The Tax Reform Act of 1986

The Tax Reform Act of 1986 was one of the major accomplishments initiated by the Reagan Administration, passed by a Democratic House and Republican Senate. One of the most important pieces of tax legislation since WWII, it sought to "level the playing field" by curbing tax shelters, lowering corporate tax rates, and eliminating special treatment for capital gains. Thereafter, capital gains, earned income, and unearned income were all taxed at the same rate. In economists' language, it brought the average marginal tax rates on labor and capital income closer together.

Since 1986, other tax legislation has again increased taxation on earned income to a higher rate than that on capital gains, which again received preferential status. While the top rate on capital gains remained at 28%, the top earned income tax rate was increased to 31% in 1991 in a package endorsed by President Bush as a tactic for addressing burgeoning federal deficits. This violated his "Read my lips...No new taxes." campaign pledge as was thought to be a factor underlying his defeat in the 1992 elections. In 1993, under President Clinton, the earned income rate climbed even higher, to 39.6%.

Other features of the Tax Reform Act of 1986:

Tax reform is technical and complex, giving rise in the debate over the Tax Reform Act of 1986 to the following well-publicized quote: "Very frankly, Madam Speaker, I respectfully submit there is not a person alive who knows what is in this bill." -- Rep. Stan Parris (R-VA), Congressional Record, 25 Sep 1986, p. H-8375

Source: D. Garson, with permission.