Historic Tax Code Changes Eroded in Years Since 1986

One of Ronald Reagan's greatest legislative achievements -- the Tax Reform Act of 1986 -- was the most extensive overhaul of the federal tax system since the income tax was created in 1913. The sweeping way that it slashed rates and blew away billions of dollars of narrow tax breaks, Reagan said, was "a triumph for the American people and the American system."

That was then.

Today, while vestiges of the historic measure remain, the tax code has been allowed to revert in many ways to its pre-1986 form and politicians of both parties are eager to push it back further. It has been repopulated with dozens of targeted tax breaks and its rates have not only gone up, but the number of brackets have multiplied. "The trend these days is to go in the opposite direction of the '86 act," said Allen Schick, a political scientist at the University of Maryland.

"Reagan's philosophy was for a broader tax base and lower rates so that people and not government could decide how to spend their money," said Mark Weinberger, a former assistant treasury secretary under President Bush. "Unfortunately, as tax bills wind through Congress, special interests get to them and Reagan's legacy is harder and harder to keep in place."

The 1986 bill was hard enough to pass as it was. With the indefatigable backing of a Democrat, Dan Rostenkowski of Illinois, then the chairman of the House Ways and Means Committee, Reagan pushed through Congress a bill that lowered the top nominal tax rate for individuals to 28 percent from 50 percent. He also reduced the number of brackets to two from 14.

Tax shelters for the wealthy, which proliferated before the bill became law, were struck a mortal blow. Millionaires who had gotten away with paying little or no taxes under the old loophole-ridden system were forced to fork over at least something because of a new "minimum tax." The once-all-powerful oil-and-gas lobby also had a few of its tax benefits clipped.

In addition, millions of low-income Americans were taken off the income tax rolls entirely.

Many corporations got relief as well. Corporate tax rates were dropped to a maximum of 34 percent from 48 percent, a change that was paid for by eliminating or trimming scores of long-established tax preferences. For businesses, the investment tax credit and bank deduction for bad-debt reserves were repealed. The "three-martini lunch" deduction was scaled back. And many other shavings of benefits were tucked into the massive legislation, along with a few giveaways to secure support for the broader bill.

So controversial was the undertaking that the bill was almost killed several times by interest groups. Over its tortuous, two-year odyssey, the measure was nearly lost in committee in both the House and the Senate. Reagan had to personally plead for its survival during a visit to Capitol Hill in 1985 before the measure finally passed in the House. The bill came back from the dead so often that it became known among lawmakers as the "Phoenix Project" after the mythological creature that rose from its own ashes.

It did not take long, however, for many of the law's accomplishments to be whittled away. Such backpedaling was predicted almost from the moment Reagan signed the legislation into law on Oct. 22, 1986. Then-Sen. Bob Packwood (R-Ore.), who was chairman of the Finance Committee, likened the tax system -- even the new one that he had helped to write -- to a shrubbery. It can be pruned, he said, but it would always grow back bigger and fuller. And that has been the case for the Tax Reform Act of 1986.

Budget deficits have been its greatest enemy. To stanch red ink, a succession of presidents has led the way for increases in federal revenues. In 1990, under President George H.W. Bush, and again in 1993, under President Bill Clinton, taxes were raised and the code was again complicated with tax preferences given to favored interests.

Clinton in particular encouraged a resurgence of social engineering through the tax code, which was exactly what Reagan's tax reform had hoped to end. During the Clinton administration, dozens of savings and education incentives were inserted into the law. In addition, tax rates have inched upward over the years, which in turn put pressure on Congress to draft even more tax breaks to protect vulnerable or politically potent groups.

By the end of the Clinton years, Congress had shoehorned many new breaks back into the system and rates for individuals hovered near 40 percent. The effective tax rate for some Americans was even higher than that, because of the phase-out of certain tax benefits.

In the past three years, President Bush has returned to at least part of the Reagan legacy -- the Republican-led portion -- by starting again to cut tax rates. Like Reagan, Bush is a firm advocate of rate cuts as a way to stimulate economic growth. He lobbied Congress hard to make the change.

Today, mostly because of Bush's prodding, tax rates are lower than during the Clinton administration, but not as low as during the Reagan administration. The top nominal income tax rate for individuals is 35 percent and the number of brackets is six. Corporate tax rates are now higher than at the end of the 1980s.

Some of Reagan's reforms remain pretty much intact. For example, millions of Americans with low and moderate incomes still do not have to pay income taxes. And not all of the loopholes that were closed in 1986 have been reopened on either the individual or corporate sides of the ledger.

But the overall direction of the debate and of pending legislation is going against the spirit of the 1986 act. Almost no decision-makers talk about eliminating tax breaks anymore, except for the most egregious, tax-sheltering kind. Instead, lawmakers and the president routinely recommend new tax benefits for one sector or another. And with federal budget deficits soaring, Democrats have long pressed for an increase in taxes for upper income people. In fact, the Democrats' presumptive presidential nominee, Sen. John F. Kerry, is running on that proposal.

Lawmakers are considering various pieces of legislation that would insert tax breaks into the code. One bill high on the agenda of the Republican-controlled Congress would establish a new manufacturers' tax credit to replace a foreign-tax subsidy declared illegal by the European Union. That credit is reminiscent of the investment tax credit that the 1986 law eliminated. Lawmakers are also eager to skin back the minimum tax, which is gradually pulling into its net a growing number of upper middle-income families as well as millionaires.

After years of being dormant, tax-sheltering has also come back into vogue, though largely among corporations. "There has been retreat from the Reagan tax reforms," concludes C. Eugene Steuerle, a scholar at the Urban Institute and a former Reagan treasury official. "The world has moved on."