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October 12, 2011
1986? Who Cares?
Joseph J. Thorndike

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Joseph J. Thorndike (Photo by Derek Squires)Joseph J. Thorndike is a contributing editor for Tax Notes.

In this article, Thorndike writes that the Tax Reform Act of 1986 has had less impact on the tax system than the tax cuts passed five years earlier.

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We're marking the wrong anniversary. Sure, it's been 25 years since the legislative anomaly known as the Tax Reform Act of 1986. But it's been 30 years since Congress approved a more lasting piece of legislation: the tax cuts of 1981.

The TRA 1986 reform made profound changes to tax policy. But it did nothing to change tax politics. By contrast, the Economic Recovery Tax Act of 1981 (ERTA) transformed the political economy of federal revenue.

ERTA included vital policy reforms, of course. Some -- like the introduction of indexing -- were every bit as profound as those enacted five years later. But it was ERTA's political success that ensured its lasting importance. It shapes our fiscal world even today.

The Exception

1986 was an anomaly. It was the exception to my iron rule of tax politics: Reform happens when it must, not when it should. Over the past century or so, episodes of major tax reform have always emerged from a crisis -- usually a war, but sometimes a serious economic slump like the Great Depression.

TRA 1986 was different. Nothing forced the collective hand of Washington policymakers. No emergency or impending disaster drove Democrats and Republicans to the bargaining table. Rather, the legislation emerged from a window of political opportunity.

Which isn't to say that revenue worries were absent from the political calculus of TRA 1986. After pushing through ERTA and its steep tax cuts in the first year of his presidency, Ronald Reagan had been forced to change course. In 1982 and 1984, he endorsed major tax hikes to help shrink soaring deficits. Congress unhappily went along.

Revenue, in other words, was never far from anyone's mind as tax reform got underway. But reform was not designed to solve the nation's lingering deficit problems, at least not directly. Instead, it was conceived to make the tax system fairer, more efficient, and (ostensibly) simpler.

Indeed, TRA 1986 was the apotheosis of a particular school of tax reform, defined by a mantra of sorts: "broaden the base and lower the rates." This was not the only model for reform. In an earlier era, Franklin Roosevelt had equated reform with raising taxes on the rich. And by the early 1980s, many Republicans were starting to define reform as lower taxes for almost everyone.

But since at least the early 1950s, the broader-base/lower-rates model had guided the thoughts, if not always the deeds, of fiscal policymakers. TRA 1986, then, was never about necessity. Instead, it emerged from a political calculus that seemed to promise benefits for all parties.

Reagan, for his part, hoped to make tax reform a signature achievement of his presidency, delivering the American people from their long national nightmare of corrupt income taxation. More specifically, he hoped to drive down marginal rates, sending them to historic lows long considered unattainable.

Congressional Democrats, meanwhile, hoped to raise the tax burden on wealth by eliminating preferences enjoyed mostly by the rich. They recognized that base broadening could be a tool for making the tax system more progressive. And they, too, hoped to share in the glory that would surround any major tax overhaul.

In many ways, TRA 1986 delivered on its promises, at least for a while. But the law's achievements began to erode almost immediately. In the early 1990s, persistent deficit worries prompted lawmakers to raise rates, especially on high-income taxpayers. These same fiscal pressures prompted a surge of tax expenditures, as lawmakers cast about for ways to spend money without looking like they were doing it.

Ultimately, the high-minded ideals of traditional tax reform proved no match for the resurgent political traditions of American democracy. The anomaly of TRA 1986 -- like an episode of sunspots -- was over.

More Lasting Change

By contrast, the 1981 tax cuts have remained a vital force in American politics since the day they were signed into law. They have refashioned the Republican Party and recast the terms of debate over federal taxation.

In the years after World War II, Democrats and Republicans fought bitterly and publicly over taxation. But they had also shared a commitment -- often unspoken and usually overlooked -- to fiscal responsibility. Deficits were chronic, but worry about them was chronic, too. And bipartisan.

The 1981 tax cuts changed all that. Initially, ERTA demonstrated the electoral power of wholesale tax reduction, impressing Democrats and Republicans alike. More gradually, it also sapped the bipartisan fear of unbalanced budgets, leaving the nation without meaningful fiscal guidelines.

A few deficit hawks survived in each party. But increasingly, Republicans abandoned their traditional devotion to fiscal prudence. So completely, in fact, that Vice President Dick Cheney would eventually (and famously) declare that "deficits don't matter."

Modern Republicans, of course, would object to this narrative of fiscal declension. They would insist that GOP lawmakers are just as committed as ever to fiscal prudence. Only now, they insist that the budget equation must be balanced solely on the spending side of the ledger.

Which is plausible, if we accept the notion that George W. Bush was some sort of crypto-liberal with Great Society ambitions (although that does a disservice to Lyndon Johnson, who at least made a stab at drumming up tax revenues for Medicare, as opposed to Bush's unfunded approach to the infamous prescription drug benefit).

But even if we accept at face value all the GOP rhetoric about budget discipline, we can still discern a tectonic shift in American fiscal politics. Fiscal discipline, to the extent that it still influences GOP policy, is a secondary imperative, behind a commitment to low taxes. That marks a change from the Republican dogma of the pre-Reagan era, when most GOP leaders accepted the notion that even a bad tax was better than a big deficit.

Fiscal prudence lost its perch atop the GOP agenda after the 1981 tax cuts. Not immediately, to be sure. As my colleague Bruce Bartlett has pointed out, Reagan himself raised taxes almost immediately after cutting them, first in 1982 and again in 1984. Later Reagan took back still more, reclaiming about half the 1981 cuts by the end of his term.

But Reagan's heirs have been less frightened at the sight of red ink. And they have rationalized their carefree attitude by suggesting that deficits can be erased through tax cuts, rather than tax increases. As evidence, they point to ERTA, insisting that it actually raised revenue. Bartlett has poked holes in this myth, too, pointing out that even the most optimistic supply-siders of the 1980s never said tax cuts would actually raise money. (And they were right, of course.)

But the myth remains powerful in modern GOP circles, and it continues to shape tax politics. Impressed by Reagan's political success with tax cuts and willfully ignorant of his later willingness to raise taxes in the face of deficits, the modern Republican Party is the fiscal equivalent of a medicine peddler, offering a magic cure-all for every pain that ails ya in the form of a tax cut.

All this is from ERTA. Meanwhile, the lessons of 1986 seem quaint and more than a little pedantic by comparison. As tax professionals, we might think that's sad. But it's also the truth.