Taxing Progressively

The ‘Landmark’ Tax Reform that Fizzled

Exactly a quarter-century ago, America’s punditocracy proclaimed victory in the struggle against tax complexity and unfairness. The rich applauded right along. We should have been suspicious.

By Sam Pizzigati

Can a small army of policy wonks, working in a bipartisan political environment overflowing with lawmakers willing to compromise, actually put into law a reform package that leaves the U.S. tax code considerably more simple and fair?

Twenty-five years ago, on October 22, 1986, legions of Washington wonks and lawmakers thought they had accomplished just that. Media heavyweights agreed, and so did President Ronald Reagan. He signed into law that day legislation that pundits immediately branded the “landmark” Tax Reform Act of 1986.

The silver anniversary of the “landmark” 1986 tax act  is coming and going without any gala celebrations.

America will now have, President Reagan crowed at the signing ceremony, “the most modern tax code among major industrialized nations, one that encourages risk-taking, innovation, and that old American spirit of enterprise.”

“Fair and simpler for most Americans,” he added, “this is a tax code designed to take us into a future of technological invention and economic achievement, one that will keep America competitive and growing into the 21st century.”

Democrats crowed, too. Senator Bill Bradley from New Jersey considered the 1986 legislation his greatest legislative triumph. Democrats pointed proudly to the many tax loopholes the new reform act plugged and the legislation’s most signal achievement: the end to preferential tax treatment for capital gains, the profits from buying and selling stocks and other assets.

But this Saturday, the silver anniversary of the “landmark” 1986 tax act — “the broadest revision of the federal income tax in history,” according to the Washington Post — is coming and going without any gala celebrations.

“Was it all,” Bruce Bartlett, a former Reagan aide, mused last week, “much ado about nothing?”

The 1986 tax reform legislation would be a top-down exercise right from the start.

The Tax Reform Act of 1986 today seems just another milestone on the road to a federal tax code that has our mega rich, as billionaire Warren Buffett has so colorfully noted, paying taxes at a lower rate than their secretaries. The act’s most admirable features have long since evaporated.

We need to understand why — before we let this 25th anniversary slide by. Did the 1986 tax reform effort, we ought to ask, have to end up hijacked by America’s high-income set? The short answer: Yes.

Sweeping tax reform, to succeed and leave the tax code truly simpler and fairer, requires two political prerequisites: a set of elected leaders committed to confronting the rich and powerful who benefit from tax code unfairness and a mass popular upsurge that keeps those elected leaders’ feet to the fire.

The 1986 tax reform battle had neither.

The 1986 tax battle began in the wake of the 1984 elections, a debacle for Democrats. Their Presidential candidate, Walter Mondale, had talked vaguely about the inevitability of having to raise taxes. But Mondale never defined who he would be taxing. On Election Day, Reagan crushed him.

Mondale’s defeat would shove any proposals to tax the rich, or anybody else, off the table. Top Democrats would now talk only about tax “simplification.” Toward that end, Bradley and other Democrats would negotiate a grand bargain with the White House: You let us plug tax loopholes and we’ll give you lower tax rates.

Reagan agreed. The legislation he signed hiked the capital gains tax rate, plugged various other loopholes, and lowered the top tax rate on ordinary income.

Newspaper editorials would celebrate this bargain as a grand step toward common sense tax fairness. Reformers who read the fine print did no cheering. “Behind the facade of eliminating ‘tax preferences for the rich,’” as political analyst Kevin Phillips would later point out, the 1986 act shoved into law some 650 new provisions that benefited special interests.

Most incredibly of all, the legislation set the highest tax rate not on America’s wealthy, but on the nation’s upper middle class. Ordinary income between $70,000 and $170,000, under the reform, would be taxed at a special “bubble” rate of 33 percent. Income above $170,000 would face only a 28 percent levy, the same top rate that the 1986 legislation placed on capital gains income.

For the rich, a good deal. The capital gains rate, to be sure, had jumped from 20 to 28 percent. But the top rate on other income had been 70 percent when Reagan won election in 1980. His 1981 tax legislation had chopped that top rate down to 50 percent. The new 1986 reform now cut that 50 percent nearly in half.

How could all this happen? All this could happen because the 1986 tax legislation had been a top-down exercise right from the start. No grassroots movement had mobilized to demand a fairer tax system — and keep lawmakers honest. So all the wheeling and dealing around the 1986 reform legislation essentially involved only lawmakers, wonks, and lobbyists for the rich and powerful.

The resulting “reform” didn’t do much more than inconvenience America’s economic elite. The wealthy, in the years right after 1986, found themselves having to “shift” their income around to avoid higher taxes.

The new law, for instance, left the top individual tax rate lower than the top corporate tax rate. Business owners, notes former Reagan aide Bruce Bartlett, would react by reorganizing their operations into “sole proprietorships and other business forms that caused income that was previously reported on corporate returns to be reported on individual returns.”

But the wealthy didn’t just shift income around. They pushed back — against the 1986 act’s noblest advances. The capital gains tax rate, under their pressure, would eventually drop back from 28 to almost 20 percent in 1997. That rate would drop even further, in 2003, to 15 percent, and that remains the rate today.

The top federal tax rate on ordinary income, in the meantime, did rise in 1993 to 39.6 percent, only to fall back to 35 percent eight years later. That’s higher than the 28 percent tax on top-bracket income the 1986 act legislated, but still only half the 70 percent top rate in 1980 — and only a little over a third the 91 percent top rate in effect as late as 1963.

signupThe good news amid all this? With Occupy Wall Street, we have taking root a broad and varied popular movement that openly challenges a system rigged to benefit the top 1 percent, the movement we so sorely missed back in 1986.

A century ago, we also had a broad and varied popular movement that openly challenged America’s rich. That movement paved the way for the original progressive income tax in 1913 — and then reappeared in the Great Depression years and sparked a strengthening of that tax in the 1930s and 1940s.

Without that popular spark, “tax reform” will always devolve into “tax charade.” On this 25th anniversary of the 1986 Tax Reform Act, let’s remember that lesson.

Sam Pizzigati edits Too Much, the online weekly on excess and inequality published by the Washington, D.C.-based Institute for Policy Studies. Read the current issue or sign up at Inequality.Org to receive Too Much in your email inbox.

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