On This Date: Reagan's Second Round of Tax Cuts Became Law

On October 22, 1986 President Ronald Reagan signed the Tax Reform Act of 1986 into law, lowering income tax rates and consolidating tax brackets while also eliminating deductions. The legislation dramatically changed America’s tax code and is the most significant overhaul the tax code has undergone in recent decades.

The “supply-side” policies of the Reagan administration still influence the political debate surrounding U.S. economic policy, as the Republican party continues to advocate for lower rates across the board and fewer tax brackets and the Democratic party generally disagrees. With President Donald Trump in the White House and a GOP Congress, tax reform is the focus on Capitol Hill, so here's a look back at the last major overhaul of the U.S. tax code.

Why did it come up?

When Ronald Reagan ran for president in 1980, he defeated incumbent Jimmy Carter in an election that was heavily focused on economic issues. The U.S. was experiencing what’s known as “stagflation” — meaning that unemployment and inflation were both rising — and the economy wasn’t showing signs of improving.

Reagan advanced a platform that called for cutting income tax rates across-the-board while simplifying the tax code by reducing the number tax brackets. Shortly after taking office as president, he enacted his first round of tax cuts in 1981, which reduced the number of income tax brackets from 25 to 14 and lowered the top income tax rate from 70 percent to 50 percent.

By the time he ran for reelection, the American economy began to rebound and Reagan campaigned for further tax cuts, ultimately riding that momentum to a landslide victory over Walter Mondale in 1984.

What did it do?

Much of 1985 was spent drafting the tax cut package, which was introduced by (now retired) Rep. Dan Rostenkowski (D-IL). The House passed it by voice vote in December before the Senate passed an amended version in June by a 97-3 margin. After the conference committee ironed out the differences in September 1986, Congress passed the revised bill with bipartisan support in both chambers as the House approving 292-136 and the Senate following suit on a 74-23 vote.

The 1986 legislation further simplified the tax code, shrinking the number of tax brackets from 14 down to two over the course of two years. The top income tax rate fell from 50 percent to 28 percent. The rate for the lowest-income Americans rose slightly from 12 percent to 15 percent, just above the level it had been prior to Reagan’s first tax plan, but lower than the rate had been between World War II and 1964.

The bill also made significant changes to the deductions available to taxpayers. The Home Mortgage Interest Deduction was increased, allowing people to deduct interest they repay on their home mortgage loan. Meanwhile deductions for consumer loans (like credit card debt) were eliminated. There were also new restrictions placed on deductions available for business depreciation and contributions to an Individual Retirement Account (IRA).

What has its impact been?

The Reagan tax cuts remain controversial to this day. Proponents note the strength of America’s economic recovery during Reagan’s administration, when the unemployment rate fell from a high of 10.8 percent to 5.4 percent, households of virtually every type experienced wage growth, and over 16 million jobs were created. On the other hand, detractors point to a marked increase in budget deficits during Reagan’s administration and argue that the tax cuts helped fuel income inequality, as the richest Americans saw their incomes grow faster than those who earned less.

Reagan’s successor in the White House, President George H.W. Bush famously broke his “read my lips, no new taxes” pledge by raising income tax rates slightly and adding a third bracket in 1991. SInce then, the trend has been back toward higher rates and more brackets. President Clinton added two more brackets and raised the top rate to 39.6 percent from 31 percent. President George W. Bush added a single bracket but reduced the top rate to 35 percent, which was then raised back to the Clinton-era level by President Obama (who added a seventh bracket).

As for the future? The details of the tax reform bill being worked on by the Trump administration and Congress are still in flux, with the Trump administration initially proposing three brackets but GOP lawmakers talking about adding a fourth. We'll have more on the finer points of the tax reform proposal as they're released, so stay tuned!

— Eric Revell

(Photo Credit: White House Photo / Public Domain)