Kemp-Roth Tax Cut
Encyclopedia
The Economic Recovery Tax Act of 1981 , also known as the ERTA or "Kemp-Roth Tax Cut," was a federal law enacted in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 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".
Included in the act was an across-the-board decrease in the marginal income tax
Income tax
An income tax is a tax levied on the income of individuals or businesses . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate...

 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. Additionally the tax rates were indexed for inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

, though the indexing was delayed until 1985.

The Act's sponsors, Representative Jack Kemp
Jack Kemp
Jack French Kemp was an American politician and a collegiate and professional football player. A Republican, he served as Housing Secretary in the administration of President George H. W. Bush from 1989 to 1993, having previously served nine terms as a congressman for Western New York's 31st...

 of New York
New York
New York is a state in the Northeastern region of the United States. It is the nation's third most populous state. New York is bordered by New Jersey and Pennsylvania to the south, and by Connecticut, Massachusetts and Vermont to the east...

 and Senator William V. Roth, Jr.
William V. Roth, Jr.
William Victor "Bill" Roth, Jr. was an American lawyer and politician from Wilmington in New Castle County, Delaware. He was a veteran of World War II and a member of the Republican Party, who served as U.S. Representative and U.S...

 of Delaware
Delaware
Delaware is a U.S. state located on the Atlantic Coast in the Mid-Atlantic region of the United States. It is bordered to the south and west by Maryland, and to the north by Pennsylvania...

, had hoped for more significant tax cut
Tax cut
A tax cut is a reduction in taxes. The immediate effects of a tax cut are a decrease in the real income of the government and an increase in the real income of those whose tax rate has been lowered. Due to the perceived benefit in growing real incomes among tax payers politicians have sought to...

s, but settled on this bill after a great debate in Congress. It passed Congress
United States Congress
The United States Congress is the bicameral legislature of the federal government of the United States, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C....

 on August 4, 1981 and was signed into law on August 13, 1981 by President Ronald Reagan
Ronald Reagan
Ronald Wilson Reagan was the 40th President of the United States , the 33rd Governor of California and, prior to that, a radio, film and television actor....

 at Rancho del Cielo
Rancho del Cielo
Rancho del Cielo, or "Sky's or Heaven's Ranch," is a ranch located on the top of the Santa Ynez Mountain range northwest of Santa Barbara, California...

, 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:
  • 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
Tax Equity and Fiscal Responsibility Act of 1982
The Tax Equity and Fiscal Responsibility Act of 1982 , also known as TEFRA, was a United States federal law that rescinded some of the effects of the Kemp-Roth Act passed the year before. As a result of ongoing recession, a short-term fall in tax revenue generated concern over the budget deficit...

 and the 15% interest exclusion repealed before it took effect by the Deficit Reduction Act of 1984
Deficit Reduction Act of 1984
The Deficit Reduction Act of 1984 , also known as the DEFRA, was a federal law enacted in the United States in 1984. Originally part of the stalled Tax Reform Act of 1983, it was adjusted and reintroduced as the Tax Reform Act of 1984. After passing in the House, it was merged with the Senate...

.

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. 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.

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 - 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. 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. Another explanation is any such across the board tax cut removes some from the tax rolls. Those remaining pay a higher percentage of a now smaller tax pie even though they pay less in absolute taxes.

In addition to changes in marginal tax rates, the capital gains tax was reduced from 28% to 20% under ERTA. Afterwards revenue from the capital gains tax increased 50% by 1983 from $12.5 billion in 1980 to over $18 billion in 1983. In 1986, revenue from the capital gains tax rose to over $80 billion; following restoration of the rate to 28% from 20% effective 1987, capital gains revenues declined through 1991.

Critics claim the tax cuts worsened the deficits in the budget of the United States government. Reagan supporters credit them with helping the 1980s economic expansion that eventually lowered the deficits. After peaking in 1986 at $221 billion the deficit fell to $152 billion by 1989. Supporters of the tax cuts also argue, using the Laffer curve
Laffer curve
In economics, the Laffer curve is a theoretical representation of the relationship between government revenue raised by taxation and all possible rates of taxation. It is used to illustrate the concept of taxable income elasticity . The curve is constructed by thought experiment...

, tax cuts increased government revenue. This is hotly disputed—-critics contend, although government income tax receipts did rise, it was due to--arguably Keynesian--economic growth, not tax cuts, and would have risen more if the tax cuts had not occurred; in fact, revenue was down more than 4% the fourth year after enactment. Supporters see the growth as caused by the tax cuts.
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