Tax Reform Act of 1986: Comprehensive Overview and Historical Impact

August 24, 2024 4 min read Taxation Government Regulations Tax Reform Income Tax Capital Gains Tax 1986 Legislation U.S. Congress

An in-depth examination of the Tax Reform Act of 1986, including its provisions, historical context, and long-term effects on income tax and capital gains tax rates.

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The Tax Reform Act of 1986 was a significant piece of legislation passed by the United States Congress that sought to simplify the federal income tax code, broaden the tax base, eliminate many tax shelters, and reduce the number of tax brackets. This act also notably lowered the maximum rate on ordinary income and increased the tax rate on long-term capital gains.

This landmark legislation, signed into law by President Ronald Reagan on October 22, 1986, has had lasting implications on the American tax system.

Key Provisions of the Tax Reform Act of 1986

Reduction in Tax Brackets

One of the primary objectives of the Tax Reform Act of 1986 was to simplify the tax system by reducing the number of tax brackets. Prior to the act, there were 15 tax brackets; the legislation reduced this to just two—15% and 28%.

Changes in Ordinary Income Tax Rates

The maximum rate on ordinary income was significantly reduced. Before the act, the highest marginal tax rate on ordinary income was 50%. The 1986 reform set the maximum tax rate for individuals at 28%.

Long-Term Capital Gains

To balance the reduction in ordinary income tax rates, the Tax Reform Act increased the tax rate on long-term capital gains, which are profits from the sale of assets held for more than one year. The capital gains tax rate increased from 20% to match the ordinary income tax rate.

Historical Context

The necessity for tax reform became apparent in the 1980s due to widespread dissatisfaction with the complexity, unfairness, and numerous loopholes in the existing tax system. President Reagan emphasized the need for a tax code that was fairer, simpler, and more efficient during his administration.

Prior Attempts at Tax Reform

Several attempts to tackle the complexities of the tax code occurred before the 1986 act, but none were as comprehensive or successful. The bipartisan support in Congress was crucial to passing this extensive reform.

Economic Considerations

The economic context of the mid-1980s, characterized by recovery from the early 1980s recession, provided a backdrop that allowed for significant tax policy changes aimed at stimulating further economic growth.

Long-Term Effects

Impact on Revenue and Deficits

While the act initially aimed to be revenue-neutral, various dynamic factors led to debates regarding its impact on federal deficits and revenue streams. Studies show mixed results on whether the act achieved long-term neutrality.

Influence on Future Tax Legislation

The principles established by the 1986 reform influenced future tax policies and reforms. It set a precedent for bipartisan cooperation on tax reforms that subsequent administrations have drawn upon.

Tax Cuts and Jobs Act of 2017

For comparison, the Tax Cuts and Jobs Act (TCJA) of 2017 also sought to simplify the tax code and reduce tax rates. While the TCJA further reduced the top individual tax rate, it also introduced new brackets and widened income ranges.

Income Tax: A tax that governments impose on financial income generated by all entities within their jurisdiction.
Capital Gains Tax: A tax on the growth in value of investments incurred when individuals and corporations sell those investments.

FAQs

What was the main goal of the Tax Reform Act of 1986?

The main goal was to simplify the tax code, reduce the number of tax brackets, lower the maximum rates on ordinary income, and raise the rates on long-term capital gains to create a fairer and more efficient tax system.

How did the Tax Reform Act of 1986 affect ordinary taxpayers?

Most ordinary taxpayers saw a reduction in their tax rates, which simplified their tax filings and potentially reduced their overall tax burden.

Are the changes from the 1986 Tax Reform Act still in effect today?

While many provisions of the Tax Reform Act of 1986 have been modified or replaced by subsequent legislation, its influence is still evident in the structure and principles of the current tax system.

References

U.S. Congress. “Tax Reform Act of 1986.” Public Law 99-514, 99th Cong., October 22, 1986.
Reagan, Ronald. “Remarks on Signing the Tax Reform Act of 1986.” October 22, 1986. The American Presidency Project.
Joint Committee on Taxation. “General Explanation of the Tax Reform Act of 1986.”

Summary

The Tax Reform Act of 1986 was a landmark legislative achievement aimed at simplifying the federal income tax system, reducing tax rates on ordinary income, and increasing the tax rate on long-term capital gains. Its passage marked a significant shift in U.S. tax policy, influencing future legislation and demonstrating the power of bipartisan cooperation in achieving comprehensive tax reform.