Tax Reform Act of 1986

The U.S. Congress passed the Tax Reform Act (TRA) of 1986 to simplify the income tax code, broaden the tax base and eliminate many tax shelters and other preferences. The top tax rate was lowered from 50% to 28% while the bottom rate was raised from 11% to 15% - the only time in the history of the U.S. income tax (which dates back to the passage of the Sixteenth Amendment in 1913) that the top rate was reduced and the bottom rate increased concomitantly. In addition, capital gains faced the same tax rate as ordinary income. Moreover, interest on consumer loans and state and local sales or income taxes was no longer deductible. The law increased the personal exemption and standard deduction.

Related Topics:
U.S. Congress - 1986 - Income tax - Sixteenth Amendment - 1913 - Capital gains

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While often referred to as the second of the two "Reagan tax cuts" (the Kemp-Roth Tax Cut of 1981 being the first), the official sponsors of the bill were actually two liberal Democrats, Richard Gephardt of Missouri in the House of Representatives and Bill Bradley of New Jersey in the Senate.

Related Topics:
Kemp-Roth Tax Cut - 1981 - Liberal - Democrats - Richard Gephardt - Missouri - House of Representatives - Bill Bradley - New Jersey - Senate

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The Tax Reform Act of 1986 also increased incentives favoring investment in owner-occupied housing relative to rental housing by increasing the Home Mortgage Interest Deduction. The imputed income an owner receives from an investment in owner-occupied housing has always escaped taxation, but TRA86 changed the treatment of imputed rent, local property taxes, and mortgage interest payments to favor homeownership, while phasing out many investment incentives for rental housing. Since low-income people are more likely to live in rental housing than in owner-occupied housing, this would have decreased the new supply of housing accessible to them. The Low-Income Housing Tax Credit was hastily added to TRA86 to provide some balance and encourage investment in multifamily housing for the poor.

Related Topics:
Home Mortgage Interest Deduction - Low-Income Housing Tax Credit

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By removing tax shelters, especially for real estate investments, the Act significantly decreased the value of many such investments which had been held more for their tax-advantaged status than for their inherent profitability. This contributed to the end of the real estate boom of the early to mid '80s as well as to the Savings and Loan crisis. However, most economists consider the net long-term effect of eliminating tax shelters and other distortions to be positive for the economy, by redirecting money to the most inherently profitable investments.

Related Topics:
Tax shelters - Savings and Loan crisis

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