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TRA86: DID CONGRESS LOVE IT OR LEAVE IT?
THE TAX REFORM ACT
OF 1986: DID CONGRESS
LOVE IT OR LEAVE IT?
RANDALL D. WEISS
*
Abstract - The Congressional consensus
for tax reform in 1986 grew around two
major principles: substantial rate
reduction and improvement in horizontal equity. Tax legislation in the early
1980s foreshadowed these principles,
since it involved either rate reduction or
base broadening (although not in the
same package). This article describes tax
legislation that followed the Tax Reform
Act of 1986 in order to see what new
principles, if any, emerged as important
forces. The objectives of several of the
current reform proposals appear to be
inconsistent with those driving recent
legislation and with the consensus likely
to be necessary for fundamental tax
reform. Thus, it may be a number of
years before such a consensus develops.
Depending on whom you ask, the
system is either too favorable (or not
favorable enough) to the rich or too
complicated. Some people are simply
frustrated with government in general
and vent their feelings on the tax system
and the Internal Revenue Service. So,
politicians put forth a variety of proposals in response to the public’s dissatisfaction. In 1980, for example, President
Reagan’s election campaign emphasized
tax cuts; many believed that this issue
played a decisive role in his victory. Yet,
after tax cuts were implemented in
1981, people were still dissatisfied.
Politicians believed that the public
wanted a fairer system, and a five-year
debate and significant political struggle
ensued, leading to the Tax Reform Act
of 1986. Discontent with the system
seems to be on the rise again, perhaps
spurring another cycle of tax reduction
and reform. The recent Congressional
reform proposals can be seen as a
response to this discontent. Although
many agree that the present system is
burdensome to both taxpayers and the
economy, little consensus exists as to
which proposal promises the best
solution.
INTRODUCTION
Taxes are never popular, and they are so
complicated that people have a hard
time communicating to politicians the
actual source of their displeasure. Most
people believe that taxes are too high,
others believe there are too few (or too
many) deductions or exclusions.
*
Just about ten years ago, on June 24,
1986, the U.S. Senate passed its version
of the Tax Reform Act of 1986 by a vote
Deloitte & Touche LLP, Washington, D.C. 20004.
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NATIONAL TAX JOURNAL VOL. XLIX NO. 3
of 97 to 3. If for only a brief period, this
high degree of consensus on what the
tax system should look like was astounding. What led to the development
of this consensus? How durable was the
consensus? Are there parallels between
recent tax legislation and the events
leading up to the 1986 Act that shed
any light on the likelihood of another
round of fundamental reform? These
are the questions this paper attempts to
analyze.
The paper devotes only scant attention
to two key factors necessary to fully
understand the shape of tax legislation
in the last 15 years—the political
process and the budget process. They
are de-emphasized not because I believe
that they are unimportant, but rather
because they are outside the scope of
this particular exercise.
PREDECESSORS OF THE 1986 ACT
Tax legislation from 1981 through 1984
revealed several Congressional preferences concerning tax policy. First, low
tax rates were attractive. The Economic
Recovery Tax Act (ERTA) of 1981
featured large individual rate cuts and
indexing of brackets. After 1981, tax
legislation usually was motivated by a
desire to increase revenue rather than
cut revenue. Yet, through the major
revenue raising legislation in 1982,
1983, and 1984, tax rates were not
significantly raised. This outcome
reflected Presidential, as well as Congressional, preferences, of course, but
Congress did not mount a major
challenge to this policy tenet during this
period.
In the next section of the paper, I review
the legislation that led up to the 1986
Act and emphasize that lower tax rates
and broadening the base were changes
with which Congress had considerable
experience by the time the Act was
developed. I then discuss what I believe
were the two primary features of the
Act that allowed the formation of the
pro-reform consensus in 1986: substantial rate reduction and improvement in
horizontal equity. With respect to
economic growth issues, Congress was
able to ignore many entreaties to save
specific tax provisions that provided a
boost to particular sectors of the
economy in the belief that lower rates
would themselves protect the economy
from significant disruption. The next
section of the paper briefly contrasts the
principles of the current round of reform
proposals to those of the 1986 Act.
Although they apparently share objectives of low rates and a broad base, the
approach toward equity issues is very
different. Legislation since 1986 is then
described in order to identify whether
principles guiding tax legislation have
changed in a way that points toward
the emergence of a consensus around
one or more of the current proposals.
My conclusion is that we are at least
several years away from an evolution
toward a view that these proposals
embody feasible Congressional tax
policy decisions.
Second, income tax base broadening
and excise tax increases were the
preferred means of meeting revenue
increase requirements. The early 1980s
provided Congress with extensive
experience with the substance and
politics of base broadening. Indeed, part
of the Tax Equity and Fiscal Responsibility Act of 1982 was the repeal of base
narrowing provisions that had just been
enacted the previous year. This experience allowed Congress to evaluate the
credibility of the horror stories that
affected parties unfolded during the
consideration of these cutbacks in tax
subsidies. As a result, there was growing
skepticism about the worst predictions
of the results of these changes on the
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TRA86: DID CONGRESS LOVE IT OR LEAVE IT?
particular industries affected and on the
economy generally.
the appeal and feasibility of measures to
lower rates, to broaden the base, and to
deal with perceptions of unfairness—
three key principles incorporated in the
Act.
Third, Congress began to demonstrate
concern about the perception of
unfairness that results from tax benefit
transfer mechanisms and from excessive
tax benefits. For example, safe harbor
leasing, enacted in 1981, was explicitly
designed to allow companies that could
not use the tax benefits associated with
equipment purchases to sell their tax
benefits to other taxpayers that could
use the benefits. This provision was
recommended by the Treasury Department because of the knowledge that
the combination of depreciation
deductions and investment credit
provided in the legislation was so
generous that many taxpayers would
exhaust their tax bases. Within months
after ERTA’s enactment, the safe harbor
leasing transactions generated considerable publicity, with individual taxpayers
raising questions such as: why were they
not allowed to sell their dependent
exemptions to the highest bidder?
Congress responded in 1982 both by
repealing safe harbor leasing and by
scaling back the depreciation and
investment credit benefits.
ECONOMIC PRINCIPLES OF THE
1986 ACT
It is hard to overemphasize the degree
to which horizontal equity was the
driving force behind the Tax Reform Act
of 1986. Publicity in the early 1980s
about high-income individuals and large
corporations that paid little or no tax
was perhaps the most important force
that kept the Act alive on its perilous
legislative journey.1 Members of
Congress were sensitized to perceptions
of unfairness that can arise when items
of income are omitted from the tax
base. The sharp difference between
economic income and the corresponding tax liability was the aspect of prior
law that was so indefensible that even
members who were not enthusiastic
about the substance of the 1986 Act
felt that they had to avoid being blamed
for its demise. Of course, the features of
the Act aimed at this phenomenon
complemented most of the other
principles (e.g., broad base and low
rates), so that trade-offs were not
usually observed. The only exception, of
course, was simplicity, a goal that was
not actively pursued except with respect
to middle- and lower-income individuals
without business income.
Finally, the debate over the 1981 Act
showed that discussion of vertical equity
provoked controversy. Democrats had
attempted, unsuccessfully, to challenge
the shape of the rate reduction on the
grounds that it was too generous to the
highest-income taxpayers and provided
little or no relief to those at the bottom
of the income scale. Senator Bradley’s
design of his seminal tax reform proposal
of the early 1980s reflected the judgment that a broad consensus for reform
would be difficult to achieve if a reform
proposal provoked another such debate.
The attack on perceived horizontal
inequity involved restrictions on both
tax benefits that allowed individuals
and corporations with substantial
economic income to sharply reduce
their tax liabilities and on mechanisms
(“tax shelters”) that involved the
transfer of tax benefits from taxpayers
who could not use them to those who
could.
The legislation immediately before the
1986 Act thus allowed Congress to test
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Restriction on tax benefit transfers
included the passive loss limitation,
which generally prevented individual
investors from using tax losses on
passive investments to offset earned
income or interest or dividend income,
and the kiddie tax, which limited the
ability of parents to transfer assets to
their children in order to obtain a lower
tax rate on the associated income. On
the corporate side, tax benefits that
could be transferred through such
mechanisms as the dividends received
deduction and purchase of companies
with net operating losses were limited.
A desire to prevent corporations that
reported income to their shareholders
from paying little or no tax largely
motivated the adoption of the corporate minimum tax. The tightening of the
individual minimum tax had a similar
motivation. Tax benefits associated
with unusually low tax liability also
were subject to restriction. Tax-exempt
bonds, for example, were significantly
limited, and pension benefits available
to higher-income individuals were cut
back. Industries perceived as often
generating tax losses, such as real
estate and property and casualty
insurance, had various tax benefits
tightened.
Lower tax rates certainly were a major
principle of the 1986 Act. In the last
phase of the Senate Finance Committee
markup, Chairman Packwood led the
Committee through a “zero-based
budgeting” exercise in examining the
trade-off between lower rates and a
broader base. He started by requesting
that the Joint Committee on Taxation
analyze a plan that repealed virtually all
individual tax expenditures. He then
established that the top rate could be
reduced to 25 percent (he dubbed this
the Brockway plan, after the Joint
Committee’s chief of staff). Members
gradually added back key tax expenditures to the plan, including deductions
for mortgage interest and charitable
contributions, the exclusion for employer health plan contributions, and
the partial exclusion of social security
benefits, increasing the top rate to
maintain revenue neutrality, until the
members felt comfortable with the
trade-off. The Finance Committee
reported bill had a top rate of 27
percent, one percentage point less than
the rate that emerged from conference.
In addition to generating enthusiasm
among members of Congress, the
substantial rate reduction also was a key
goal of President Reagan and helped to
ensure his support of the ultimate
product.
Finally, the most important business tax
benefit eliminated was the investment
tax credit. For much equipment, the
investment credit tended to be associated with low effective tax rates. For
debt-financed investment, low effective
tax rates from liberal capital cost
recovery provisions combined with the
interest deductions associated with the
debt financing tend to produce tax
losses. Thus, the repeal of the investment credit also can be seen as being
aimed at circumstances in which
profitable businesses could pay little or
no tax.
Distribution tables were very much part
of the 1986 Act political process. The
rate schedules were designed to
produce a small, mildly progressive
change in the distribution of tax
burdens for middle- and upper-income
groups. The distribution tables for the
conference report showed that tax
liabilities for the upper-income groups
were reduced by about two percent,
while middle-income groups experienced a tax cut in the range of about
eight to ten percent. (Significant tax
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relief for the poor, largely through an
expansion of the earned income credit,
was a deliberate goal of the Act; both
political parties by then had acknowledged the failure of the 1981 Act to
provide such relief.) There was not a
broad debate about whether the degree
of progressivity in the existing tax
system was optimum public policy.
Rather, the distributional outcome
reflected a political decision, also
embodied in the earlier Bradley–
Gephardt tax reform bill, that a large
change in tax distribution would add an
additional layer of controversy that
could threaten bipartisan support for
the reform.
Congress largely viewed rate reduction
as the major contribution in this area.
Claims by particular groups of substantial economic harm were ignored in
many cases. Congress did not make any
attempt to significantly lower the overall
cost of capital, a goal which conflicted
with the high priorities of low rates and
horizontal equity.2
Finally, Table 1 provides a useful
benchmark of the base broadening left
undone during the 1986 tax reform
process. The table reproduces a
compilation, published by the Joint
Committee in October 1987, of base
broadening proposals that were part of
either the 1985 Treasury tax reform
study or the 1986 Administration
proposal but which were not adopted.
Excluded from this table are proposals
for tax expenditures that even the 1984
Treasury tax reform proposal omitted for
reasons of feasibility or political controversy, such as the repeal of the preference for qualified retirement plans or
the deduction for home mortgage
interest. Most of these items fall into
four groups: employer-provided fringe
benefits, savings incentives (pensions
and life insurance), the deduction for
state and local income and property
taxes, and energy and mining industry
provisions. The remainder are mostly
miscellaneous industry-specific proposals; the major exception is the ill-fated
rate differential recapture proposal that
Treasury argued was justified by the rate
reductions but that was never considered seriously by Congress.
Similarly, the political agreement that
the Act should be revenue neutral was a
temporary device, also established in the
Bradley–Gephardt bill, to isolate the tax
reform exercise from Congress’s
continual attempts to deal with the
budget deficit. Indeed, the 1986 Act
was unusual in that most of the tax
legislation of the 1980s increased
revenue. Certainly, many of the
participants in shaping the 1986 Act
had little doubt that Congress would
enact revenue increases in future years.
Some even expected tax rates to rise.
For example, during the conference, the
staff discussed the potential simplification that could have been accomplished
had the Act eliminated all distinctions
between capital gains and ordinary
income, since they were taxed at the
same rate for both individuals and
corporations. A belief that rates on
ordinary income could rise in the near
future and that a capital gains differential would reemerge prevented that
from happening.
This table indicates that the remaining
available base broadeners would be
substantively and politically difficult for
Congress to approve. Especially lacking
were feasible reform measures targeted
to high-income taxpayers that could be
used as part of a revenue increase
With respect to issues involving the
impact of tax reform on the economy
and on specific economic sectors,
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TABLE 1
ESTIMATED REVENUE EFFECTS OF UNADOPTED PROVISIONS CONTAINED IN THE PRESIDENT’S AND TREASURY’S
TAX REFORM PROPOSALS, FISCAL YEARS 1988–90
(BILLIONS OF DOLLARS)
Provision
1988–90
I. Income Tax Reform for Individuals
Excluded sources of income:
Include a portion of employer-provided health insurance in taxable income ($10/individual;
$25/family per month)
Cap exclusion of employer-provided health insurance ($70/individual; $175/family per month)
Repeal exclusion of employer-provided group term life insurance
Repeal exclusion of employer-provided death benefits
Repeal exclusion of workers’ compensation and black lung benefits
Repeal exclusion of employer-provided dependent-care assistance
Cafeteria plans:
Cap cash option ($500 annually)
Repeal exclusion for FICA and FUTA
Disqualify dependent-care assistance from cafeteria plan exception
Preferred uses of income:
Disallow state and local income and real property tax deduction
Disallow nonbusiness state and local personal property tax deduction
Business meals and entertainment expenses:
Allow 75 percent deductibility
Allow 50 percent deductibility
Limit temporary assignments to one year
11.6
16.8
8.4
(a)
7.7
0.2
4.1
3.5
0.2
52.8
0.9
1.3
6.6
(a)
II. Retirement Saving
Eliminate deferral of appreciation of employer retirement securities
Repeal cash and deferred arrangements (CODAs)
0.2
14.6
III. Basic Taxation of Capital and Business Income
Recapture of rate differential on accelerated depreciation
52.3
IV. Specific Industry, Tax Shelter, and Other Tax Provisions
Restrict use of cash accounting for large nonfarm business
Repeal cash accounting for farms with gross receipts over $5 million
0.7
0.8
Energy provisions:
Repeal business energy credits; limit gasohol exemption
Repeal percentage depletion for:
Oil and natural gas (all wells)
Oil and natural gas—all wells except stripper wells owned by independent producers
Other minerals
1.4
1.0
1.5
Financial institutions:
Repeal depository institutions’ bad-debt reserve deductions
Repeal tax exemption of large credit unions
1.9
0.9
Life and property/casualty insurance:
Limit life insurance reserve deductions; repeal exemption of certain small companies
Limit property and casualty insurance company reserves
Insurance investment income:
Repeal exclusion of inside buildup (no grandfather)
Repeal exclusion of current annuity income (no grandfather)
Treat surrenders of life insurance as income
Loans from life insurance policies treated as distributions
Deductions for reserves limited to surrender value
0.9
0.5
0.3
8.1
3.7
0.1
0.7
0.2
State and local government debt and investments:
2.8
Repeal exemption for nongovernmental bonds
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TABLE1 (Continued)
Provision
1988–90
Special expensing and amortization rules:
Repeal expensing of conservation expenditures and farmers’ fertilizer and field clearing
Repeal 5-year amortization of pollution control
Repeal 84-month amortization, 10 percent credit for reforestation
(b)
(a)
(a)
Other specific industry provisions:
Repeal rehabilitation tax credits
Repeal special rules for returns of magazines, etc.
Repeal expensing of multiperiod timber growing costs
Repeal targeted jobs tax credit
Repeal exclusion of Merchant Marine Capital Construction Fund
Require employers to make nondeductible payments to employees who receive ESOP dividends
Limit artificial losses (at-risk rules)
2.4
0.2
(b)
0.7
0.2
(a)
(a)
International issues:
Possessions tax credit
Repeal title passage source rule
Other provisions affecting international income
3.7
1.7
4.3
Source: Joint Committee on Taxation, October 8, 1987.
(a) Gain of less than $50 million.
(b) Estimate not available.
package providing a balanced distributional effect. (The deduction for state
and local income taxes may have had a
useful distributional pattern, but its
proposed repeal proved very controversial and would not have allowed a
significant reduction in combined
federal and state marginal tax rates.)
Thus, for meeting future demands for
additional revenue to be raised without
significant distributional effect, it should
not be surprising that Congress turned
to rate increases on high-income
individuals.
and a subtraction method value added
tax; a national retail sales tax, proposed
by Representatives Schaefer and Tauzin;
and the so-called flat tax, sponsored by
Representatives Armey and Senator
Shelby, which is a value-added tax with
a deduction for wages along with a
personal tax on wages in excess of an
exempt amount. In addition, Representative Gephardt has announced a plan
to reform the individual income tax. In
order to compare the 1986 Act with
these proposals, I summarize their major
elements:
PRINCIPAL ELEMENTS OF CURRENT
REFORM PROPOSALS
Consumption as the Tax Base
The value added tax, personal consumption tax, retail sales tax, and flat tax all
use consumption as the base of the tax;
the differences largely involve varying
points of collection in the chain of
production and distribution. All of these
taxes share the fundamental characteristic of excluding from tax income from
capital by excluding from tax, or
allowing expensing of, purchases of
In what ways are the current tax reform
proposals inconsistent with the 1986
Act? Is what has transpired since 1986
leading to another round of fundamental reform? The key current reform
proposals that have thus far been
introduced are the USA tax, sponsored
by Senators Nunn and Domenici, that
includes a personal consumption tax
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capital items such as equipment, real
estate, and inventory. Only the
Gephardt proposal retains the current
system of using income as the tax base.
of saving (or capital income, depending
on the proposal) to pay much less tax
than other taxpayers with the same
economic income but less of the
excluded item. Although the 1986 Act
retained consumption tax elements,
such as qualified pension plans, that
allowed some such divergence, strict
limits were placed on any taxpayer’s use
of them. Similarly, the expensing of all
capital items prescribed in the proposals
would increase the likelihood that many
profitable businesses, especially growing
ones, would pay little or no tax.
Elimination of any devices to prevent
high-income taxpayers from eliminating
a substantial portion of tax liability
would be a very significant change from
the 1986 Act ethos.
Comprehensive Tax Base
All the proposals eliminate many
exclusions and deductions and thus
move toward a comprehensive measure
of either consumption or income as the
basis for taxation. Thus, they would
repeal many of the provisions, which
survived the 1986 act, that provide
favorable treatment for specific activities, such as fringe benefits, home
ownership, and state and local taxes.
Progressivity
The proposals differ in their treatment
of the desirable degree of progressivity
in the system. Only the USA tax uses the
old Bradley–Gephardt formulation of
attempting to keep the individual
distribution by income class and the
individual-business split of tax collections unchanged. The retail sales tax and
flat tax would make the system less
progressive, while the Gephardt
proposal would make it more progressive.
Further, several of the proposals would
spur a debate about vertical equity by
making the system much less progressive, especially with respect to the
relative effective tax rates of upper- and
middle-income groups.3 The biggest
change would be caused by the retail
sales tax, which would eliminate any
personal tax from the system. A
personal tax clearly is necessary to
maintain the current degree of
progressivity, since it allows taxpayer-bytaxpayer computation of the tax base,
to which a graduated rate schedule can
be applied.
Replacement System
The consumption tax proposals would
entirely replace the income tax. In
addition, several of them would
eliminate other taxes, such as estate and
gift, social security, and selective excise
taxes as part of their plan.
The proposals generally share the 1986
Act’s goal of keeping rates low by
maintaining a broad base (with the
exception, for the consumption tax
proposals, of capital income). In addition, unlike previous discussions of consumption taxes, these proposals would
not add another tax to the system.
The principles reflected in most of these
proposals contrast significantly with
those of the 1986 Act. Perhaps most
important is a fundamentally different
view of horizontal equity. Inherent in
using a consumption tax base is the
ability of individuals with high amounts
In addition to contrasting principles, the
arguments put forth by the proposal’s
proponents also differ from those made
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in connection with the 1986 Act. The
sponsors emphasize economic growth
as a prime reason to exclude capital income from the tax base. This view clearly
differs from the 1986 Act view that low
tax rates were sufficient to minimize the
drag of the tax system on the economy.
And, as described above, the exemption
of capital income also is the source of
the differences from the Act in the
implicit view of horizontal equity.
The 1987 and 1989 Acts were driven by
relatively modest revenue increases
required as part of those years’ Congressional budget resolutions; their net
annual revenue increases in the first few
years after enactment averaged $15
and $5 billion, respectively. The 1988
tax bill was a revenue-neutral bill
containing base broadeners as the
principal revenue raisers and eliminating
some of the political and substantive
“rough edges” from the 1986 Act. (For
example, the 1988 Act repealed the
much ridiculed provision requiring artists
and authors to capitalize expenses
related to their works.) The 1989
legislation also contained some revenuelosing provisions, including modification
of corporate minimum tax provisions of
the 1986 Act. The 1988 and 1989
revenue losers hardly represented a
rejection of the philosophy of the Tax
Reform Act, however. They can be seen
as simply substituting new base
broadeners for 1986 provisions that
proved relatively unacceptable.
Reduction of compliance burden is
another argument emphasized by the
proponents of current proposals.
Although the 1986 Act did simplify the
system for many lower- and middleincome taxpayers, it is fair to say that
simplicity was not a major objective of
tax provisions affecting business and
high-income individuals.
The next section of the paper reviews
tax legislation after the 1986 Act in
order to examine whether Congress’s
recent actions reveal that its principles
of tax legislation are evolving toward
those consistent with the current reform
proposals. The key questions appear to
be: Is Congress becoming more amenable to a very different view of
horizontal equity, to be justified by
economic growth arguments? Is
simplicity becoming a more important
objective? Is a vertical equity debate
consistent with the bipartisan consensus
likely to be necessary for reform?
In formulating the 1989 legislation,
Congress had rejected a controversial
provision that President Bush had
proposed as a revenue raiser: restoration
of a preferential rate (15 percent) for
individual capital gains. The Act’s
elimination of the capital gains differential had been an important tool in
achieving a large rate reduction for
high-income groups without reducing
their average tax liability. Thus, the Bush
proposal can be seen as the beginning
of a challenge to the 1986 Act principles in several respects. First, using the
then prevailing Congressional methodology, this proposal had a distinct distributional effect in providing disproportionate relief to the highest income groups.
It was not accompanied by tax cuts for
middle-income groups to provide
distributional balance. Second, it
TAX LEGISLATION SINCE THE 1986 ACT
In fashioning the tax legislation of 1987,
1988, and 1989, Congress followed the
pattern of the early 1980s by using base
broadeners to meet the revenue
increase requirements of these bills
(even though the 1986 Act had already
used up many of the easy ones) and by
avoiding rate increases.
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reopened possibilities for significantly
lower tax liability for those who received
their income in the form of capital gains
rather than ordinary income, although,
of course, there is a big difference
between a 15 percent rate and the zero
rate contained in some of the current
reform proposals. Third, it was justified
as an economic growth measure. In
contrast, during the 1986 Act design,
neither the Administration nor Congress
identified particular exclusions or
deductions as particularly necessary to
promote economic growth. Rather, the
view was that if disparities in treatment
were evened out and rates were low,
any significant roadblocks that the tax
system imposed on the economy would
be removed.
tax credit. These were included in a
package that raised $10.9 billion in the
first fiscal year in which it was fully
effective. After extensive “budget
summit” negotiations, Congress
produced a tax bill with considerably
larger revenue increases, averaging
about $30 billion per year. Bush’s
acceptance of this package meant his
repudiation of his “read my lips: no new
taxes” pledge of the 1988 campaign.
Individual income and Social Security tax
rate increases targeted on upper income
groups, along with excise tax increases,
were the major revenue-raising provisions. The income tax base broadening
(other than a provision affecting life
insurance companies) was minor,
although it more than offset the basenarrowing provisions. The capital gains
rate was not reduced as the President
proposed, although the alternative
capital gains tax resulted in the creation
of a differential between tax rates on
ordinary and capital gains income. The
proposal to liberalize IRAs was not
adopted either.
The 1990 legislation marked a turning
point in attitudes toward rate increases
and distribution. Before the negotiations on this legislation, Congressional
Democrats had been developing a set of
“fairness” arguments concerning the
effect on each income class of the
economic policies of the 1980s. The
general theme was that the richest
Americans benefited unduly from these
policies. One element of this theme was
that the tax legislation of the 1980s,
specifically the 1981 Act, had caused an
unjustified reduction in the tax burden
on high-income taxpayers. The program
the Democrats developed to address
these concerns included rate increases
on these high-income taxpayers and tax
relief to the working poor.
Although reliance on excise tax increases for a large part of the revenue
raising would have required some tax
increase provisions aimed at highincome individuals in order to achieve
distributional balance, Congress went
further. According to the Joint Committee distributional table released after the
conference agreement, the tax increase
for taxpayers in the income category
above $200,000 averaged 6.3 percent,
while the middle-income groups had
about a 2 percent increase. In addition,
continuing what was started in 1986, a
tax cut was provided to the lowest
groups. Although this distributional
change was only about half as large as
that provided by the 1986 Act, it was
quite significant given the smaller scale
of the 1990 legislation. Clearly, the issue
of the proper distribution of tax burdens
In his fiscal year 1991 budget presented
early in 1990, President Bush proposed
numerous base-narrowing provisions.
Not only did he renew his call for a
lower capital gains rate (19.6 percent),
but he also proposed the establishment
of nondeductible, tax-free “back
ended” IRAs, enterprise zone incentives,
energy tax incentives, and a new child
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TRA86: DID CONGRESS LOVE IT OR LEAVE IT?
had been specifically addressed by
Congress for the first time since 1981;
ironically, awareness of this issue was
probably increased by the extensive
debate over the distributional aspects of
the President’s capital gains proposal.
distributional balance would have
required, however, and made the system
more progressive. However, the 1990
Act did not adopt a “pro-growth”
approach that systematically narrowed
the income tax base nor did it reveal a
lessening of concern with the horizontal
equity issues so important to the 1986
Act. Finally, there was no evidence that
Congress was becoming more sensitive
to the problems caused by adding
complex provisions to the Code.
Rate increases resulted both from a
desire to be explicit about the impact on
the highest income groups and from a
dearth of base-broadening measures
targeted on that group. Not only were
the rates increased to a top nominal
regular tax rate of 31 percent and an
alternative minimum tax rate of 24
percent, they were changed in complicated ways that were difficult to
understand. Hidden marginal rates were
introduced through the personal
exemption phaseout and limitation on
itemized deduction provisions and the
increase in the limit on taxable wages in
the Health Insurance (HI) portion of the
Social Security payroll tax. From a
system which had only four brackets
and in which most taxpayers could
easily learn their marginal rate, the
individual income tax changed to a
system with many brackets, most of
them hidden, in which very few people
had the ability to calculate (let alone
remember) their marginal tax rate.
Effective marginal tax rates were
increased substantially for the highest
income taxpayers. For an earner
affected by the HI change and in the
range in which the personal exemptions
were being phased out, the total
marginal tax rate increased from 28 to
over 35 percent.
Throughout the remainder of the Bush
presidency, the Administration pushed
its capital gains, enterprise zone, and
IRA proposals and added other basereducing proposals, such as an investment tax allowance, passive loss relief
for real estate, an interest deduction for
student loans, and a first-time
homebuyer tax credit. Again, these
represented the view that the tax system
was an impediment to economic growth
and that a specific subsidy was necessary to promote a particular type of
activity. At the same time, Congressional
Democrats continued to develop their
fairness program. In early 1992, Bush
proposed a number of business incentives in response to weakness in the
economy, while Congress was ready to
shape legislation that reflected its
program. Although Congress agreed to
many of the incentives proposed by the
President, it added a number of items
that later were incorporated into the
1992 Clinton campaign program and
the subsequent 1993 Clinton Administration budget proposal. The tax bill sent
by Congress to President Bush in March
1992 (and vetoed by Bush) included
such items as an increase in the top
individual income tax rate to 36 percent,
a 10 percent surtax on millionaires,
middle-class tax cuts, and miscellaneous
revenue raisers flowing from the fairness
theme, such as limits on deductions for
executive compensation and club dues.
The 1990 Act’s emphasis on rate
increases clearly represented a movement away from the principles of the
1986 Act. However, it is not clear what
alternatives existed, given the revenue
requirements of the budget process and
a desire for distributional balance. The
rate increases went further than
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During the 1992 campaign, the Clinton
program adopted many of the items in
the March 1992 tax bill, including the
individual rate increases and some of
the revenue losers, such as enterprise
zones, a small business capital gains
exclusion, and a targeted investment tax
credit. The embrace by Clinton of many
of the pro-growth initiatives of the Bush
Administration seemed to anticipate a
possible attack, on economic grounds,
on the individual rate increases. The
actual budget package announced in
February 1993 included other tax
increases not mentioned during the
campaign, such as an increase in the
corporate tax rate, the elimination of
the cap on the amount of wages subject
to the HI payroll tax, an increase in the
social security benefits subject to income
taxation, and a broad-based energy tax.
The tax package was largely designed
for deficit reduction purposes; the final
Act raised revenues by about $50 billion
per year. As in 1990, the 1993 Act had
relatively little base broadening, even
more significant rate increases on highincome individuals combined with
additional relief for the lowest income
groups through an expansion of the
earned income credit, and a relatively
small corporate increase. Some of the
base broadeners were included largely
for their symbolic value, such as the
restrictions on deductions for executive
compensation and lobbying expenses.
Revenue losers included further paring
away at the individual and corporate
minimum taxes, passive loss relief for
real estate professionals, and a targeted
capital gains incentive. In general, this
bill was dominated by fairness considerations and economic stimulus concerns.
Unlike 1986, however, vertical equity,
rather than horizontal equity, was the
concern. Largely as a result of the
emphasis on vertical equity, the bill was
very controversial and barely passed
Congress.
Interestingly, the major Republican tax
package of 1995, contained in the
vetoed budget bill of that year, did not
repudiate or undo the rate increases of
the 1993 legislation. Rather, the
proposals concentrated on a capital
gains reduction, IRA expansions, and tax
cuts for families with children. A
business proposal aimed at reducing the
overall cost of capital, the Neutral Cost
Recovery System retrieved from the
Kemp–Kasten tax reform bill of the mid1980s, gained no support and was not
included in the final package. Some
base-broadening provisions (mostly
business items) were included in the
package to offset the revenue loss,
although these appear to have been
motivated chiefly by a desire to reduce
“corporate welfare” in order to provide
an appearance of balance to the
numerous spending cuts on individuals
that were part of the package. At
present, neither Congress nor the
President views rate reduction as a
priority nor do either of them hesitate to
propose new targeted tax provisions to
address economic and social issues.
Conclusions
Has Congress loved the 1986 Act or left
it? Congress loved it with only minor
arguments until 1990. Confronting the
economic pressures of the budget
deficit, a lack of significant and palatable base broadeners, and the political
attraction of a debate on vertical equity,
estrangement began. The cooling of the
relationship accelerated in 1993, and, at
present, it is fair to say that a separation
has occurred. Tax rate reduction appears
to have little appeal, and base-narrowing proposals seem to be proliferating.
Is Congress rushing into the arms of
another fundamental reform? I think
not; it is going in a different direction.
Unlike the early 1980s, in which tax
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TRA86: DID CONGRESS LOVE IT OR LEAVE IT?
legislation appeared consistent with the
reform that followed, tax legislation of
the 1990s does not seem to follow the
principles of the current reform proposals. There does not seem to be much
attraction to simplicity, low rates, and a
broad base. Rather, targeted provisions
that narrow the tax base are quite
popular. The vertical equity debate that
would be raised by serious consideration
of several of the proposals would
probably be as divisive as ever and
would be likely to overwhelm any
possible consensus about a change that
would already have many large winners
and losers. Finally, there is no evidence
in recent legislation that Congress is
likely to adopt a totally different view of
horizontal equity than that contained in
the 1986 Act. Although the tax system
does not seem to be so stable that it is
immune from significant reform,
considerable time will be required to
develop a consensus that would support
one of the current proposals.
ENDNOTES
I am indebted to Thomas Barthold for comments
on a draft of this article.
1
See Conlan, Wrightson, and Beam (1990) for
examples of relevant press reports.
2
See Birnbaum and Murray (1987) for examples of
the dire economic forecasts presented to members
of Congress. See Steuerle (1992) for analyses of
the Act’s effect on the cost of capital.
3
See U.S. Treasury Department (1996) for an analysis
of various current consumption tax proposals on the
distribution of tax burdens by income class.
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Birnbaum, Jeffrey H., and Alan S. Murray.
Showdown at Gucci Gulch. New York: Random
House, 1987.
Conlan, Timothy J., Margaret T. Wrightson,
and David R. Beam. Taxing Choices. Washington, D.C.: CQ Press, 1990.
Steuerle, C. Eugene. The Tax Decade.
Washington, D.C.: Urban Institute Press, 1992.
U.S. Department of Treasury.
Office of Tax
Analysis. “ ‘New’ Armey–Shelby Flat Tax Would
Still Lose Money, Treasury Finds.” Tax Notes 70
No. 4 (January 22, 1996): 451–61.
459