Ronald Reagan Signs the Economic Recovery Tax Act of 1981

The Economic Recovery Tax Act of 1981 (also known as ERTA or the Kemp-Roth Tax Cut) was "A bill to amend the Internal Revenue Code of 1954 to encourage economic growth through reductions in individual income tax rates, the expensing of depreciable property, incentives for small businesses, and incentives for savings, and for other purpose." Pub.L. 97-34, 95 Stat. 172, enacted August 13, 1981). The Act also reduced marginal income tax rates in the United States by 25% over three years (the top rate falling from 70% to 50% while the bottom rate dropped from 14% to 11%) and indexed the rates for inflation, though the indexing was delayed until 1985. Its sponsors, Representative Jack Kemp and Senator William Roth, had hoped for more significant tax cuts, but settled on this bill after a great debate in Congress. It passed Congress on August 4, 1981 and was signed into law on August 13, 1981 by President Ronald Reagan at his California ranch.

Summary of Bill

The Office of Tax Analysis of the United States Department of the Treasury summarized the tax changes as follows[1]:

* phased-in 23% cut in individual tax rates; top rate dropped from 70% to 50%
* accelerated depreciation deductions; replaced depreciation system with ACRS
* indexed individual income tax parameters (beginning in 1985)
* created 10% exclusion on income for two-earner married couples ($3,000 cap)
* phased-in increase in estate tax exemption from $175,625 to $600,000 in 1987
* reduced Windfall Profit taxes
* allowed all working taxpayers to establish IRAs
* expanded provisions for employee stock ownership plans (ESOPs)
* replaced $200 interest exclusion with 15% net interest exclusion ($900 cap) (begin in 1985)

The accelerated depreciation changes were repealed by Tax Equity and Fiscal Responsibility Act of 1982 and the 15% interest exclusion repealed before it took effect by the Deficit Reduction Act of 1984.

Effect and Controversies

The most lasting impact and significant change of this bill was the indexing of the tax code parameters for inflation. Of nine tax bills between 1968 and this bill, six were tax cuts compensating for inflation driven bracket creep. The elimination of bracket creep tax increases, combined with the other tax cut provisions of this bill, caused nine of the subsequent eleven tax bills through 1993 increasing taxes.

Critics claim the tax cuts worsened the deficits in the budget of the United States government. Reagan supporters credit them with helping the 1980s economic expansion that eventually lowered the deficits. Supporters of the tax cuts also argue, using the Laffer curve, that the tax cuts increased government revenue. This is hotly disputed--critics contend that, although government income tax receipts did rise, it was due to economic growth not caused by the tax cuts, and would have risen more if the tax cuts had not occurred. Supporters see the growth as caused by the tax cuts. Controversy still remains as to whether the tax cuts of 1981 increased revenues.

During the summer of 1981 the central focus of policy debate was on the Economic Recovery Tax Act (ERTA) of 1981, the Reagan tax cuts. The core of this proposal was a version of the Kemp-Roth bill providing a 25 percent across-the-board cut in personal marginal tax rates. By reducing marginal tax rates and improving economic incentives, ERTA would increase the flow of resources into production, boosting economic growth. Opponents used static revenue projections to argue that ERTA would be a giveaway to the rich because their tax payments would fall.