1986 Tax Reform Act

Definition

The 1986 Tax Reform Act was a significant piece of legislation aimed at simplifying the U.S. tax code, broadening the tax base, and eliminating many tax shelters. It represented a major overhaul of the federal income tax system, lowering individual tax rates while simultaneously reducing deductions and credits, thereby making the system more equitable and efficient.

5 Must Know Facts For Your Next Test

1. The 1986 Tax Reform Act reduced the number of tax brackets from 15 to 2, with rates set at 15% and 28%, significantly simplifying the tax structure.
2. The Act eliminated many popular tax deductions and credits, including those for business expenses and certain investment losses, broadening the taxable income base.
3. It included provisions that aimed to curb tax avoidance strategies and eliminate loopholes that allowed wealthy individuals and corporations to minimize their tax liabilities.
4. One of its key impacts was on capital gains taxation, as it changed how profits from asset sales were taxed, aligning them more closely with ordinary income rates.
5. The 1986 Tax Reform Act was part of President Reagan's broader economic strategy known as 'Reaganomics,' which sought to stimulate economic growth through tax cuts and deregulation.

Review Questions

• How did the 1986 Tax Reform Act impact individual taxpayers in terms of tax rates and deductions?
  • The 1986 Tax Reform Act significantly lowered individual tax rates while simplifying the tax system by reducing the number of brackets. It established just two main rates: 15% and 28%, making it easier for individuals to understand their tax obligations. However, this simplification came with the elimination of many deductions and credits, which meant some taxpayers could see an increase in their taxable income despite lower rates.
• Discuss how the changes in capital gains taxation introduced by the 1986 Tax Reform Act affected investment behavior in the United States.
  • The 1986 Tax Reform Act adjusted capital gains taxation by aligning it more closely with ordinary income rates. This shift meant that individuals faced higher taxes on profits from asset sales than they had previously. Consequently, this change influenced investor behavior as some chose to hold onto investments longer to defer taxes, impacting market liquidity and trading strategies during that period.
• Evaluate the overall effectiveness of the 1986 Tax Reform Act in achieving its goals of simplifying the tax code and promoting fairness in taxation.
  • The overall effectiveness of the 1986 Tax Reform Act can be assessed through its dual objectives: simplification of the tax code and promoting fairness. By reducing tax brackets and lowering rates, it did simplify how taxes were calculated. However, while it aimed to broaden the base and eliminate loopholes, critics argue that it disproportionately affected middle-income earners due to the loss of deductions. Additionally, some wealthy individuals found new ways to navigate around these changes, raising ongoing debates about equity in the U.S. tax system.

Related terms

Tax Bracket: A range of income levels that are taxed at a particular rate, which determines how much an individual pays in taxes based on their earnings.

Capital Gains Tax: A tax on the profit realized from the sale of a non-inventory asset, such as stocks or real estate, which was affected by changes in the 1986 Tax Reform Act.

Tax Deductions: Expenses that taxpayers can deduct from their taxable income to reduce their overall tax liability, significantly impacted by the changes introduced by the 1986 Tax Reform Act.