What Was the Economic Recovery Tax Act of 1981?

What Was the Economic Recovery Tax Act of 1981?

Let me tell you about the Economic Recovery Tax Act of 1981, or ERTA, which stands as the largest tax cut in U.S. history. President Ronald Reagan signed it into law just six months after taking office, and it dramatically reduced the top income tax rate while allowing for quicker expensing of depreciable assets. You'll see it also provided incentives for small businesses and retirement savings, plus it introduced inflation indexing for tax brackets to prevent bracket creep.

Key Takeaways from the ERTA

Signed in Reagan's first year, the ERTA marked a historic tax reduction that cut the highest income tax bracket from 70% to 50%. When you combine this with ramped-up military spending, it played a role in the U.S. public debt tripling during his presidency. These changes were bold, but they came with significant fiscal consequences that we're still discussing today.

Understanding the Economic Recovery Tax Act of 1981

You might know ERTA as the Kemp-Roth tax cut, named after its sponsors, Representative Jack Kemp from New York and Senator William V. Roth from Delaware. The most substantial cuts targeted wealthy Americans, dropping the top rate from 70% to 50% over three years, while the bottom bracket fell from 14% to 11%.

Beyond those rate reductions and faster depreciation deductions, the law eased rules for employee stock ownership plans, or ESOPs, and broadened eligibility for Individual Retirement Accounts, known as IRAs. It also lowered the capital-gains tax from 28% to 20% and raised the estate-tax exemption. One crucial element was indexing tax brackets to inflation, which was vital during that time of double-digit inflation pushing everyday families into higher tax categories.

ERTA Inspired By Supply-Side Economics

This legislation drew heavily from supply-side economics, championed by economist Arthur Laffer, who advised Reagan. The core concept is that slashing taxes on the rich encourages more capital investment and innovation, with benefits trickling down to everyone through jobs and spending. Proponents believed this would ultimately boost tax revenues via economic expansion.

However, ERTA didn't deliver the quick economic spark its backers anticipated. Business investments stayed weak, unemployment remained elevated, and consumer spending didn't surge. Instead, the year after its passage, tax revenues plummeted, causing the federal deficit to spike sharply.

Congress Blunts ERTA a Year Later

As ERTA took effect, the U.S. entered the second phase of a double-dip recession, exacerbated by Federal Reserve Chair Paul Volcker's aggressive inflation-fighting measures, including interest rates up to 20%. With the economy faltering and revenues dropping, deficits ballooned, prompting Congress to act.

In September 1982, they passed the Tax Equity and Fiscal Responsibility Act, spearheaded by Senate Finance Committee chair Robert Dole, which rolled back some ERTA provisions. Recovery started soon after. The ERTA is still debated today—growth did pick up in the mid- to late 1980s, and supporters credit the tax cuts, but a 2012 Congressional Research Service analysis of data from 1940 to 2010 found that cutting top tax rates doesn't drive economic growth or productivity; it mainly increases wealth inequality. Under Reagan, national debt tripled to $2.6 trillion.