Simplify the Tax Code, But Leave 1986 Out of It

Interest is growing in tax policy circles in a new round of tax reform, with many experts hoping the White House and Congress will enact legislation that’s roughly modeled on the landmark Tax Reform Act of 1986.

Before moving too far down that path, however, they might want to keep in mind how different the world of 2011 is from that of 1986. Three major differences immediately come to mind:

First, as the effort of the 1980s got underway, President Reagan mandated that tax reform be “revenue neutral” – that is, that policymakers not use tax reform as a vehicle for raising federal revenues.

That may have been fine at a time when we faced large, but not explosive, deficits and when policymakers had already made progress in reining them in, as they had with major legislation in 1982, 1983, and 1984. But, it’s not fine today, when we face truly explosive deficits that many experts believe will require tax increases to accompany whatever spending cuts are enacted.

Second, the 1986 act shifted tax burdens from individuals to corporations – that is, policymakers financed their cuts in personal tax rates partly by raising taxes on corporations.

That may have been fine at a time when our economy and our corporations dominated the world more than they do now. But, it’s not fine today, after most of our major competitor nations have cut their corporate tax rates, making our 35 percent marginal rate unusually high by global standards and putting our corporations at a competitive disadvantage with those headquartered elsewhere.

Third, the 1986 act included what’s called the alternative minimum tax (AMT), which was designed to ensure that no wealthy individual could avoid paying at least a minimal level of taxes.

That may have been fine at a time when newspapers were running stories about corporations and individuals who didn’t pay taxes. But, it’s clearly not fine now because of how policymakers structured the AMT.

Because the income threshold at which a person faces the AMT does not rise with increases in average incomes, the AMT has the potential to hit tens of millions of middle-income Americans with more taxes. That’s why Congress routinely raises the threshold on a temporary basis, ensuring that only one or two million households a year face the AMT. And it’s why tax experts generally agree that, in reforming the code, Congress will have to kill the AMT altogether.

No one doubts that the tax code is now a complicated mess, with many Americans suspicious that, with their high-priced accountants, the rich find ways to game the system and pay less than they should.

This year’s 25th anniversary of the 1986 act, which was surely a major bipartisan achievement, is nourishing interest in another round of tax reform. Yes, let’s simplify the tax code. But, let’s not assume that an updated version of the 1986 act is appropriate for a world that is far different than that of 1986.

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