TRA86: DID CONGRESS LOVE IT OR LEAVE IT?

THE TAX REFORM ACT OF 1986: DID CONGRESS LOVE IT OR LEAVE IT? RANDALL D. WEISS *

Abstract - The Congressional consensus Depending on whom you ask, the for tax reform in 1986 grew around two system is either too favorable (or not major principles: substantial rate favorable enough) to the rich or too reduction and improvement in horizon- complicated. Some people are simply tal equity. Tax legislation in the early frustrated with government in general 1980s foreshadowed these principles, and vent their feelings on the tax system since it involved either rate reduction or and the Internal Revenue Service. So, base broadening (although not in the politicians put forth a variety of propos- same package). This article describes tax als in response to the public’s dissatisfac- legislation that followed the Tax Reform tion. In 1980, for example, President Act of 1986 in order to see what new Reagan’s election campaign emphasized principles, if any, emerged as important tax cuts; many believed that this issue forces. The objectives of several of the played a decisive role in his victory. Yet, current reform proposals appear to be after tax cuts were implemented in inconsistent with those driving recent 1981, people were still dissatisfied. legislation and with the consensus likely Politicians believed that the public to be necessary for fundamental tax wanted a fairer system, and a five-year reform. Thus, it may be a number of debate and significant political struggle years before such a consensus develops. ensued, leading to the Tax Reform Act of 1986. Discontent with the system seems to be on the rise again, perhaps spurring another cycle of tax reduction and reform. The recent Congressional INTRODUCTION reform proposals can be seen as a response to this discontent. Although Taxes are never popular, and they are so many agree that the present system is complicated that people have a hard burdensome to both taxpayers and the time communicating to politicians the economy, little consensus exists as to actual source of their displeasure. Most which proposal promises the best people believe that taxes are too high, solution. others believe there are too few (or too many) deductions or exclusions. Just about ten years ago, on June 24, 1986, the U.S. Senate passed its version *Deloitte & Touche LLP, Washington, D.C. 20004. of the Tax Reform Act of 1986 by a vote

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of 97 to 3. If for only a brief period, this The paper devotes only scant attention high degree of consensus on what the to two key factors necessary to fully tax system should look like was as- understand the shape of tax legislation tounding. What led to the development in the last 15 years—the political of this consensus? How durable was the process and the budget process. They consensus? Are there parallels between are de-emphasized not because I believe recent tax legislation and the events that they are unimportant, but rather leading up to the 1986 Act that shed because they are outside the scope of any light on the likelihood of another this particular exercise. round of fundamental reform? These are the questions this paper attempts to analyze. PREDECESSORS OF THE 1986 ACT Tax legislation from 1981 through 1984 In the next section of the paper, I review revealed several Congressional prefer- the legislation that led up to the 1986 ences concerning tax policy. First, low Act and emphasize that lower tax rates tax rates were attractive. The Economic and broadening the base were changes Recovery Tax Act (ERTA) of 1981 with which Congress had considerable featured large individual rate cuts and experience by the time the Act was indexing of brackets. After 1981, tax developed. I then discuss what I believe legislation usually was motivated by a were the two primary features of the desire to increase revenue rather than Act that allowed the formation of the cut revenue. Yet, through the major pro-reform consensus in 1986: substan- revenue raising legislation in 1982, tial rate reduction and improvement in 1983, and 1984, tax rates were not horizontal equity. With respect to significantly raised. This outcome economic growth issues, Congress was reflected Presidential, as well as Con- able to ignore many entreaties to save gressional, preferences, of course, but specific tax provisions that provided a Congress did not mount a major boost to particular sectors of the challenge to this policy tenet during this economy in the belief that lower rates period. would themselves protect the economy from significant disruption. The next Second, income tax base broadening section of the paper briefly contrasts the and excise tax increases were the principles of the current round of reform preferred means of meeting revenue proposals to those of the 1986 Act. increase requirements. The early 1980s Although they apparently share objec- provided Congress with extensive tives of low rates and a broad base, the experience with the substance and approach toward equity issues is very politics of base broadening. Indeed, part different. Legislation since 1986 is then of the Tax Equity and Fiscal Responsibil- described in order to identify whether ity Act of 1982 was the repeal of base principles guiding tax legislation have narrowing provisions that had just been changed in a way that points toward enacted the previous year. This experi- the emergence of a consensus around ence allowed Congress to evaluate the one or more of the current proposals. credibility of the horror stories that My conclusion is that we are at least affected parties unfolded during the several years away from an evolution consideration of these cutbacks in tax toward a view that these proposals subsidies. As a result, there was growing embody feasible Congressional tax skepticism about the worst predictions policy decisions. of the results of these changes on the

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particular industries affected and on the the appeal and feasibility of measures to economy generally. lower rates, to broaden the base, and to deal with perceptions of unfairness— Third, Congress began to demonstrate three key principles incorporated in the concern about the perception of Act. unfairness that results from tax benefit transfer mechanisms and from excessive tax benefits. For example, safe harbor ECONOMIC PRINCIPLES OF THE leasing, enacted in 1981, was explicitly 1986 ACT designed to allow companies that could It is hard to overemphasize the degree not use the tax benefits associated with to which horizontal equity was the equipment purchases to sell their tax driving force behind the Tax Reform Act benefits to other taxpayers that could of 1986. Publicity in the early 1980s use the benefits. This provision was about high-income individuals and large recommended by the Treasury Depart- corporations that paid little or no tax ment because of the knowledge that was perhaps the most important force the combination of depreciation that kept the Act alive on its perilous deductions and investment credit legislative journey.1 Members of provided in the legislation was so Congress were sensitized to perceptions generous that many taxpayers would of unfairness that can arise when items exhaust their tax bases. Within months of income are omitted from the tax after ERTA’s enactment, the safe harbor base. The sharp difference between leasing transactions generated consider- economic income and the correspond- able publicity, with individual taxpayers ing tax liability was the aspect of prior raising questions such as: why were they law that was so indefensible that even not allowed to sell their dependent members who were not enthusiastic exemptions to the highest bidder? about the substance of the 1986 Act Congress responded in 1982 both by felt that they had to avoid being blamed repealing safe harbor leasing and by for its demise. Of course, the features of scaling back the depreciation and the Act aimed at this phenomenon investment credit benefits. complemented most of the other principles (e.g., broad base and low Finally, the debate over the 1981 Act rates), so that trade-offs were not showed that discussion of vertical equity usually observed. The only exception, of provoked controversy. Democrats had course, was simplicity, a goal that was attempted, unsuccessfully, to challenge not actively pursued except with respect the shape of the rate reduction on the to middle- and lower-income individuals grounds that it was too generous to the without business income. highest-income taxpayers and provided little or no relief to those at the bottom The attack on perceived horizontal of the income scale. Senator Bradley’s inequity involved restrictions on both design of his seminal tax reform proposal tax benefits that allowed individuals of the early 1980s reflected the judg- and corporations with substantial ment that a broad consensus for reform economic income to sharply reduce would be difficult to achieve if a reform their tax liabilities and on mechanisms proposal provoked another such debate. (“tax shelters”) that involved the transfer of tax benefits from taxpayers The legislation immediately before the who could not use them to those who 1986 Act thus allowed Congress to test could.

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Restriction on tax benefit transfers Lower tax rates certainly were a major included the passive loss limitation, principle of the 1986 Act. In the last which generally prevented individual phase of the Senate Finance Committee investors from using tax losses on markup, Chairman Packwood led the passive investments to offset earned Committee through a “zero-based income or interest or dividend income, budgeting” exercise in examining the and the kiddie tax, which limited the trade-off between lower rates and a ability of parents to transfer assets to broader base. He started by requesting their children in order to obtain a lower that the Joint Committee on Taxation tax rate on the associated income. On analyze a plan that repealed virtually all the corporate side, tax benefits that individual tax expenditures. He then could be transferred through such established that the top rate could be mechanisms as the dividends received reduced to 25 percent (he dubbed this deduction and purchase of companies the Brockway plan, after the Joint with net operating losses were limited. Committee’s chief of staff). Members A desire to prevent corporations that gradually added back key tax expendi- reported income to their shareholders tures to the plan, including deductions from paying little or no tax largely for mortgage interest and charitable motivated the adoption of the corpor- contributions, the exclusion for em- ate minimum tax. The tightening of the ployer health plan contributions, and individual minimum tax had a similar the partial exclusion of social security motivation. Tax benefits associated benefits, increasing the top rate to with unusually low tax liability also maintain revenue neutrality, until the were subject to restriction. Tax-exempt members felt comfortable with the bonds, for example, were significantly trade-off. The Finance Committee limited, and pension benefits available reported bill had a top rate of 27 to higher-income individuals were cut percent, one percentage point less than back. Industries perceived as often the rate that emerged from conference. generating tax losses, such as real In addition to generating enthusiasm estate and property and casualty among members of Congress, the insurance, had various tax benefits substantial rate reduction also was a key tightened. goal of President Reagan and helped to ensure his support of the ultimate Finally, the most important business tax product. benefit eliminated was the investment tax credit. For much equipment, the Distribution tables were very much part investment credit tended to be associ- of the 1986 Act political process. The ated with low effective tax rates. For rate schedules were designed to debt-financed investment, low effective produce a small, mildly progressive tax rates from liberal capital cost change in the distribution of tax recovery provisions combined with the burdens for middle- and upper-income interest deductions associated with the groups. The distribution tables for the debt financing tend to produce tax conference report showed that tax losses. Thus, the repeal of the invest- liabilities for the upper-income groups ment credit also can be seen as being were reduced by about two percent, aimed at circumstances in which while middle-income groups experi- profitable businesses could pay little or enced a tax cut in the range of about no tax. eight to ten percent. (Significant tax

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relief for the poor, largely through an Congress largely viewed rate reduction expansion of the earned income credit, as the major contribution in this area. was a deliberate goal of the Act; both Claims by particular groups of substan- political parties by then had acknowl- tial economic harm were ignored in edged the failure of the 1981 Act to many cases. Congress did not make any provide such relief.) There was not a attempt to significantly lower the overall broad debate about whether the degree cost of capital, a goal which conflicted of progressivity in the existing tax with the high priorities of low rates and system was optimum public policy. horizontal equity.2 Rather, the distributional outcome reflected a political decision, also Finally, Table 1 provides a useful embodied in the earlier Bradley– benchmark of the base broadening left Gephardt tax reform bill, that a large undone during the 1986 tax reform change in tax distribution would add an process. The table reproduces a additional layer of controversy that compilation, published by the Joint could threaten bipartisan support for Committee in October 1987, of base the reform. broadening proposals that were part of either the 1985 Treasury tax reform Similarly, the political agreement that study or the 1986 Administration the Act should be revenue neutral was a proposal but which were not adopted. temporary device, also established in the Excluded from this table are proposals Bradley–Gephardt bill, to isolate the tax for tax expenditures that even the 1984 reform exercise from Congress’s Treasury tax reform proposal omitted for continual attempts to deal with the reasons of feasibility or political contro- budget deficit. Indeed, the 1986 Act versy, such as the repeal of the prefer- was unusual in that most of the tax ence for qualified retirement plans or legislation of the 1980s increased the deduction for home mortgage revenue. Certainly, many of the interest. Most of these items fall into participants in shaping the 1986 Act four groups: employer-provided fringe had little doubt that Congress would benefits, savings incentives (pensions enact revenue increases in future years. and life insurance), the deduction for Some even expected tax rates to rise. state and local income and property For example, during the conference, the taxes, and energy and mining industry staff discussed the potential simplifica- provisions. The remainder are mostly tion that could have been accomplished miscellaneous industry-specific propos- had the Act eliminated all distinctions als; the major exception is the ill-fated between capital gains and ordinary rate differential recapture proposal that income, since they were taxed at the Treasury argued was justified by the rate same rate for both individuals and reductions but that was never consid- corporations. A belief that rates on ered seriously by Congress. ordinary income could rise in the near future and that a capital gains differen- This table indicates that the remaining tial would reemerge prevented that available base broadeners would be from happening. substantively and politically difficult for Congress to approve. Especially lacking With respect to issues involving the were feasible reform measures targeted impact of tax reform on the economy to high-income taxpayers that could be and on specific economic sectors, used as part of a revenue increase

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TABLE 1 ESTIMATED REVENUE EFFECTS OF UNADOPTED PROVISIONS CONTAINED IN THE PRESIDENT’S AND TREASURY’S TAX REFORM PROPOSALS, FISCAL YEARS 1988–90 (BILLIONS OF DOLLARS) Provision 1988–90

I. Income Tax Reform for Individuals

Excluded sources of income: Include a portion of employer-provided health insurance in taxable income ($10/individual; $25/family per month) 11.6 Cap exclusion of employer-provided health insurance ($70/individual; $175/family per month) 16.8 Repeal exclusion of employer-provided group term life insurance 8.4 Repeal exclusion of employer-provided death benefits (a) Repeal exclusion of workers’ compensation and black lung benefits 7.7 Repeal exclusion of employer-provided dependent-care assistance 0.2 Cafeteria plans: Cap cash option ($500 annually) 4.1 Repeal exclusion for FICA and FUTA 3.5 Disqualify dependent-care assistance from cafeteria plan exception 0.2

Preferred uses of income: Disallow state and local income and real property tax deduction 52.8 Disallow nonbusiness state and local personal property tax deduction 0.9 Business meals and entertainment expenses: Allow 75 percent deductibility 1.3 Allow 50 percent deductibility 6.6 Limit temporary assignments to one year (a)

II. Retirement Saving

Eliminate deferral of appreciation of employer retirement securities 0.2 Repeal cash and deferred arrangements (CODAs) 14.6

III. Basic Taxation of Capital and Business Income

Recapture of rate differential on accelerated depreciation 52.3

IV. Specific Industry, Tax Shelter, and Other Tax Provisions

Restrict use of cash accounting for large nonfarm business 0.7 Repeal cash accounting for farms with gross receipts over $5 million 0.8

Energy provisions: Repeal business energy credits; limit gasohol exemption 0.9 Repeal percentage depletion for: Oil and natural gas (all wells) 1.4 Oil and natural gas—all wells except stripper wells owned by independent producers 1.0 Other minerals 1.5

Financial institutions: Repeal depository institutions’ bad-debt reserve deductions 1.9 Repeal tax exemption of large credit unions 0.9

Life and property/casualty insurance: Limit life insurance reserve deductions; repeal exemption of certain small companies 0.5 Limit property and casualty insurance company reserves 0.3 Insurance investment income: Repeal exclusion of inside buildup (no grandfather) 8.1 Repeal exclusion of current annuity income (no grandfather) 3.7 Treat surrenders of life insurance as income 0.1 Loans from life insurance policies treated as distributions 0.7 Deductions for reserves limited to surrender value 0.2

State and local government debt and investments: Repeal exemption for nongovernmental bonds 2.8

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TABLE1 (Continued) Provision 1988–90

Special expensing and amortization rules: Repeal expensing of conservation expenditures and farmers’ fertilizer and field clearing (b) Repeal 5-year amortization of pollution control (a) Repeal 84-month amortization, 10 percent credit for reforestation (a)

Other specific industry provisions: Repeal rehabilitation tax credits 2.4 Repeal special rules for returns of magazines, etc. 0.2 Repeal expensing of multiperiod timber growing costs (b) Repeal targeted jobs tax credit 0.7 Repeal exclusion of Merchant Marine Capital Construction Fund 0.2 Require employers to make nondeductible payments to employees who receive ESOP dividends (a) Limit artificial losses (at-risk rules) (a)

International issues: Possessions tax credit 3.7 Repeal title passage source rule 1.7 Other provisions affecting international income 4.3 Source: Joint Committee on Taxation, October 8, 1987. (a) Gain of less than $50 million. (b) Estimate not available.

package providing a balanced distribu- and a subtraction method value added tional effect. (The deduction for state tax; a national retail sales tax, proposed and local income taxes may have had a by Representatives Schaefer and Tauzin; useful distributional pattern, but its and the so-called flat tax, sponsored by proposed repeal proved very controver- Representatives Armey and Senator sial and would not have allowed a Shelby, which is a value-added tax with significant reduction in combined a deduction for wages along with a federal and state marginal tax rates.) personal tax on wages in excess of an Thus, for meeting future demands for exempt amount. In addition, Represen- additional revenue to be raised without tative Gephardt has announced a plan significant distributional effect, it should to reform the individual income tax. In not be surprising that Congress turned order to compare the 1986 Act with to rate increases on high-income these proposals, I summarize their major individuals. elements:

PRINCIPAL ELEMENTS OF CURRENT Consumption as the Tax Base REFORM PROPOSALS The value added tax, personal consump- In what ways are the current tax reform tion tax, retail sales tax, and flat tax all proposals inconsistent with the 1986 use consumption as the base of the tax; Act? Is what has transpired since 1986 the differences largely involve varying leading to another round of fundamen- points of collection in the chain of tal reform? The key current reform production and distribution. All of these proposals that have thus far been taxes share the fundamental characteris- introduced are the USA tax, sponsored tic of excluding from tax income from by Senators Nunn and Domenici, that capital by excluding from tax, or includes a personal consumption tax allowing expensing of, purchases of

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capital items such as equipment, real of saving (or capital income, depending estate, and inventory. Only the on the proposal) to pay much less tax Gephardt proposal retains the current than other taxpayers with the same system of using income as the tax base. economic income but less of the excluded item. Although the 1986 Act Comprehensive Tax Base retained consumption tax elements, such as qualified pension plans, that All the proposals eliminate many allowed some such divergence, strict exclusions and deductions and thus limits were placed on any taxpayer’s use move toward a comprehensive measure of them. Similarly, the expensing of all of either consumption or income as the capital items prescribed in the proposals basis for taxation. Thus, they would would increase the likelihood that many repeal many of the provisions, which profitable businesses, especially growing survived the 1986 act, that provide ones, would pay little or no tax. favorable treatment for specific activi- Elimination of any devices to prevent ties, such as fringe benefits, home high-income taxpayers from eliminating ownership, and state and local taxes. a substantial portion of tax liability would be a very significant change from Progressivity the 1986 Act ethos. The proposals differ in their treatment of the desirable degree of progressivity Further, several of the proposals would in the system. Only the USA tax uses the spur a debate about vertical equity by old Bradley–Gephardt formulation of making the system much less progres- attempting to keep the individual sive, especially with respect to the distribution by income class and the relative effective tax rates of upper- and 3 individual-business split of tax collec- middle-income groups. The biggest tions unchanged. The retail sales tax and change would be caused by the retail flat tax would make the system less sales tax, which would eliminate any progressive, while the Gephardt personal tax from the system. A proposal would make it more progres- personal tax clearly is necessary to sive. maintain the current degree of progressivity, since it allows taxpayer-by- taxpayer computation of the tax base, Replacement System to which a graduated rate schedule can The consumption tax proposals would be applied. entirely replace the income tax. In addition, several of them would The proposals generally share the 1986 eliminate other taxes, such as estate and Act’s goal of keeping rates low by gift, social security, and selective excise maintaining a broad base (with the taxes as part of their plan. exception, for the consumption tax proposals, of capital income). In ad- The principles reflected in most of these dition, unlike previous discussions of con- proposals contrast significantly with sumption taxes, these proposals would those of the 1986 Act. Perhaps most not add another tax to the system. important is a fundamentally different view of horizontal equity. Inherent in In addition to contrasting principles, the using a consumption tax base is the arguments put forth by the proposal’s ability of individuals with high amounts proponents also differ from those made

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in connection with the 1986 Act. The The 1987 and 1989 Acts were driven by sponsors emphasize economic growth relatively modest revenue increases as a prime reason to exclude capital in- required as part of those years’ Con- come from the tax base. This view clearly gressional budget resolutions; their net differs from the 1986 Act view that low annual revenue increases in the first few tax rates were sufficient to minimize the years after enactment averaged $15 drag of the tax system on the economy. and $5 billion, respectively. The 1988 And, as described above, the exemption tax bill was a revenue-neutral bill of capital income also is the source of containing base broadeners as the the differences from the Act in the principal revenue raisers and eliminating implicit view of horizontal equity. some of the political and substantive “rough edges” from the 1986 Act. (For Reduction of compliance burden is example, the 1988 Act repealed the another argument emphasized by the much ridiculed provision requiring artists proponents of current proposals. and authors to capitalize expenses Although the 1986 Act did simplify the related to their works.) The 1989 system for many lower- and middle- legislation also contained some revenue- income taxpayers, it is fair to say that losing provisions, including modification simplicity was not a major objective of of corporate minimum tax provisions of tax provisions affecting business and the 1986 Act. The 1988 and 1989 high-income individuals. revenue losers hardly represented a rejection of the philosophy of the Tax The next section of the paper reviews Reform Act, however. They can be seen tax legislation after the 1986 Act in as simply substituting new base order to examine whether Congress’s broadeners for 1986 provisions that recent actions reveal that its principles proved relatively unacceptable. of tax legislation are evolving toward those consistent with the current reform In formulating the 1989 legislation, proposals. The key questions appear to Congress had rejected a controversial be: Is Congress becoming more ame- provision that President Bush had nable to a very different view of proposed as a revenue raiser: restoration horizontal equity, to be justified by of a preferential rate (15 percent) for economic growth arguments? Is individual capital gains. The Act’s simplicity becoming a more important elimination of the capital gains differen- objective? Is a vertical equity debate tial had been an important tool in consistent with the bipartisan consensus achieving a large rate reduction for likely to be necessary for reform? high-income groups without reducing their average tax liability. Thus, the Bush proposal can be seen as the beginning TAX LEGISLATION SINCE THE 1986 ACT of a challenge to the 1986 Act prin- In fashioning the tax legislation of 1987, ciples in several respects. First, using the 1988, and 1989, Congress followed the then prevailing Congressional methodol- pattern of the early 1980s by using base ogy, this proposal had a distinct distribu- broadeners to meet the revenue tional effect in providing disproportion- increase requirements of these bills ate relief to the highest income groups. (even though the 1986 Act had already It was not accompanied by tax cuts for used up many of the easy ones) and by middle-income groups to provide avoiding rate increases. distributional balance. Second, it

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reopened possibilities for significantly tax credit. These were included in a lower tax liability for those who received package that raised $10.9 billion in the their income in the form of capital gains first fiscal year in which it was fully rather than ordinary income, although, effective. After extensive “budget of course, there is a big difference summit” negotiations, Congress between a 15 percent rate and the zero produced a tax bill with considerably rate contained in some of the current larger revenue increases, averaging reform proposals. Third, it was justified about $30 billion per year. Bush’s as an economic growth measure. In acceptance of this package meant his contrast, during the 1986 Act design, repudiation of his “read my lips: no new neither the Administration nor Congress taxes” pledge of the 1988 campaign. identified particular exclusions or Individual income and Social Security tax deductions as particularly necessary to rate increases targeted on upper income promote economic growth. Rather, the groups, along with excise tax increases, view was that if disparities in treatment were the major revenue-raising provi- were evened out and rates were low, sions. The income tax base broadening any significant roadblocks that the tax (other than a provision affecting life system imposed on the economy would insurance companies) was minor, be removed. although it more than offset the base- narrowing provisions. The capital gains The 1990 legislation marked a turning rate was not reduced as the President point in attitudes toward rate increases proposed, although the alternative and distribution. Before the negotia- capital gains tax resulted in the creation tions on this legislation, Congressional of a differential between tax rates on Democrats had been developing a set of ordinary and capital gains income. The “fairness” arguments concerning the proposal to liberalize IRAs was not effect on each income class of the adopted either. economic policies of the 1980s. The general theme was that the richest Although reliance on excise tax in- Americans benefited unduly from these creases for a large part of the revenue policies. One element of this theme was raising would have required some tax that the tax legislation of the 1980s, increase provisions aimed at high- specifically the 1981 Act, had caused an income individuals in order to achieve unjustified reduction in the tax burden distributional balance, Congress went on high-income taxpayers. The program further. According to the Joint Commit- the Democrats developed to address tee distributional table released after the these concerns included rate increases conference agreement, the tax increase on these high-income taxpayers and tax for taxpayers in the income category relief to the working poor. above $200,000 averaged 6.3 percent, while the middle-income groups had In his fiscal year 1991 budget presented about a 2 percent increase. In addition, early in 1990, President Bush proposed continuing what was started in 1986, a numerous base-narrowing provisions. tax cut was provided to the lowest Not only did he renew his call for a groups. Although this distributional lower capital gains rate (19.6 percent), change was only about half as large as but he also proposed the establishment that provided by the 1986 Act, it was of nondeductible, tax-free “back quite significant given the smaller scale ended” IRAs, enterprise zone incentives, of the 1990 legislation. Clearly, the issue energy tax incentives, and a new child of the proper distribution of tax burdens

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had been specifically addressed by distributional balance would have Congress for the first time since 1981; required, however, and made the system ironically, awareness of this issue was more progressive. However, the 1990 probably increased by the extensive Act did not adopt a “pro-growth” debate over the distributional aspects of approach that systematically narrowed the President’s capital gains proposal. the income tax base nor did it reveal a lessening of concern with the horizontal Rate increases resulted both from a equity issues so important to the 1986 desire to be explicit about the impact on Act. Finally, there was no evidence that the highest income groups and from a Congress was becoming more sensitive dearth of base-broadening measures to the problems caused by adding targeted on that group. Not only were complex provisions to the Code. the rates increased to a top nominal regular tax rate of 31 percent and an Throughout the remainder of the Bush alternative minimum tax rate of 24 presidency, the Administration pushed percent, they were changed in compli- its capital gains, enterprise zone, and cated ways that were difficult to IRA proposals and added other base- understand. Hidden marginal rates were reducing proposals, such as an invest- introduced through the personal ment tax allowance, passive loss relief exemption phaseout and limitation on for real estate, an interest deduction for itemized deduction provisions and the student loans, and a first-time increase in the limit on taxable wages in homebuyer tax credit. Again, these the Health Insurance (HI) portion of the represented the view that the tax system Social Security payroll tax. From a was an impediment to economic growth system which had only four brackets and that a specific subsidy was neces- and in which most taxpayers could sary to promote a particular type of easily learn their marginal rate, the activity. At the same time, Congressional individual income tax changed to a Democrats continued to develop their system with many brackets, most of fairness program. In early 1992, Bush them hidden, in which very few people proposed a number of business incen- had the ability to calculate (let alone tives in response to weakness in the remember) their marginal tax rate. economy, while Congress was ready to Effective marginal tax rates were shape legislation that reflected its increased substantially for the highest program. Although Congress agreed to income taxpayers. For an earner many of the incentives proposed by the affected by the HI change and in the President, it added a number of items range in which the personal exemptions that later were incorporated into the were being phased out, the total 1992 Clinton campaign program and marginal tax rate increased from 28 to the subsequent 1993 Clinton Adminis- over 35 percent. tration budget proposal. The tax bill sent by Congress to President Bush in March The 1990 Act’s emphasis on rate 1992 (and vetoed by Bush) included increases clearly represented a move- such items as an increase in the top ment away from the principles of the individual income tax rate to 36 percent, 1986 Act. However, it is not clear what a 10 percent surtax on millionaires, alternatives existed, given the revenue middle-class tax cuts, and miscellaneous requirements of the budget process and revenue raisers flowing from the fairness a desire for distributional balance. The theme, such as limits on deductions for rate increases went further than executive compensation and club dues.

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During the 1992 campaign, the Clinton Interestingly, the major Republican tax program adopted many of the items in package of 1995, contained in the the March 1992 tax bill, including the vetoed budget bill of that year, did not individual rate increases and some of repudiate or undo the rate increases of the revenue losers, such as enterprise the 1993 legislation. Rather, the zones, a small business capital gains proposals concentrated on a capital exclusion, and a targeted investment tax gains reduction, IRA expansions, and tax credit. The embrace by Clinton of many cuts for families with children. A of the pro-growth initiatives of the Bush business proposal aimed at reducing the Administration seemed to anticipate a overall cost of capital, the Neutral Cost possible attack, on economic grounds, Recovery System retrieved from the on the individual rate increases. The Kemp–Kasten tax reform bill of the mid- actual budget package announced in 1980s, gained no support and was not February 1993 included other tax included in the final package. Some increases not mentioned during the base-broadening provisions (mostly campaign, such as an increase in the business items) were included in the corporate tax rate, the elimination of package to offset the revenue loss, the cap on the amount of wages subject although these appear to have been to the HI payroll tax, an increase in the motivated chiefly by a desire to reduce social security benefits subject to income “corporate welfare” in order to provide taxation, and a broad-based energy tax. an appearance of balance to the The tax package was largely designed numerous spending cuts on individuals for deficit reduction purposes; the final that were part of the package. At Act raised revenues by about $50 billion present, neither Congress nor the per year. As in 1990, the 1993 Act had President views rate reduction as a relatively little base broadening, even priority nor do either of them hesitate to more significant rate increases on high- propose new targeted tax provisions to income individuals combined with address economic and social issues. additional relief for the lowest income groups through an expansion of the Conclusions earned income credit, and a relatively small corporate increase. Some of the Has Congress loved the 1986 Act or left base broadeners were included largely it? Congress loved it with only minor for their symbolic value, such as the arguments until 1990. Confronting the restrictions on deductions for executive economic pressures of the budget compensation and lobbying expenses. deficit, a lack of significant and palat- Revenue losers included further paring able base broadeners, and the political away at the individual and corporate attraction of a debate on vertical equity, minimum taxes, passive loss relief for estrangement began. The cooling of the real estate professionals, and a targeted relationship accelerated in 1993, and, at capital gains incentive. In general, this present, it is fair to say that a separation bill was dominated by fairness consider- has occurred. Tax rate reduction appears ations and economic stimulus concerns. to have little appeal, and base-narrow- Unlike 1986, however, vertical equity, ing proposals seem to be proliferating. rather than horizontal equity, was the concern. Largely as a result of the Is Congress rushing into the arms of emphasis on vertical equity, the bill was another fundamental reform? I think very controversial and barely passed not; it is going in a different direction. Congress. Unlike the early 1980s, in which tax

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legislation appeared consistent with the ENDNOTES reform that followed, tax legislation of I am indebted to Thomas Barthold for comments the 1990s does not seem to follow the on a draft of this article. principles of the current reform propos- 1 See Conlan, Wrightson, and Beam (1990) for als. There does not seem to be much examples of relevant press reports. 2 attraction to simplicity, low rates, and a See Birnbaum and Murray (1987) for examples of the dire economic forecasts presented to members broad base. Rather, targeted provisions of Congress. See Steuerle (1992) for analyses of that narrow the tax base are quite the Act’s effect on the cost of capital. popular. The vertical equity debate that 3 See U.S. Treasury Department (1996) for an analysis would be raised by serious consideration of various current consumption tax proposals on the distribution of tax burdens by income class. of several of the proposals would probably be as divisive as ever and would be likely to overwhelm any possible consensus about a change that REFERENCES would already have many large winners Birnbaum, Jeffrey H., and Alan S. Murray. and losers. Finally, there is no evidence Showdown at Gucci Gulch. New York: Random in recent legislation that Congress is House, 1987. likely to adopt a totally different view of Conlan, Timothy J., Margaret T. Wrightson, horizontal equity than that contained in and David R. Beam. Taxing Choices. Washing- ton, D.C.: CQ Press, 1990. the 1986 Act. Although the tax system does not seem to be so stable that it is Steuerle, C. Eugene. The Tax Decade. Washington, D.C.: Urban Institute Press, 1992. immune from significant reform, U.S. Department of Treasury. Office of Tax considerable time will be required to Analysis. “ ‘New’ Armey–Shelby Flat Tax Would develop a consensus that would support Still Lose Money, Treasury Finds.” Tax Notes 70 one of the current proposals. No. 4 (January 22, 1996): 451–61.

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