The Mostly Forgotten Tax Increases of 1982-1993
The Economic Recovery Act of 1981, also known as the Reagan tax cuts, was the biggest reduction in U.S. taxes of the past 70 years, possibly even the biggest ever. 1 That much is reasonably well-known.
What is less well-known is that these cuts were then followed by a series of tax increases that, if you add them all together, were almost as big as or even bigger than the 1981 cuts, depending on the measure you use.
I did not know this myself until a reader question about the source of the federal budget surpluses of 1998 through 2001 sent me looking again at the report on Revenue Effects of Major Tax Bills produced in 2013 by the Treasury Department's Office of Tax Analysis, which I featured in a column last week. The 1981 tax cut reduced revenue by an average of 2.89 percent of gross domestic product over the four years after it was enacted, according to the Treasury Department's analysis, which does not attempt to incorporate any macroeconomic effects of tax changes. When I added up the four-year average revenue impact of the next seven significant tax changes approved by Congress, in 1982, 1983, 1984, 1986, 1987, 1990 and 1993, I found that they equaled 2.98 percent of gross domestic product. Who knew?
Now, while the four-year average revenue impact is the most comprehensive measure in the Treasury report, it's not necessarily the best one. The negative revenue impact of the 1981 tax cut got bigger over time, for example, thanks mainly to a provision that indexed tax brackets to inflation starting in 1985, while the Tax Reform Act of 1986 went from modestly revenue-positive in the first couple of years after its passage to modestly revenue-negative after that. So in the chart below I've also included the estimated revenue impact in just the fourth year after enactment, plus the impact of the capital gains tax cut of 1997, which also preceded those 1998-2001 surpluses.
Going by the fourth-year estimates, then, the sum total of the tax cuts of 1981, 1986 and 1997 was 0.95 percent of GDP bigger than the sum total of the tax increases over that period. Or, if that's a little hard to get your head around, it was $77.6 billion bigger (a $337.8 billion cut versus a $260.2 billion increase) in constant 2012 dollars:
Even using the fourth-year numbers, the tax increases from 1982 through 1993 still made up for the great majority of the revenue losses from the 1981 cuts. What were these increases? The ones in 1990 and 1993 you may have heard about. The former came when President George H.W. Bush reneged on his "read my lips, no new taxes" pledge and signed into law the Omnibus Budget Reconciliation Act of 1990, which increased taxes in several different ways, including a hike in the top personal income tax rate to 31 percent from 28 percent. The Omnibus Budget Reconciliation Act of 1993, signed into law by President Bill Clinton, increased the top rate to 39.6 percent, among other changes.
The 1980s tax increases are less well-known, in part because they didn't involve increases in individual income tax rates. The biggest, the Tax Equity and Fiscal Responsibility Act of 1982, increased revenue mainly by tightening up rules on depreciation, leasing, contract accounting and investment tax credits. The Social Security Amendments of 1983 sped up planned increases in payroll tax rates, among other things. The Deficit Reduction Act of 1984 changed rules on interest exclusions, income averaging and such. The Omnibus Budget Reconciliation Act of 1987 closed a few loopholes and extended a telephone excise tax. And the Tax Reform Act of 1986, while it lowered the top individual income tax rate to 28 percent from 50 percent, contained enough offsetting changes that, for the first two years after enactment, it raised tax revenue.
It's important to keep in mind that the numbers in the above charts represent not the actual revenue losses or gains resulting from tax changes -- which are impossible to know with certainty -- but estimates churned out by the Treasury Department's and Joint Committee on Taxation's static tax analysis models. They are not partisan estimates; the 2013 report I cite is simply an update of earlier ones published under other administrations both Democratic and Republican. But neither are they necessarily the truth.
Still, they do seem to indicate that one big factor in the improvement in U.S. government finances from the yawning deficits of the mid-1980s to the surpluses of 1998 through 2001 was the straightforward mechanism of tax increases. Other factors included big cuts in defense spending in the 1990s, favorable Social Security demographics in the years before the baby boomers started to retire, and strong economic growth that may well have been strengthened by the reductions in income tax rates in the 1981 and 1986 tax bills (which were partially but far from fully reversed by the 1990 and 1993 tax increases). The big rise in income inequality in the 1980s and 1990s also had a positive effect on revenue, because those with higher incomes pay taxes at higher rates, as did the stock market boom/bubble of the late 1990s.
My overall impression of the 1981 tax law is that it was a positive if perhaps overdone change in direction. Cutting the top tax rate to 50 percent from 70 percent may well have increased the amount of money coming into the Treasury as incentives to avoid taxes were reduced and incentives to make lots of money increased. Ending the "bracket creep" through which inflation surreptitiously increased tax rates for millions of Americans every year was a necessary corrective. But overall the legislation was still a tax cut that left a hole in government finances, and that hole didn't magically disappear thanks to the resulting economic growth. In the sympathetic accounting of economist Lawrence B. Lindsey, who was a staffer on President Ronald Reagan's Council of Economic Advisers and went on to be a Federal Reserve governor in the 1990s and a top economic adviser to President George W. Bush in the 2000s, the positive economic and behavioral effects of the 1981 cuts recouped about a third of the revenue losses. So it also took spending cuts and tax increases to move the federal budget into surplus territory.
The tax legislation that congressional Republicans and President Donald Trump hope to turn into law next week would, to go by the Joint Committee on Taxation analysis of the version passed by the Senate, reduce revenue by an average of $178 billion a year, or 0.9 percent of GDP, over the next four years, and by $217.5 billion, or 1 percent of GDP, in 2021. Some of that loss may be recouped by stronger economic growth and less strenuous efforts by corporations to avoid a top corporate income tax rate that's slated to drop to 21 percent from 35 percent. Most of it, if past experience and the current projections of economic modelers can be relied upon, will not. Reductions in overall government spending also seem unlikely as long as the baby boomers are enjoying their golden years. And so, just as in the Reagan era and during the administrations that followed, Congress will eventually have to turn to tax increases.
Other contenders include the Revenue Act of 1945, which had a bigger impact (as a percentage of GDP) in the first year after passage than the 1981 legislation did, but it probably didn't increase in impact in subsequent years as the 1981 act did. We can't know for sure because Treasury provides only one-year estimates for bills enacted before 1968. It provides no estimates at all for tax bills enacted before 1940, but a glance at government revenue statistics indicates that the cuts in the Revenue Act of 1921 were similar in impact to those of 1945 and 1981.
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