Annette Nellen
Tax Reform Act of 1986

What lessons did we learn?

October 14, 2010
by Annette Nellen, CPA, Esq.

On September 23, 2010, the Senate Finance Committee held a hearing entitled "Tax Reform: Lessons from the Tax Reform Act of 1986." Testimony was provided by four individuals who worked in Congress or Treasury in the 1980's. This hearing continued a string of occasional tax committee hearings on some aspect of tax reform dating back to 2007. Prior hearings focused on such topics as the following:

Senate Finance Committee:

  • The Future of Individual Tax Rates: Effects on Economic Growth and Distribution (July 14, 2010)
  • The Middle Income Tax Relief Question: Extend, Modify or Expire? (March 25, 2009)
  • The Foundation of International Tax Reform: Worldwide, Territorial and Something in Between (June 26, 2008)
  • Cracking the Code: Tax Reform for Individuals (May 13, 2008)
  • Tax Fundamentals in Advance of Reform (April 15, 2008)

House Ways and Means Committee:

This article summarizes key points raised in the recent hearing on lessons learned from the Tax Reform Act of 1986 (TRA'86), offers observations on the relevance for any upcoming tax reform and provides an opportunity for readers to share their thoughts on what lessons they think were learned.

Tax Reform Act of 1986

Many likely view the TRA'86 as landmark legislation especially since so many changes were made that the Internal Revenue Code had to be renamed to IRC of 1986 (rather than of 1954). Concerns over high tax rates and rampant tax shelter activity, united President Reagan, a majority of legislators and many in the public to enable extensive tax changes.

Significant work was done leading up to enactment of TRA'86 in October 1986. Treasury researched various tax policy issues including equity, economic distortion and complexity. In addition, alternative tax systems, including a value-added tax (VAT), were studied. Numerous hearings were held on general and specific aspects of tax reform. (For further information, see Strategy for Major Tax Reform.)

Hearing Participants

Statements and testimony were offered by Senators Max Baucus (D-MT.) and Chuck Grassley (R-IA) as well as four witnesses. A few Senate Finance Committee members were present and asked questions. The invited witnesses:

  1. Former Congressman Richard Gephardt who previously served on the House Ways and Means Committee. In 1995, he introduced a tax reform plan known as the "10% tax" designed to lower rates and broaden the base.
  2. Former Congressman Bill Archer who previously served on and chaired (1995 – 2001) the House Ways and Means Committee. While chair, he held several hearings on tax reform covering such topics as the effect of tax reform on families, manufacturing, natural resources, small businesses and international competitiveness. At a tax reform hearing on June 6, 1995, Congressman Archer made the following statement:
    "In my opinion, our challenge will do no less than pull the current Income Tax Code out by its roots and throw it away so that it can never grow back."
  3. John E. Chapoton who served as Assistant Secretary for Tax Policy in the Treasury Department from 1981 to 1984. This was the time when the Economic Recovery Tax Act of 1981 and Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) were enacted. During this time, Treasury also worked reports that supported the TRA'86 work including Tax Reform for Fairness, Simplicity and Economic Growth (November 1984).
  4. Randall D. Weiss, Ph.D., was an economist with the Joint Committee on Taxation from 1977 to 1989.

Themes and Topics

Participants noted several "lessons" as well as reasons why reform is needed today. Key points are summarized below:

  • Complexity: Senator Baucus referred to today's federal tax law as 70,000 pages long requiring people to spend seven billion hours annually to comply. He further observed that subsequent to TRA'86 "Congress has made more than 15,000 changes to the tax code. Congress made these changes with the best intentions. Some to collect revenue, some to stabilize the economy, others to further other social objectives. But each change created additional complexity. And each change created the potential for exploitation."

    Senator Grassley described the complexity and the "creeping effects" of the AMT as "a recipe for disaster." Per Chapotan it is "disturbing how far we've come since 1986."
  • Equity: Participants stressed that the TRA'86 brought greater equity to the tax law. Per Senator Baucus, the Act "leveled the playing field." Per Weiss: "The public’s perception that the income tax was unfair — driven by countless stories of high-income individuals and large corporations that paid little or no tax — was pervasive during the early 1980s. It is hard to overemphasize how important this perception was in driving the progress of the Act."
  • International considerations: Witnesses also noted that unlike in 1986, international competitiveness needs to be considered in any tax reform today.
  • Players and commitment: Highly stressed at the hearing was the need for both Congress and the President to be committed to reform. Chapotan noted the need for taking "personal ownership" of the process and goals. Also stressed was the need for bipartisanship.
Gephardt described the efforts of himself and then Senator Bill Bradley (D-NJ) in 1982 to simplify the Code and restore fairness. He observed that when Congressman Jack Kemp and Senator William Roth (R-DE) also recommended reforms, the four engaged in bipartisan discussions with a common goal. However, he notes, "it wasn’t until President Reagan embraced the idea of tax reform that real action started." Archer further emphasized this stating: "Without doubt, President Reagan's personal commitment to lowering individual tax rates was a key factor that helped keep tax reform on track."

Gephardt also stressed the need to inform the public via an open and transparent process.

  • Comprehensiveness: Per Gephardt the "most important [lesson is that] nothing should be off-limits in terms of discussion about the design of the code."
  • Principles: Participants noted that the focus on lowering tax rates was helpful in keeping all players on track in 1986.
  • Understanding: Per Gephardt, Treasury studies in the early 1980s and hearings called by Ways and Means Committee Chairman Rostenkowski shed light on the operations of the tax system and its faults. He observes that "without this level of understanding of the complex issues involved we could never have reached the bipartisan consensus that in the end passed the bill."

    Another aspect of understanding noted by Weiss as helping to make TRA'86 possible was that it moved the "tax base closer to actual income."
  • Economic consequences: Archer observed that while he supported the goals of TRA'86, he voted against it due to concerns over the uncertainty of its impact. He noted that some economists and the Federal Reserve believe that the retroactive nature of the passive loss limitation rules adversely affected real estate investments leading to the savings and loan crisis in the years immediately following 1986.  He suggested that a lesson for future reform be the need to consider the "economic consequences of proposed changes."
  • Baseline: Senator Grassley raised the issue of tax revenues noting the difference between our current tax design based on the 2001/2003 tax cuts and the higher taxes that come into play with their expiration at the end of 2010. Per Senator Grassley:
    "there is a key premise to tax reform that needs to be fleshed out. The premise I refer to is whether we assume current law levels of tax relief remain in effect or whether we assume that the bipartisan tax relief plans of 2001 and 2003 have expired. If we use the latter assumption, i.e., that the post-2010 record level tax increase goes into effect, then tax reform really becomes a historic tax increase."
    He further noted his support for "lowering the overall level of taxation."
  • Need: Complexity, equity, international competitiveness and budget issues were all mentioned as justifying and necessitating tax reform today.  Archer observed that "our economy, jobs and the ability to be competitive globally rely on a well-designed tax system."
  • Books: Chapotan highly recommended a reading of Eugene Steuerle's The Tax Decade (1991) to understand TRA'86. In his opening remarks, Senator Baucus referred to a quote from Jeffrey Birnbaum, co-author of Showdown at Gucci Gulch (1998) that chronicles the events leading up to TRA'86.


A key driver of efforts leading to TRA'86 was concerns over equity fueled by widespread use of tax shelters by middle- to high-income individuals. In addition, tax rates were high — 46 percent for corporations and 50 percent for individuals. Today, problems are different and arguably less focused. Chapotan observed: "A disadvantage today may be that there are not the broad, high-profile tax culprits like the tax shelter industry in the 1980s."

There are far more special provisions in the law today than in the 1980s. But is there sufficient public perception of unfairness when special provisions exist for just about every taxpayer?  Will complexity be enough to drive tax reform or will taxpayers prefer their tax breaks over simplification and the uncertainty of what tax reform will really mean for them?

Congressional tax committees have been talking about the need for tax reform for the past few years. Yet, the law grows more complex with each new tax act. Politicians' campaign promises tend to include additional tax breaks making it harder to convince the public that the complexity they bring should be eliminated. And the growing national debt likely makes it harder to sell the public on any promise of a repeat of the TRA'86 in which repeal of tax breaks is accompanied by lower tax rates.

Looking Forward

Per Senator Baucus: "Now is exactly the time to talk about tax reform. I am committed to tackling it. That’s what our constituents sent us here to do." Let's see if the 112th Congress can go beyond talk and indeed improve the federal tax system to enable it to meet principles of good tax policy and support 21st century ways of living and doing business.

Reader Thoughts and Observations

What lessons do you think were learned from TRA'86? How might such lessons be relevant to tax reform efforts today? You can share your ideas with others by posting a comment at the 21st Century Taxation blog (hosted by the author) here.

 Rate this article 5 (excellent) to 1 (poor). Send your responses here.

Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.