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Annette Nellen
25th Anniversary of the Tax Reform Act of 1986

Is the 25th anniversary a time to celebrate it or wonder what happened to it?

October 13, 2011
by Annette Nellen, CPA, Esq.

October 22, 2011 marks the 25th anniversary of the enactment of the Tax Reform Act of 1986 (TRA86) (P.L. 99–514). This was an act that made so many changes to the tax law that Congress renamed Title 26 of the U.S. Code to be the "Internal Revenue Code of 1986" (previously it was the IRC of 1954). President Reagan's signing of H.R. 3838 on October 22, 1986 culminated a significant effort that started two years earlier with the Treasury Department's 800 page report on tax reform (Tax Reform for Fairness, Simplicity and Economic Growth: The Treasury Department Report to the President (PDF) (Nov. 1984)).

This article recalls the reasons behind TRA86. In addition, selected changes are noted along with their current status. Finally, a brief review is provided on changes made since 1986 that leave us to wonder what happened to the 25-year-old focus on making the tax system "fairer, more efficient and simpler" (Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (May 4, 1987), page 6).

Purpose Behind TRA86

Prior to TRA86, the top individual tax rate was 50 percent (down from 70% in 1980) and the top corporate tax rate was 46 percent. Congress and President Reagan sought to make the tax system fairer, more efficient and simpler. Fairness was pursued by curtailing a growing tax shelter industry that enabled higher income individuals to generate losses to apply against wage and investment income. Change also included ones that reduced taxes, even to zero, for millions of low-income individuals.

To improve efficiency of the tax system, many special provisions were removed thereby reducing the role of the tax law in decision-making. In addition, lower tax rates were expected to reduce the role of taxes in investment and spending decisions.

Congress believed simplicity was achieved by reducing the number of tax brackets for individuals from 14 to two (14% and 28%). An increased standard deduction made the system simpler for many individuals who would no longer need to itemize deductions.

Current Status of Selected TRA86 Changes

How well did TRA86 changes persist? How are some of these rules viewed today? See table, which attempts to answer these questions for selected provisions of TRA86.

Post-TRA86 Changes

Rate Structure: The TRA86 goal of a simple rate structure (two rates for the regular tax and a single rate for the AMT) has been lost. Today's rate structure for individuals is complex and non-transparent due to the multiple brackets, numerous phase-out provisions that change marginal tax rates, varying rates for different types of capital assets and a two-rate AMT.

Complexity: Most likely no one would challenge the statement that the federal income tax has become more complex since TRA86. The Internal Revenue Service (IRS) National Taxpayer Advocate has noted in annual reports to Congress that the most serious tax issue is the complexity of the tax law. The 2008 NTA report states:

"Since the beginning of 2001, there have been more than 3,250 changes to the tax code, an average of more than one a day, including more than 500 changes in 2008 alone." (NTA report (PDF), page 4)

Growth of Tax Expenditures: The goals for TRA86 of simplicity, efficiency and fairness have been diluted with the almost doubling of special tax rules (tax expenditures). In September 2011, the Joint Committee on Taxation presented testimony to the Joint Select Committee on Deficit Reduction that included data about the federal tax system. One data point was the number of tax expenditures added since TRA86. Per the JCT 34 public laws enacted since 1986 added 157 new special deductions, credits or exclusions to the income tax system. (JCT 2011, pages
61 – 70)

Temporary Code: Many provisions added since TRA86 have been temporary provisions. As noted by Senator Baucus at a March 2011 hearing (PDF) on changes subsequent to TRA86:

"In 1986, there was no concept of an annual tax extenders bill. Last year there were 141 expiring provisions vying to be extended. The debate took nine weeks of Senate floor time. We must look at why we have so many expiring provisions and how they affect our economy." (Baucus testimony (PDF), March 1, 2011)

A Changed World: A lot of economic and technological changes have occurred since 1986. The U.S. faces greater competitive challenges from other countries and we have moved from the industrial era to the information age. Web-based transactions challenge many existing rules because the Internet typically makes location and borders irrelevant and allows for new transfer modes, such as sales of digital goods and provision of services online.

Looking Forward

A lot has changed since TRA86, most notably that our federal tax system has become more complex and less equitable and efficient. The growth of temporary provisions brings great uncertainty to the law and extra time spent by lawmakers that does not necessarily make the tax system more efficient or effective.

Many lessons can be learned from TRA86. One lesson that remains elusive though is how to maintain the results of reform efforts to ensure that the principles and results achieved through reform can persist.

References

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Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the AICPA, ABA and California State Bar. She chairs the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.