The Economic Recovery Tax Act of 1981 (Pub.L. 97-34), also known as the ERTA or "Kemp-Roth Tax Cut," was a federal law enacted in the United States in 1981. It was an Act "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 purposes".[1] Included in the act was an across-the-board decrease in the marginal income tax rates in the U.S. by 23% over three years, with the top rate falling from 70% to 50% and the bottom rate dropping from 14% to 11%. This act slashed estate taxes and trimmed taxes paid by business corporations by $150 billion over a five year period. Additionally the tax rates were indexed for inflation, though the indexing was delayed until 1985.
The Act's sponsors, Representative Jack Kemp of New York and Senator William V. Roth, Jr. of Delaware, 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 Rancho del Cielo, his California ranch.
The Office of Tax Analysis of the United States Department of the Treasury summarized the tax changes as follows[2]:
- phased-in 23% cut in individual tax rates over 3 years; 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The accelerated depreciation changes were repealed by Tax Equity and Fiscal Responsibility Act of 1982 and the 15% interest exclusion repealed before it took effect by the Deficit Reduction Act of 1984.
The most lasting impact and significant change of the Act was the indexing of the tax code parameters for inflation. Of nine federal tax laws between 1968 and this Act, six were tax cuts compensating for inflation driven bracket creep.[2] Following enactment in August 1981, the first 5% of the 25% total cuts took place beginning in October of the same year. An additional 10% began in July 1982, followed by a third decrease of 10% beginning in July 1983.[3]
As a result of ERTA and other tax acts in the 1980s, the top 10% were paying 57.2% of total income taxes by 1988 - up from 48% in 1981[3] - while the bottom 50% of earners share dropped from 7.5% to 5.7% in the same period. The total share borne by middle income earners of the 50th to 95th percentile decreased from 57.5% to 48.7% between 1981 and 1988.[4] Much of the increase can be attributed to the decrease in capital gains taxes, while the ongoing recession and subsequently high unemployment contributed to stagnation among other income groups until the mid-1980s.[5] Another explanation is any such across the board tax cut removes some from the tax rolls. Those remaining pay a higher percentage of a now smaller tax pie even though they pay less in absolute taxes.
In addition to changes in marginal tax rates, the capital gains tax was reduced from 28% to 20% under ERTA. Afterwards revenue from the capital gains tax increased 50% by 1983 from $12.5 billion in 1980 to over $18 billion in 1983.[3] In 1986, revenue from the capital gains tax rose to over $80 billion; following restoration of the rate to 28% from 20% effective 1987, capital gains revenues declined through 1991.[3]
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[6] that eventually lowered the deficits. After peaking in 1986 at $221 billion the deficit fell to $152 billion by 1989.[7] Supporters of the tax cuts also argue, using the Laffer curve, tax cuts increased government revenue. This is hotly disputed—-critics contend, although government income tax receipts did rise, it was due to—arguably Keynesian—economic growth, not tax cuts, and would have risen more if the tax cuts had not occurred; in fact, revenue was down more than 4% the fourth year after enactment.[8] Supporters see the growth as caused by the tax cuts.
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