Economic Recovery Tax Act of 1981

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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. As a result, in 1986, the annual revenue of the federal government had been cut by $200 billion. 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.

Summary of provisions

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The accelerated depreciation changes were repealed by Tax Equity and Fiscal Responsibility Act of 1982 and the 15% interest exclusion repealed before it took effect by the Deficit Reduction Act of 1984.

Effect and controversies

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 80s, 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-80s.[5]

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