A dense fog rolling in off the Pacific enveloped President Ronald Reagan’s majestic 688-acre ranch, high in the hills above Santa Barbara, California.
Visibility was limited, but a crowd of cameramen, photographers and reporters were gathered on that day in 1981 to record the president signing a major piece of legislation.
Wearing jeans, a faded dungaree jacket and cowboy boots, Reagan strolled out of the adobe farmhouse where he and first lady Nancy Reagan were vacationing to a table on the gravel driveway below the house. As he slid into an old leather chair, Reagan flashed his radiant smile to the journalists awaiting the ceremony.
He had much to smile about. Stacked on the table was ERTA, the 185-page Economic Recovery Tax Act of 1981, whose passage fulfilled a campaign promise to cut taxes in a big way.
Signing the bill repudiated everything he had once believed in as a New Deal supporter. ERTA slashed personal, corporate and estate taxes and was stuffed with other tax favors for high-net-worth individuals and corporations. The tax cuts carved a $750 billion hole in the federal budget, prompted cuts in multiple public programs and added to the deficit. The cuts, spread over six years, totaled $2.4 trillion in today’s dollars — basically the cost of the Biden administration’s multi-year, scaled-down Build Back Better bill that never made it out of Congress.
But that was just the beginning. The bill signing on that foggy day set in motion a trend in tax policy that is supercharging America’s escalating income inequality. In the past four decades, Congress after Congress has cut taxes on the richest people and corporations — billions of dollars that would otherwise have gone to the federal till for spending that could help the rest of the public get ahead.
Along the way there were some tax increases, most recently the Inflation Reduction Act signed by President Joe Biden in August that levied a 15% minimum tax on corporations and a 1% excise tax on stock repurchases by public companies. That law was a modest but significant breakthrough for the Democrats after years of Republican-driven tax cuts.
To some, the value of the reforms isn’t just monetary: “They will help restore the public’s confidence in the fairness of our tax system,” said Frank Clemente, executive director of Americans for Tax Fairness, a coalition that advocates for progressive taxation.
These increases notwithstanding, the trajectory over the past two generations has been in the opposite direction.
In 1980, the top income tax rate for individuals was 70%. Today it’s 37%.
The political forces behind that seismic shift haven’t stopped pushing for more. Already, House Republicans are proposing to extend or make permanent some of the most recent tax cuts.
Setting the pattern
Before the income tax was enacted in 1913, average Americans paid the bulk of federal taxes through levies on imported goods. Democrats succeeded in passing the income tax as a way to compel the wealthy to pay more of the cost of running the national government.
Until World War II, the income tax was levied on only the richest Americans. Even after that, the system was designed so people with more money paid higher rates — much higher for the wealthiest.
Elected officials, largely Republicans with some assists from Democrats, have spent the past four decades pulling that system apart.
They’ve tucked large breaks for the rich into proposals with small cuts for millions of other Americans, effectively disguising the main beneficiaries. They’ve promoted tax cuts with claims about economic benefits that have not panned out.
“It’s vastly oversold that tax cuts will generate job and economic growth,” said William Gale, co-director of the Urban-Brookings Tax Policy Center. “When you cut taxes for the upper income, you give them more after-tax income, but you don’t do anything for growth.”
The nonpartisan Congressional Research Service reached essentially the same conclusion in 2012 that tax cuts don’t spur growth but do increase income inequality. After Senate Republicans heatedly objected to the report, CRS withdrew it.
ERTA charted the course in 1981. It cut the top tax rate from 70% to 50% on so-called unearned income — dividends from stocks and interest on bonds and savings. While modest tax breaks sprinkled throughout the bill affected millions of taxpayers, the top rate cut had just one constituency. Only the richest 2% of taxpayers were subject to taxes up to the 70% rate.
Lowering that rate had long been a Republican goal, but the party’s lawmakers had been reluctant to propose it in ERTA for fear that voters would see them as favoring the rich. Instead, it was the Democrats who proposed it. It was a trade, a way to get Republican support for other provisions in the bill.
ERTA gave the wealthiest Americans who received dividend and interest payments a hefty yearly tax cut of $6.7 billion, the equivalent of $21 billion today. Out of 95 million taxpayers who filed that year, this bounty went to just 82,000: the richest sliver of the top 1%.
People in this group who received $250,000 in dividends owed $175,000 in taxes on them for the 1981 tax year. ERTA gave them a tax cut of $50,000 the next year — more than twice what the majority of American families lived on at the time. It was a gift that kept giving, year after year.
To fully understand the amount of money involved, think of it this way:
If the 70% rate were still on the books, taxpayers with more than $1 million in income in 2019 could have owed $87.9 billion more in taxes that year, according to a Center for Public Integrity analysis of IRS data. That’s more than enough money to rebuild and repair all the bridges and water systems across the country slated for work under the Infrastructure Investment and Jobs Act passed by Congress in 2021.
Cutting taxes for the rich over the past 40-plus years has had a huge impact, leaving less money for public programs that benefit millions of Americans while enriching a tiny percentage of the population. Where once the code strove for a certain balance — the more you earned, the more you paid — the rates have been reduced so much that there’s not nearly as much difference now between the top tax rate a billionaire investor pays on their income and what a middle-class salaried professional pays on theirs.
Income inequality in America is at heights not seen for a century. A variety of factors have contributed, including the erosion of good-paying manufacturing jobs, deregulation, a weakened trade union movement and the elimination of pensions and other rungs in the safety net. But taxes have been a principal engine of worsening economic inequality simply because the wealthy, thanks to their success in Congress, now have more money — to buy stocks, invest in real estate, build megayachts, blast off into space and make campaign contributions to politicians so the cycle isn’t interrupted.
It wasn’t always this way.
For decades leading up to 1980, all incomes from top to bottom rose at nearly the same pace. But that changed dramatically afterward. While median family income was largely stagnant, top incomes soared.
In 1980, the top 4% of taxpayers earned as much as the bottom 39%. By 2019, the top 4% earned as much as the bottom 57%, according to a Public Integrity analysis of the most recent IRS data.
As more money flowed upward, the gap in accumulated wealth widened. In 2019, the top 10% of Americans had three times the wealth of everyone else in the country combined.
The pandemic greatly exacerbated the trend. The stock market has been volatile this year, but a June study by Americans for Tax Fairness and the Institute for Policy Studies concluded that 745 U.S. billionaires had grown $2.1 trillion richer since the start of COVID-19.
The tax reform game
Five years after ERTA, tax cutters triumphed again.
Two Democrats, Sen. Bill Bradley of New Jersey and Rep. Richard Gephardt of Missouri, cosponsored bills to wipe out abusive tax shelters in exchange for lowered tax rates.
Reagan embraced the plan as a way to further gut progressive taxation. As it worked its way through Congress, the Tax Reform Act of 1986 was widely hailed by Democrats and Republicans.
On the plus side, the law for the first time taxed long-term capital gains at the same rate as wages and salaries in addition to restricting tax shelters.
“[The bill] will close the loopholes and curb the tax shelters that giant corporations and wealthy individuals have used for decades to escape their responsibilities and avoid paying taxes,” Rep. Robert A. Borski, a Pennsylvania Democrat, told his House colleagues on Sept. 25, 1986.
But overlooked in the euphoria was the price paid in other parts of the legislation. It lowered the top rate on wages, salaries and all other personal income from 50% to 28%, the largest single drop in the history of the federal income tax.
Proponents contended that was justified because few wealthy people were paying the top rate, thanks to tax shelters.
However, the data shows that not every wealthy taxpayer was loaded with tax shelters, and the 1986 act gave them a big break.
