Economic Recovery Tax Act of 1981 - Effect and Controversies

Effect and Controversies

The most lasting impact and significant change of the Act was the indexing of the tax code parameters for inflation. Of nine federal tax laws between 1968 and this Act, six were tax cuts compensating for inflation driven bracket creep. Following enactment in August 1981, the first 5% of the 25% total cuts took place beginning in October of the same year. An additional 10% began in July 1982, followed by a third decrease of 10% beginning in July 1983.

As a result of ERTA and other tax acts in the 1980s, the top 10% were paying 57.2% of total income taxes by 1988 - up from 48% in 1981 - while the bottom 50% of earners share dropped from 7.5% to 5.7% in the same period. The total share borne by middle income earners of the 50th to 95th percentile decreased from 57.5% to 48.7% between 1981 and 1988. Much of the increase can be attributed to the decrease in capital gains taxes, while the ongoing recession and subsequently high unemployment contributed to stagnation among other income groups until the mid-1980s. Another explanation is any such across the board tax cut removes some from the tax rolls. Those remaining pay a higher percentage of a now smaller tax pie even though they pay less in absolute taxes.

In addition to changes in marginal tax rates, the capital gains tax was reduced from 28% to 20% under ERTA. Afterwards revenue from the capital gains tax increased 50% by 1983 from $12.5 billion in 1980 to over $18 billion in 1983. In 1986, revenue from the capital gains tax rose to over $80 billion; following restoration of the rate to 28% from 20% effective 1987, capital gains revenues declined through 1991.

Critics claim the tax cuts worsened the deficits in the budget of the United States government. Reagan supporters credit them with helping the 1980s economic expansion that eventually lowered the deficits. After peaking in 1986 at $221 billion the deficit fell to $152 billion by 1989. Supporters of the tax cuts also argue, using the Laffer curve, tax cuts increased economic growth and government revenue. This is hotly disputed—-critics contend that, although government income tax receipts did rise, it was due to economic growth, not tax cuts, and would have risen more if the tax cuts had not occurred; the Office of Tax Analysis estimates that the act lowered federal income tax revenue by 13% relative to where it would have been in the bill's absence.