The Gipper's Forgotten Tax Victory


By Christopher Farrell The nation is honoring Ronald Reagan. Politicians, diplomats, high-level administrators, foreign leaders, commentators, and citizens of all political persuasions are fondly recalling his optimism and steady leadership at a dark time in the global economy. All, even political foes, admire the historic role he played in ending the Cold War. Reaganomics gets more mixed reviews, with praise for his faith in deregulation and private markets offset by doubts over his Administration's staggering budget deficits and embrace of supply-side ideology.

Surprisingly, little commentary has touched on President Reagan's shining economic achievement -- the 1986 Tax Reform Act. It was the boldest tax legislation in a half-century. Against the odds, opposed by high-paid "Gucci Gulch" lobbyists and pork-obsessed legislators, and scorned by the political cognoscenti for his naivetReagan got Congress to make the tax code dramatically simpler and fairer. It was a stirring moment when he engineered a victory for the average citizen over the savvy Washington insiders.

ABOMINABLE SYSTEM. Sad to say, his successors, especially Presidents Bill Clinton and George W. Bush, abandoned his lead. Instead, they deliberately chose to make the tax code increasingly unfair and complex. One reason we aren't hearing much about Reagan's tax triumph in 1986 is that neither Republicans nor Democrats have any intention of drawing inspiration from his example.

No one doubts that the current tax system is an abomination. The federal income tax code is almost 55,000 pages -- up from 26,300 in 1984 -- a legal maze riddled with exemptions, exclusions, deductions, and credits, most geared toward rewarding favored constituencies. Billions of dollars are spent on accountants and lawyers every year. Billions of hours are spent struggling to fill out forms.

Tax economist Joel Slemrod at the University of Michigan estimates that it costs taxpayers $100 billion a year to complete their returns. That's no chump change, and the money could be far better used elsewhere, on education and health care, say, or paying for the occupation of Iraq.

KEY PLAYER. Still, conventional wisdom is that the pursuit of tax simplification is a fool's errand, good for a few sound bites by ambitious politicians, but not worth the expenditure of any real political capital. Too many industries and individuals support complexity, either because reform would hurt their pocketbooks, or because they're adroit at ordering their finances around existing incentives. And Washington likes handing out tax goodies in return for power and votes -- just ask President Bush and his presumptive Democratic challenger, John Kerry.

Yet some two decades ago, President Reagan decided to confront conventional wisdom head-on -- and won. The public was increasingly disgusted with the tax system. Members of Congress were proposing reforms, with the two best-known tax-simplification bills put forward by Republicans Jack Kemp and Robert Kasten and Democrats Bill Bradley and Dick Gephardt.

Still, most reporters among the Washington press corps and well-heeled lobbyists doubted anything would change. They were right -- until Reagan got involved. "The most important player in tax reform was Ronald Reagan himself," wrote Jeffrey Birnbaum and Alan Murray in their book, Showdown at Gucci Gulch.

The Great Communicator didn't operate alone, however. Bipartisanship still meant something back then. Two key backers were Democratic Congressman Dan Rostenkowski, a savvy pol and chairman of the powerful House Ways & Means Committee. The other was Republican Senator Robert Packwood, head of the Senate Finance Committee, a reluctant ally but, in the end, a tax-reform convert.

TAKE UP THE FIGHT. The basic idea behind the 1986 act was simple: Lower marginal tax rates by broadening the tax base while limiting exemptions and deductions. Advocates argued the change would boost savings, encourage a more efficient allocation of resources, encourage compliance, and lower the blood pressure of the average American taxpayer come April. The top marginal tax rate came down from 50% to 28%. Marginal rates were cut on most other brackets, and overall individual-income rates fell by 7 percentage points. The legislation limited various itemized deductions, such as medical expenses, interest expenses, and state and local government taxes.

Most striking, the preferential treatment of capital gains was eliminated, and investors could no longer use passive investment losses to offset other forms of income. Among the accomplishments of the legislation listed by Citizens for Tax Justice, a nonprofit organization: shutting down a huge, wasteful tax-shelter industry for high-income individuals, closing corporate-tax loopholes, tax relief for millions of moderate-income Americans, and a simplified income tax for most individuals.

Of course, the final package fell short of its promise. Yet it was a step in the right direction, a breathtaking moment when a leader triumphed over the special interests and their millions of dollars in campaign contributions. Washington should build on this part of his legacy -- for the Gipper. Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online


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