How Has the Tax Code Changed Since 1986?
The Tax Reform Act of 1986 is often hailed as a major bipartisan achievement, a reform that simplified the tax code and lowered marginal tax rates. Of course, more holes were opened up, more tax brackets were added, and significant complexity was introduced to the tax code thereafter.
Third Way's recent paper on tax reform shows some of the changes made to the code in the 1986 reform and what has been added on since. The carveouts they mention that were eliminated or limited in the reform are:
- Elimination of the deduction for credit card and other loan interest
- Elimination of the second earner deduction
- Elimination of income averaging
- Elimination of the unemployment benefits exclusion
- Elimination of the state and local sales tax deduction
- Limiting of the business meals and entertainment deduction to 80 percent (now at 50 percent)
- Elimination of the investment tax credit
Notably, many of these tax expenditures have returned in some form or another. The second earner deduction's purpose was to reduce marriage penalties, which is now done through other parts of the tax code. Income averaging, which allows people with volatile income levels to smooth out their tax burden over a period of time, returned permanently in 2004 for farmers and fishermen only. The unemployment benefits exclusion returned for 2009, although it has now expired. The state and local sales tax deduction returned in 2004 legislation as a temporary "tax extender" (although it can only be used in lieu of the companion income tax deduction). The investment tax credit returned in 2005 legislation for renewable energy companies as a tax extender as well.
In addition to reinstating some of the pre-1986 loopholes that were closed, many new tax expenditures have been created as well. Third Way cites the following as some examples:
- Exclusion of small business capital gains
- Preferential rates for gains from self-created musical works
- Health Savings Accounts
- Tax credit for maintaining railroad tracks
- Deduction for film and TV production costs
- Tax credit for taxes paid on inventoried distilled spirits
- Tax credit for securing agricultural chemicals
As Ezra Klein notes, tax expenditures are much less transparent than government programs and are, as a whole, regressive. Their costs are less tangible to citizens who must pay for these subsidies with either higher tax rates or reduced spending elsewhere in government. While there may be a case for running some benefits through the tax code (like the EITC) since the IRS may better track income data than other agencies, the sheer size and number of tax expenditures makes for poor tax policy. And their presence has exploded over the last 25 years.
Further deterioration of the tax code since 1986 comes from the fact that much of it is now temporary, a trend that has dramatically accelerated in the past decade. The paper notes that the number of temporary tax provisions increased from 25 in 1985 to over 140 in 2010. This number includes not only the tax extenders, which have grown significantly in number and size (especially in the past decade), but also central features of the tax code, like the income tax rate schedules, the estate tax parameters, and the expansions of the Earned Income and Child Tax Credits.
Third Way's paper concludes what many already know: our tax code needs fixing. With so many provisions expiring at the end of this year and so many provisions that expired last year that Congress will look to extend retroactively, we hope that lawmakers will find it more pleasant to re-write the code rather than patch another temporary one together for the next few years. The Modified Zero plan from the Fiscal Commission is certainly a good place to start to comprehensively re-work the tax system.