great Seal of the United States
Long titleAn act to amend the Internal Revenue Code of 1954 to encourage economic growth through reduction of the tax rates for individual taxpayers, acceleration of the capital cost recovery of investment in plant, equipment, and real property, and incentives for savings, and for other purposes.
Acronyms (colloquial)ERTA
NicknamesKemp–Roth Tax Cut
Enacted bythe 97th United States Congress
EffectiveAugust 13, 1981
Citations
Public law97-34
Statutes at Large95 Stat. 172
Legislative history
  • Introduced in the House as H.R. 4242 by Dan Rostenkowski (D-Ill.) on July 23, 1981
  • Committee consideration by House Ways and Means,
  • Passed the House on July 29, 1981 (323–107)
  • Passed the Senate on July 31, 1981 (voice vote)
  • Reported by the joint conference committee on August 1, 1981; agreed to by the Senate on August 3, 1981 (67–8) and by the House on August 4, 1981 (282–95)
  • Signed into law by President Ronald Reagan on August 13, 1981
President Ronald Reagan signs the bill at Rancho del Cielo in 1981

The Economic Recovery Tax Act of 1981 (Pub.L. 97–34), also known as the ERTA or "Kemp–Roth Tax Cut", was a federal law enacted in the United States in 1981. It was an act "to amend the Internal Revenue Code of 1954 to encourage economic growth through reductions in individual income tax rates, the expensing of depreciable property, incentives for small businesses, and incentives for savings, and for other purposes".[1] Included in the act was an across-the-board decrease in the marginal income tax rates in the United States by 25% over three years, with the top rate falling from 70% to 50% and the bottom rate dropping from 14% to 11%. This act slashed estate taxes and trimmed taxes paid by business corporations by $150 billion over a five-year period. Additionally the tax rates were indexed for inflation, though the indexing was delayed until 1985.

The Act's Republican sponsors, Representative Jack Kemp of New York and Senator William V. Roth Jr., of Delaware, had hoped for more significant tax cuts, but settled on this bill after a great debate in Congress. It passed Congress on August 4, 1981, and was signed into law on August 13, 1981, by President Ronald Reagan at Rancho del Cielo, his California ranch.

In the year after enactment of ERTA, the deficit ballooned, which in turn, drove interest rates from around 12% to over 20%, which, in turn, drove the economy into the second dip of the 1978-82 "double dip recession". The Dow Jones average, which had been over 1000 before enactment of ERTA, fell to 770 by September 1982. Much of the 1981 ERTA was backed out in September 1982 by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), sometimes called the largest tax increase of the post-war period. The "Reagan recovery" began within weeks of enactment of TEFRA.

This bill and the Tax Reform Act of 1986 are known together as the Reagan tax cuts.[2]

Summary[edit]

The Office of Tax Analysis of the United States Department of the Treasury summarized the tax changes as follows:[3]

  • phased-in 23% cut in individual tax rates over 3 years; top rate dropped from 70% to 50%
  • accelerated depreciation deductions; replaced depreciation system with ACRS
  • indexed individual income tax parameters (beginning in 1985)
  • created 10% exclusion on income for two-earner married couples ($3,000 cap)
  • phased-in increase in estate tax exemption from $175,625 to $600,000 in 1987
  • reduced windfall profit taxes
  • allowed all working taxpayers to establish IRAs
  • expanded provisions for employee stock ownership plans (ESOPs)
  • replaced $200 interest exclusion with 15% net interest exclusion ($900 cap) (begin in 1985)

The accelerated depreciation changes were repealed by Tax Equity and Fiscal Responsibility Act of 1982, and the 15% interest exclusion was repealed before it took effect by the Deficit Reduction Act of 1984. The maximum expense in calculating credit was increased from $2000 to $2400 for one child and from $4000 to $4800 for two or more kids. The credit increased from 20% or a maximum of $400 or $800 to 30% of $10,000 income or less. The 30% credit is diminished by 1% for every $2,000 of earned income up to $28000. At $28000, the credit for earned income is 20%. The amount a married taxpayer who files a join return increased under the Economic Recovery Tax Act to $125,000 from $100,000, which was allowed under the 1976 Act. A single person is limited to an exclusion of $62,500. It also increases the amount of a one time exclusion of gain realized on the sale of principal residence by a persons at least 55 years old.[4]

Accelerated Cost Recovery System[edit]

The Accelerated Cost Recovery System (ACRS) was a major component of the ERTA and was amended in 1986 to become the Modified Accelerated cost Recovery System. The system changed the way that depreciation deductions are allowed for tax purposes. Instead of basing the depreciation deduction on an estimate of the expected useful life of assets, the assets were placed into categories: 3, 5, 10, or 15 years of life.[5] For example, the agriculture industry saw a re-evaluation of their farming assets. Items such as automobiles and swine were given 3 year depreciation values, and things like buildings and land had a 15-year depreciation value.[6] The idea was that there would be a rise in tax cuts due to the optimistic consideration of depreciating values. This would in turn put more cash into the pockets of business owners to promote investment and economic growth.[7]

Effect and controversies[edit]

The most lasting impact and significant change of the Act was the indexing of the tax code parameters for inflation starting in years after 1984. Of the nine federal tax laws between 1968 and this Act, six were tax cuts compensating for inflation driven bracket creep.[3] Inflation was particularly high in the five years preceding the Act, and the ensuing bracket creep alone caused federal individual income tax receipts to increase from 7.94% of GDP to over 10% of GDP at the time the Act was enacted.[8] The bracket creep was so dramatic that the entire revenue loss of the other individual provisions of the Act could have been achieved by setting the indexing of the tax code for inflation retroactive to 1979.[8] After the Act was passed, federal individual income tax receipts never fell below 8.05% of GDP; thus one way to analyze it is as one final compensation for bracket creep combined with indexing to eliminate the need for future tax cuts to address it.[8]

Following enactment in August 1981, the first 5% of the 25% total cuts took place beginning on October 1, 1981. An additional 10% began on July 1, 1982, followed by a third decrease of 10% beginning on July 1, 1983.[9]

As a result of ERTA and other tax acts in the 1980s, the top 10% were paying 57.2% of total income taxes by 1988, up from 48% in 1981, the bottom 50% of earners share dropping from 7.5% to 5.7% in the same period.[9] The total share borne by middle income earners of the 50th to 95th percentiles decreased from 57.5% to the 48.7% between 1981 and 1988.[10] Much of the increase can be attributed to the decrease in capital gains taxes, and the ongoing recession and subsequently high unemployment contributed to stagnation among other income groups until the mid-1980s.[11] Another explanation is any such across the board tax cut removes some from the tax rolls. Those who remain pay a higher percentage of a now smaller tax pie even though they pay less in absolute taxes.

In addition to changes in marginal tax rates, the capital gains tax was reduced from 28% to 20% under ERTA. Afterwards revenue from the capital gains tax increased 50% by 1983 from $12.5 billion in 1980 to over $18 billion in 1983.[9] In 1986, revenue from the capital gains tax rose to over $80 billion; following restoration of the rate to 28% from 20% effective 1987, capital gains revenues declined through 1991.[9]

Critics claim that the tax cuts worsened the deficits in the budget of the United States government. Reagan supporters credit them with helping the 1980s economic expansion[12] that eventually lowered the deficits. After peaking in 1986 at $221 billion the deficit fell to $152 billion by 1989.[13] Supporters of the tax cuts also argue, by using the Laffer curve, tax cuts increased economic growth and government revenue. That is hotly disputed, and critics note that the 6% rise in government income tax receipts was due to the 12% inflation rate, not tax cuts, and would have risen more if the tax cuts had not occurred. The Office of Tax Analysis estimates that the act lowered federal income tax revenue by 13%, relative to where it would have been in the bill's absence.[14] Supporters retort by noting that the increase in income tax receipts due to the inflation rate, or bracket creep, was in reality a stealth tax increase, increasing tax as a percentage of GDP without government action, and the Act merely returned taxation levels to what they would have been without bracket creep. Under this view, the large deficits were caused by the increase in government spending (largely from index benefit programs.) Canada, which had adopted indexing of income tax in the early 1970s, saw deficits at similar and even larger levels to the United States in the late 1970s and early 1980s.[15]

The non-partisan Congressional Research Service (in the Library of Congress) issued a report in 2012, analyzing the effects of tax rates from 1945 to 2010. The CRS concluded that top tax rates have no positive effect on economic growth, saving, investment, or productivity growth; reduced top tax rates do, however, increase income inequality:[16]

The reduction in the top tax rates appears to be uncorrelated with saving, investment and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution.[17]

Proponents of the tax bill were likely trying to increase the incomes of people in lower tax brackets through increased investment from the wealthy, which was supposed to be brought on with increased demand for goods among the lower sectors. This contributed to rising deficits, and the supposed increase in demand from the lower sector did not pan out. On the supply side of the spectrum, the records show that the increase in taxes did not raise the revenues of the economy, and in turn did not increase the consumerism of lower waged citizens. The idea was one that seemed promising, but the much of this wealthy would just collect at the top of the tax bracket and not be reinvested into the economy like the legislators thought.[18]

Reagan came into office with a national debt of around $900 billion, high unemployment rates and public distrust in government. The ERTA was designed to give tax breaks to all citizens in hopes of jumpstarting the economy and creating more wealth in the country. By the summer of 1982, the double dip recession, return of high interest rates, and ballooning deficits had convinced Congress that the Act had failed to create the results that the Reagan administration hoped. Largely at the initiative of Senate Finance Committee chairman Robert Dole, most of the personal tax cuts were backed out in September 1982 by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) though, most significantly, not the indexing of individual income tax rates. When Reagan left office, the national debt had tripled, to around $2.6 trillion. Sociologist Monica Prasad contends that these kinds of tax cuts became popular among Republican candidates because the cuts were well received by voters and could help candidates get elected.[19]

References[edit]

  1. ^ Pub.L. 97–34, 95 Stat. 172, enacted August 13, 1981)
  2. ^ Kessler, Glenn (10 April 2015). "Rand Paul's claim that Reagan's tax cuts produced 'more revenue' and 'tens of millions of jobs'". Washington Post. Retrieved 16 October 2015.
  3. ^ a b Office of Tax Analysis (2003, rev. September 2006). "Revenue Effects of Major Tax Bills" (PDF). United States Department of the Treasury. Working Paper 81, page 12. Retrieved 2009-07-18. Check date values in: |date= (help)
  4. ^ http://heinonline.org/HOL/Page?handle=hein.journals/aklr15&div=24&g_sent=1&collection=journals#
  5. ^ Fullerton, Don, and Yolanda Kodrzycki Henderson, “Long-Run Effects of the Accelerated Cost Recovery System,” The Review of Economics and Statistics, vol. 67, no. 3, 1985, pp. 363–372, at [1].
  6. ^ Batte, Marvin T. “An Evaluation of the 1981 and 1982 Federal Income Tax Laws: Implications for Farm Size Structure,” North Central Journal of Agricultural Economics, vol. 7, no. 2, 1985, pp. 9–19, at [2].
  7. ^ [14].
  8. ^ a b c Steuerle, C. Eugene (1992). The Tax Decade: How Taxes Came to Dominate the Public Agenda. Urban Institute Press. pp. 43–44. ISBN 978-0877665229.
  9. ^ a b c d Arthur Laffer (1 June 2004). "The Laffer Curve: Past, Present, and Future". Retrieved 5 November 2010.
  10. ^ Joint Economic Committee (1996). "Reagan Tax Cuts: Lessons for Tax Reform". Archived from the original on 26 February 2009. Retrieved 5 November 2010.
  11. ^ Congressional Budget Office (1986). "Effects of the 1981 Tax Act". Retrieved 5 November 2010.
  12. ^ "The Reagan Expansion >The Reagan Expansion". Ronald Reagan Information Page. Archived from the original on October 23, 2008. Retrieved 2009-05-03.
  13. ^ FY 2011 Budget of the United States Government: Historic Tables. 2010. pp. 21–22. ISBN 978-0-16-084797-4.
  14. ^ Office of Tax Analysis (2003, rev. September 2006). "Revenue Effects of Major Tax Bills" (PDF). United States Department of the Treasury. Working Paper 81, page 12. Retrieved 2009-07-18. Check date values in: |date= (help)
  15. ^ Probyn, June M. (1981-08-23). "What Indexing Income Taxes Produced for Canada". New York Times. Halifax, Nova Scotia. Retrieved 2018-12-04.
  16. ^ Rick Ungar, Non-Partisan Congressional Tax Report Debunks Core Conservative Economic Theory-GOP Suppresses Study, Forbes (Nov. 2, 2012) [3]
  17. ^ Congressional Research Service, Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945, [4]
  18. ^ Lindsey, Lawrence (1985). "The 1982 Tax Cut: The Effect of Taxpayer Behavior on Revenue and Distribution". Proceedings of the Annual Conference on Taxation Held under the Auspices of the National Tax Association-Tax Institute of America. 78: 111–118. JSTOR 42911671.
  19. ^ Prasad, Monica (2012). "The Popular Origins of Neoliberalism in the Reagan Tax Cut of 1981". Journal of Policy History. 24 (3): 351–83. doi:10.1017/S0898030612000103.

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