Redefining tax reform: Could Congress “eighty six” the ’86 Act?

KPMG discussion about possibilities for tax reform

President Reagan, on October 22, 1986—with Republican Senate Majority Leader Bob Dole and Democratic Ways & Means Chair Dan Rostenkowski looking over his shoulder—signed the Tax Reform Act of 1986 into law. That legislation (the ’86 Act) with its sweeping reach, continues to be heralded as a triumph of tax legislation, perhaps even more so today than when it was enacted. Among the most notable characteristics of the ’86 Act are that it significantly lowered the statutory tax rate for both corporations and individuals simultaneously. Furthermore, it achieved this comprehensive tax reform on a revenue-neutral basis, by clearing out dozens of special preference items in the tax code. The law also balanced its books by closing a number of perceived loopholes and areas of tax abuse.

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Some 30 years later, the Tax Reform Act of 1986 still casts a long shadow on present day deliberations about tax reform. Perhaps it is human nature to define things by what we have known them to be, and for most tax professionals and policy-makers, the ‘86 Act is the only version of known tax reform. As such, much of the effort in recent years has been in trying to recreate the legislative success achieved in the fall of 1986, by creating a new comprehensive tax reform bill that also significantly lowers both the corporate and individual income tax rates on a revenue-neutral basis. For example, former Ways & Means Chairman Dave Camp’s proposed Tax Reform Act of 2014 largely followed the 1986 blueprint. Perhaps it is worth asking why that paradigm must be so.

Over the years since that October day on south lawn of the White House, much has changed in the United States and in the global economy. Take a moment to recall that on that day in 1986, a Cyndi Lauper single, sold on a 45-inch record, topped the singles charts. Mobile phones were an oddity; the Chevrolet Celebrity was the top selling passenger car; Sony Walkman sales were brisk; and the Commodore 64 was America’s top choice for its home computing needs. These serve a reminder that, just as technology has evolved, so has the economy, which is now significantly more global, and in which the U.S. position has changed. With all these changes, perhaps Congress, willingly or out of necessity, will eventually abandon the 1986 tax reform precedent.

Comprehensive reform

Arguably, the most notable feature of the ‘86 Act was that it achieved comprehensive tax reform—that is, it fundamentally reformed the taxation of both corporations and individuals (and thus, by proxy, most small businesses) at the same time. Much of the discussion of tax reform since then has been how to replicate comprehensive reform in the today’s environment. A number of good arguments have been made as to why this approach makes sense. Most notably, a simultaneous reduction of the corporate and individual rates would not discriminate against small businesses based on entity type (partnership, sole proprietorship, or S corporation). 

Yet, arguably the conditions for comprehensive reform are less compelling today than in 1986. The ‘86 Act reduced the top individual income tax rate from 50% to 28%—a 44 percentage reduction, made largely possible by the repeal of certain tax preferences (some would say tax shelters) available in 1986. It is not clear whether a reduction of similar magnitude is possible today, given the magnitude and nature of the tax preferences currently available. Former Ways & Means Chairman Dave Camp’s proposed Tax Reform Act of 2014 would have achieved an individual income tax top rate reduction from 39.6% to 35%—less than a 12 percentage reduction, with certain mathematical and distributional realities limiting a more aggressive individual rate reduction. 

If, like Camp, congressional tax-writers conclude only modest rate reductions are possible (or preferable) for individuals, part of the 1986 rationale for comprehensive reform becomes less relevant.

Revenue neutrality

As noted above, one hallmark of the ’86 Act is that it accomplished its policy objectives all while maintaining revenue neutrality in the official budget window. As evidenced by the proposed Tax Reform Act of 2014, the notion of revenue neutrality has been embraced by a current generation of tax reformers. Yet, some would argue that revenue neutrality is perhaps the greatest hindrance to creating a politically viable and growth-maximizing version of tax reform. That is, under the revenue-neutral model, every tax reduction in the Code must be accompanied by a tax increase elsewhere. This give-some-take-some approach necessarily creates a winners-and-losers dynamic, thus engendering the opposition of the losers.

Arguably, however, cracks are beginning to appear in the edifice of revenue neutrality. First, President Obama has proposed “long-term revenue neutrality” for tax reform. Under his scenario, taxes are increased in the 10-year budget window but then become neutral over a still undetermined long-run. While this concept has not been well-received on Capitol Hill, the idea introduces greater flexibility than is offered by the 1986 “revenue straightjacket.” Under this approach, conceivably Congress could enact long-term revenue-neutral tax reform that is revenue negative in the 10-year budget window. This approach could be viewed as a net tax-cut in the short-term, which has the potential to erode political opposition to tax reform itself. 

A second crack in revenue neutrality has appeared in the area of macroeconomic revenue estimates. The ’86 Act and the proposed Tax Reform Act of 2014 were deemed to be revenue neutral using conventional revenue estimating methodologies. Under conventional scoring, macroeconomic feedbacks from the tax cuts are not considered in evaluating the law’s effect on tax receipts.  This year, the House adopted a rule that would require (when feasible) congressional revenue estimators to consider these macroeconomic effects in major tax law changes. Had those methodologies been used to score the Tax Reform Act of 2014, that otherwise revenue-neutral proposal would have increased tax receipts by anywhere from $50 billion to $700 billion over a 10-year period. This dynamic scoring methodology permits Congress to rethink very difficult choices it made in 1986 and since in achieving revenue neutrality. 

Third, as discussed below, Congress is currently considering tax law changes as a way to fund highway and other infrastructure spending. This at least suggests the possibility of revenue positive tax legislation, at least in the 10-year budget window.

A final fissure in the 1986 model of revenue neutrality relates to the “tax extenders.” Tax extenders are the 50 or so expiring tax incentives that Congress must periodically extend. Congress has almost never paid for these short-term extensions of current law. In 2014 and again in 2015, however, the House proposed to make many of these extenders permanent, and would do so without offsetting revenue increases. These efforts to make certain extenders permanent, whether or not they are wrapped into tax reform, suggests (at least in the House) a more fluid definition of revenue neutrality than might have been previously understood.

Corporate rate reduction

Having now done violence to two “sacred cows” of the 1986 vision of tax reform, consider the most sacred of all—corporate rate reduction. Some would argue that reducing the corporate rate is the very point of tax reform. Indeed, the United States now has the highest statutory corporate tax rate in the OECD. After the ’86 Act lowered the corporate rate from 46% to 34%, much of the rest of the world then followed the U.S. lead by dramatically reducing corporate tax rates. 

While policy-makers on both sides of the aisle have signaled their commitment to lowering the corporate tax rate, it is something easier said than done. This is particularly true in a revenue-neutral scenario, since lowering the corporate rate from 35% to 25% is estimated to cost more than $1 trillion over the first 10 years. 

This raises the question whether there might be alternatives to reducing the corporate rate that still achieve other goals of tax reform. To be clear, the question is not whether there are better ways to achieve the goals of tax reform (there probably aren’t), but whether other means are easier or more probable. There is nothing magical about the term “tax reform” and Congress could apply that label to any legislation it chooses.

For example, Congress is currently engaged in discussions concerning how to fund highway and infrastructure spending. One idea with seeming currency, as a way of funding transportation infrastructure projects, is for Congress to enact a deemed repatriation on all untaxed corporate foreign earnings and then use that revenue to fund the Highway Trust Fund. Attached to this legislation, Congress is considering an innovation box regime for certain intellectual property. Finally Congress could theoretically then “bolt on” several popular tax extenders made permanent and call the whole package “tax reform.” While that bill would look very little like the ’86 Act in terms of scope, rate reduction, or universal appeal, it could be flagged as reform nonetheless. There are countless variations on this theme that could be viewed as intermediate steps towards a long-term tax reform ideal.

Final thoughts

The ’86 Act was a transformative piece of legislation in the tax world. It not only made the U.S. tax code simpler, flatter, and fairer, but it also set off a trend of global tax rate competition that still reverberates today. But the ’86 Act was also a product of its time, circumstances, and personalities involved. The next version of tax reform—whenever and however that may come to fruition—will be a product of its own time, circumstances, and personalities. Don’t be surprised if a final product bears little resemblance to an earlier generation’s blueprint for reform. 


Read a September 2015 report [PDF 3.6 MB] prepared by KPMG LLP.


For more information, contact a member of KPMG’s Washington National Tax (WNT) Federal Legislative and Regulatory Services group:


John Gimigliano | +1 202-533-4022 |

Carol Kulish | +1 202-533-5829 |

Tom Stout | +1 202-533-4148 |

Jennifer Bonar Gray | +1 202-533-3489 |

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