The 1986 Tax Reform:
Lessons for 2011
Garett Jones
George Mason University
and
The Mercatus Center
Overview
The Prospects Before Us
The World Before 1986
What Happened in ’86
What Really Happened in ’86:
A Public Choice Perspective
Chairman Rangel’s Bill and 2011
How to tax the rich
The Prospects Before Us
2011: When all of EGTRRA expires
Why 2011: End of 2001 Budget window.
Past and Future of taxes and spending:
(As Percent of GDP. Source: Congressional Budget Office)
What Expires in 2011?
“New” 10% bracket for low-earners
35% Top rate: Back to Clinton’s 39.6%
½ of $1000 per child tax credit
Limits on deductions and exemptions
Tax breaks for married-filing-jointly
Capital Gains and Dividend tax cuts
Revenue Gained: about 1.5% of GDP
The Olden Days before ‘86
Top Marginal Tax Rate: 50%
Average tax rate on richest 1%: 19%
But it took a lot of work to get it that low!
At 50% rate, every deductible cut taxes by 50 cents:
Net cost of $1 church donation: 50 cents!
Net cost of $100 country club dues: $50!
Net cost of $1000 business-education cruise: $500!
•
Result:
Living your life around the Tax Code…
Then what happened?
Senator Bill Bradley (D-NJ) (NY Knicks)
and President Ronald Reagan (R):
“You came to [tax reform, Bradley told
Reagan] because you were an actor who
paid at the 90 per cent rate. I came to this
because I was a depreciable asset.'
Source: Birnbaum and Murray, Showdown at Gucci Gulch
Reform: Low Rates, Broad Base
Birnbaum and Murray’s classic book,
Showdown at Gucci Gulch,
in just one slide
1.
2.
3.
4.
5.
Reagan punted tax reform past 1984 election
Treasury accidentally took the issue seriously
W&M Chairman Rostenkowski (D-IL) got religion
Finance Chairman Packwood (R-OR) fought for
union-favored tax breaks
At halftime: Sorta-low rates, kinda-broad base.
Politically–
Politically–why make lobbyists mad for such a small victory?
6.
Then, the famous “Two Pitcher Lunch” at Irish
Times. Just Packwood and Diefenderfer, his top
tax aide.
A 25% top rate? “Why not?”
The net result
Top personal rate: from 50% down to 28%
Millions taken off tax rolls
Elimination of many, many
tax incentives/loopholes
Stronger AMT
More taxes on corporations, less on individuals
Capital gains tax raised from 20% to 28%
(stopped the incentive to turn wages into capital gains)
% of tax paid by top 1%: From 19% to 20%
Sources: CBO, “Historical Effective Federal Tax Rates,”
Rates,” and Auerbach and Slemrod,
Slemrod, “Economic Effects of Tax Reform Act of 1986.”
1986.”
The Economic Result
Affluent married women worked more
Lower marginal rates
More efficiency on labor side
Higher capital taxation
(cap gains and depreciation)
Less efficiency on capital side
Maybe a wash?
No academic consensus
“The Impossible Became Inevitable”
(WaPo headline).
But how?
A powerful focal point:
A president people trusted not to raise taxes (“tax reform” was usually
code for “tax hike)–and who would give anything–anything–for low rates
Divide and conquer the lobbyists:
Darman, Reagan Treasury Aide:
Powerful tax lobbyists were too divided against each
other….“Brought down by the narrowness of their vision…”
The power to shame fellow members:
Once the issue was framed as “the general interest v. the
special interests,” the game was over.
But how does framing work? One for the other rhetoricians,
sociologists, and cognitive scientists….
But really, how?
A public choice perspective
James Buchanan, “Tax Reform as Political Choice
(Nobel 1986, George Mason University)
Short version: By 1980’s, the tax code was Swiss
cheese–no more tax breaks left to sell to lobbyists.
That meant it was time to take the tax breaks back and
start selling them again….
It’s good to be in a line of work where you can sell your
product to the same customers again and again….
Two big tax changes ahead
1. W&M Chairman Rangel’s bill:
Redistributes tax burden among individuals
Redistributes tax burden among corporations
Top corporate rate: from 35% to 30.5% Top individual rate: Back to Clinton’
Clinton’s: 39.6%
Corporate Rate: From 2nd highest in rich world to 4th
(Source: Tax Foundation)
2. 2011: Will Congress let everyone’s taxes
go up?
1.5% of GDP: 1/3 of military, 1/3 of Social Security, ½ of Medicare
Chairman Rangel’s Bill
Ends Individual Alternative Minimum Tax forever–
a big tax cut for high earners: $800B/10 years
$425 bigger standard deduction for everyone:
$48B/10 years
Pay-fors: Back to Clinton’s top rate: $831B/10 years,
Turning cap gains into wages: $26B/10 years.
Corporate side: Drop rate to 30.5% by:
Eliminating special tax break for domestic manufacturers
Changing inventory and international tax rules.
So what is the best way
to tax the rich?
Joseph Stiglitz
(Nobel 2001, Clinton CEA Chair)–pure theory:
“[E]fficient taxation requires that the marginal tax rate on the
most able individual should be negative.”
(Source: Stiglitz (1987) “Pareto Efficient Taxation and the New New Welfare Economics”
Economics”)
Only true if skilled workers help unskilled
workers do their job
Key story: The skilled help the unskilled earn more
2011: 1986 All over again?