Economic Recovery Tax Act of 1981

The Office of Tax Analysis of the United States Department of the Treasury summarized the tax changes as follows:[12]

• 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 the Accelerated Cost Recovery System (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The accelerated depreciation changes were repealed by Tax Equity and Fiscal Responsibility Act of 1982, and the 15% interest exclusion was repealed before it took effect by the Deficit Reduction Act of 1984.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.[13]

Republican Congressman Jack Kemp and Republican Senator William Roth had nearly won passage of a major tax cut during the presidency of Jimmy Carter, but President Carter had prevented passage of the bill due to concerns about the deficit.[14] Supply-side economics advocates like Kemp and Reagan asserted that cutting taxes would ultimately lead to higher government revenue because of economic growth, a proposition that was challenged by many economists.[15]

Upon taking office, Reagan made the passage of Kemp-Roth bill his top domestic priority. As Democrats controlled the House of Representatives, passage of any bill would require the support of some House Democrats in addition to the support of congressional Republicans.[16] Reagan's victory in the 1980 presidential campaign had united Republicans around his leadership, while conservative Democrats like Phil Gramm of Texas (who would later switch parties) were eager to back some of Reagan's conservative policies.[17]

Throughout 1981, Reagan frequently met with members of Congress, focusing especially on winning support from conservative Southern Democrats.[16] In July 1981, the Senate voted 89–11 in favor of the tax cut bill favored by Reagan, and the House subsequently approved the bill in a 238–195 vote.[18] Reagan's success in passing a major tax bill and cutting the federal budget was hailed as the "Reagan Revolution" by some reporters; one columnist wrote that the Reagan's legislative success represented the "most formidable domestic initiative any president has driven through since the Hundred Days of Franklin Roosevelt."[19]

The Accelerated Cost Recovery System (ACRS)[20][1] 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.[21]

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.[22]

The idea was that there would be a rise in tax cuts because of the optimistic consideration of depreciating values. That in turn would put more cash into the pockets of business owners to promote investment and economic growth.[23]

The most lasting impact and significant change of the Act was indexing the tax code parameters for inflation[20] starting in 1985. Six of the nine federal tax laws between 1968 and 1981 were tax cuts compensating for inflation driven bracket creep.[12] Inflation was particularly high in the five years preceding the Act; bracket creep alone caused federal individual income tax receipts to increase from 7.94% to over 10% of GDP.[24] Even after the Act was passed, federal individual income tax receipts never fell below 8.05% of GDP; combined with indexing, this eliminated the need for future tax cuts to address it.[24]

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.[25]

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.[25] 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.[26] 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.[27]

Under ERTA, marginal tax rates dropped,[28] and capital gains tax was reduced from 28% to 20%. Revenue from capital gains tax increased 50% (from $12.5 billion in 1980 to over $18 billion in 1983).[25] 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.[25]

Critics claim that the tax cuts worsened U.S. budget deficits. Reagan supporters credit them with helping the 1980s economic expansion[29] that eventually lowered the deficits. After peaking in 1986 at $221 billion the deficit fell to $152 billion by 1989.[30] . 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.[31]

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.[32]

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:[33]

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.[34]

Tax revenue from the wealthy dropped, consumerism of lower waged citizens did not increase, and much of the increased wealth collected at the top of the tax bracket, with little reinvested into the economy.[35][20]

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) but, 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.[36]

• Full text of the Act