TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Wednesday, April 27, 2011

Lessons from the 1986 Tax Reform Act

Jason J. Fichtner & Jacob M. Feldman (both of the George Mason University, Mercatus Center), Lessons from the 1986 Tax Reform Act: What Policy Makers Need to Learn to Avoid the Mistakes of the Past:

The 1986 Tax Reform Act (TRA86) was designed to improve three aspects of the tax code: efficiency, equity, and simplicity. TRA86 accomplished all three goals in some measure by reducing the standard rates, increasing the standard deduction, and ending various tax expenditures that distributed resources to less efficient production purposes that sometimes served as the proverbial "tax haven." ...

At the time, TRA86‘s passage seemed like a great success for tax reform. However, looking at the 2011 tax code, taxpayers would be hard pressed to find the aspects of efficiency, equity, and simplicity that were improved with passage of TRA86. The principles embodied in the tax reform of 1986 did not last. ... Michael Graetz analyzed the tax code in 2007 and exclaimed the failure of TRA86, noting "The Tax Reform Act of 1986 has not proved a stable outcome: Congress has since narrowed the tax base and raised income tax rates." Additionally, stability can be judged by the number of temporary provisions in the tax code. In contrast to the 25 expiring expenditures in the 1985 tax code, 2010 had over 141 provisions that would expire within the next two years. ...

What happened over the past quarter of a century? How quickly did the reforms of TRA86 unravel and why? This paper examines the act‘s goals of efficiency, equity, and simplicity, to find the lasting successes and failures of TRA86. Now, 25 years later, the federal tax code is again in dire need of reform. The old saying that those who ignore history are doomed to repeat it also applies to tax reform. Those wishing to reform the tax system today would be wise to learn from the past.

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The lesson of the 1986 Tax Reform is that trading tax benefits for lower rates is a fool's bargain. Politicians will be delighted to be able to propose new tax benefits for their supporters and raise tax rates on everyone in the name of taxing the rich.

Everyone knows this will happen again. Clinton supporters are still proud of his 1993 destruction of the 1986 Tax Reform, and politicians always copy a success. This knowledge is why people who advocate higher tax rates and higher revenue levels nevertheless favor base-broadening reform that reduces tax rates.

A more durable bargain would be massive revocation of benefit promises (e.g., eliminating government funding of medical care for the non-poor) in exchange for massive removal of tax benefits like the mortgage deduction and the exemption for employer-provided health insurance. Let the benefit cuts and the tax increases happen at the same time. This is what will happen in a bond market mega-crisis, so why wait until then?

Posted by: AMTbuff | Apr 27, 2011 11:12:50 AM

1. TRA 86 created PALs.

The 1980 simplified the rules for at-risk and passive losses. With that simplification many of the largest loopholes were closed.

Yes Real Estate Professionals clawed their way back into favored treatment, but dentists no longer can find investments that wipe out their entire income by investing $10,000 in a tax shelter.

Posted by: Neil | Apr 27, 2011 6:47:41 PM

Stop spending. Perot's charts.

Posted by: Sandy P | Apr 28, 2011 9:20:51 AM