Economic Recovery Tax Act of 1981 (ERTA)

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Economic Recovery Tax Act of 1981 (ERTA)

What Was the Economic Recovery Tax Act of 1981?

The 1981 Economic Recovery Tax Act (ERTA) was the greatest tax decrease in American history. President Ronald Reagan signed ERTA roughly six months after taking office, lowering the highest income tax rate and allowing for speedier depreciation of depreciable assets. It created inflation indexing of tax bands and featured incentives for small businesses and retirement savings.

Key Takeaways

  • The Economic Recovery Tax Act of 1981, signed by Ronald Reagan during his first year in office, was the greatest tax decrease in US history.
  • The ERTA reduced the top tax level from 70% to 50%.
  • Combined with rising military expenditure, the ERTA contributed to the United States’ skyrocketing national debt, which quadrupled during Reagan’s presidency.

Understanding the Economic Recovery Tax Act of 1981

The Kemp-Roth tax reduction was named after its Republican backers, Representative Jack Kemp of New York and Senator William V. Roth of Delaware. The highest tax rate was reduced from 70% to 50% over three years for the wealthiest Americans. The lowest group was reduced from 14% to 11%.

Other provisions of the law included simpler procedures for creating employee stock ownership plans (ESOPs), greater eligibility for Individual Retirement Accounts (IRAs), a drop in the capital-gains tax from 28% to 20%, and a larger estate-tax exemption. Given the era’s double-digit yearly inflation, which was driving even lower- and middle-class households into higher tax rates, indexing tax brackets was a critical feature.

ERTAInspired By Supply-Side Economics

The law was influenced by the supply-side economic views proposed by economist and Reagan advisor Arthur Laffer. The main notion was that decreasing taxes on the wealthiest would encourage greater capital investment and innovation, with the benefits “trickle down” to normal people through job growth and higher consumer spending. In exchange, tax revenues would climb as the economy expanded.

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However, as feared, ERTA did not instantly stimulate the economy. Business capital investment remained sluggish, unemployment remained high, and consumer spending remained flat. Meanwhile, the federal deficit increased in the year after the bill’s enactment due to a significant decrease in tax receipts.

Congress Blunts ERTA a Year Later

By the time ERTA was passed, the second half of the “double-dip” recession had begun in the United States, in part because Federal Reserve Chair Paul Volcker was determined to keep inflation under control, with the benchmark interest rate as high as 20%. The US deficit started to climb as the economy tanked and tax receipts fell. In September 1982, a worried Congress reacted by repealing parts of the ERTA’s provisions with the Tax Equity and Fiscal Responsibility Act, sponsored by Senate Finance Committee chair Robert Dole. The healing process started almost quickly.

The ERTA is still contentious. Growth did go up in the mid- and late-1980s, and supporters hailed the tax cuts, stating they increased tax receipts by 6%. Although it is unlikely to be the last word, the nonpartisan Congressional Research Service reported in 2012 that decreasing top tax rates had no impact on economic growth or productivity, but does lead to increasing wealth disparity. Under Reagan, the national debt of the United States quadrupled to $2.6 trillion.

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