Journey of the Most Recent Tax Reform Effort

The journey of the most recent tax reform effort began with the inauguration of the current administration. As we look back on the past few months, it is very apparent that the “swamp” of Washington D.C., as the administration has referred to it, is proving very tough to navigate. The process of tax reform has been no exception to this difficult navigation, as throughout history, tax reform process has always been fraught with problems. Many clues to the future success or failures of political measures can be found in historical actions and politicking. Let’s take a look back at some of the actions that brought us to our current tax system for clues on what might lay ahead.

The major reason the 1986 Tax Reform Act was able to be passed was that the prior tax system was perceived to be unfair toward lower- and middle-class America. This attitude of inequity was primarily driven by many stories of high-income individuals and large corporations that paid little or no tax as a result of structuring and strategies that could be implemented to shelter taxable income. The public also reacted favorably toward the concept of lower tax rates while scaling back deductions, exclusions and credits so the computation of tax liability more closely resembled the taxpayer’s income level.

The president at the time, Ronald Reagan, had made tax reform a major re-election platform issue during his 1984 campaign. The president’s plan reduced tax rates, eliminated almost all deductions, abolished most business tax breaks and simplified the tax code. The idea of eliminating wealthy tax breaks and corporate tax preferences appealed to Democrats in Congress. In a posture that seems to rarely happen in today’s Washington, Democrats joined with the Republican president in support of the framework of tax reform. The proposal and the initial draft bill of the reform was not fully backed by the president’s own party, however. After some lobbying by Mr. Reagan, enough support from Republican congressmen allowed the House bill to be approved and kept tax reform on track, though the president assured Republican congressmen that he would veto the bill if significant changes were not made prior to finalization.

As the bill moved through the Senate Finance Committee, attempts to reinstitute many of the tax breaks for business and significantly alter tax-exempt investments threatened to derail the process. A critical agreement was struck to require all amendments to the bill to be revenue neutral. Consequently, if a deduction was proposed, senators would have to find an equal amount of corresponding revenue by raising rates or eliminating another deduction. This threat to hold the Senate accountable for not lowering tax rates forced many to abandon business tax deductions for their or their states’ self-interest.

Finally, after over a year in Congress, the tax reform bill was approved by the House of Representatives on September, 27 1986, with a majority of both parties’ support. Total vote count was 292 to 136. The Senate approved the measure two days later by the count of 74 to 23. The final bill was signed into law by President Reagan on October 22, 1986. The president referred to it as, “the best antipoverty bill, the best pro-family measure and the best job creation program ever to come out of the Congress of the United States.”

The Tax Reform Act of 1986 provided a major overhaul to the previous tax code, lowering the top tax rate from 50% to 28% and raising the bottom rate from 11% to 15%. It also mandated that capital gains would be taxed at the same rate as ordinary income and eliminated certain tax shelters. It required people claiming children as dependents to provide Social Security numbers for each child on their tax return. Some refer to this as possibly the largest tax shelter reduction in U.S. history. It also expanded the Alternative Minimum Tax and increased the Home Mortgage Interest Deduction to incentivize homeownership.

As you can tell from the tax reform initiated in 1986, conditions have to be right and public perception must be strong enough to push lawmakers into action. There has to be enough revenue generation to enable permanent tax reform and that revenue generation must allow public beneficial provisions be put into play to enable enough congressional support or pressure to remove lobbyists from the process.

In the current political state, other distractions in Washington may allow time for out-of-the-spotlight dealings and negotiating to draft meaningful reform, but until public support can be generated any tax reform is likely to stall. To encourage this support, provisions of the reform must be perceived to benefit the majority of U.S. taxpayers and continue to fund the government.