Economic Recovery Tax Act Of 1981

Updated on January 25, 2024
Article byAswathi Jayachandran
Reviewed byDheeraj Vaidya, CFA, FRM

What Was The Economic Recovery Tax Act Of 1981 (ERTA)?

The Economic Recovery Tax Act of 1981, or the Kemp–Roth Tax Cut, was a US federal tax legislation intended to help individuals and businesses accomplish their financial growth goals, thereby accelerating the country’s economic growth. It is the largest tax cut in American history since the Modern Income Tax, 1913, was introduced.

Economic Recovery Tax Act of 1981

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Economic Recovery Tax Act Of 1981 (wallstreetmojo.com)

The goals of the Economic Recovery Tax Act of 1981, as stated in the US Senate Finance Committee report, were to guarantee economic growth in the future, upgrade the nation’s industrial base, stimulate productivity and innovation, reduce personal income taxes, etc. It also intended to administer major activities of economic importance undertaken by the federal government, restore certainty in economic decision-making, and offer a solid foundation for economic recovery.

Key Takeaways

  • The Economic Recovery Tax Act of 1981 (ERTA), also known as the Kemp–Roth Tax Cut, is an American legislation that introduced several tax and spending cuts. 
  • It was based on supply-side economics, which states that economic policy should focus on boosting the amount of productive resources. 
  • It was an act to alter the Internal Revenue Code of 1954 to promote economic growth through tax rate reductions for individual taxpayers. 
  • The tax cuts received mixed reactions because of their enormity and the belief of some that the decreased federal government revenues would likely damage the economy further.

Economic Recovery Tax Act Of 1981 Explained

The Economic Recovery Tax Act of 1981 (ERTA), also called the Kemp–Roth Tax Cut, is an American legislation that introduced several tax and spending cuts. On August 13, 1981, Ronald Reagan, the then-US president, signed the act. Reagan’s tax cuts were created to foster innovation and entrepreneurship, providing incentives for the growth of venture capital. It also included increasing investments in human capital through education and training.

Individual marginal tax rates were reduced by 25% under the ERTA, implemented gradually over three years. After this period, they were further adjusted for inflation. Since it influenced income from activities like investing, education, and entrepreneurship, the marginal tax rate—referred to as “the tax rate on the last dollar earned”—was assigned more importance than the average tax rate.

According to the argument, lowering marginal tax rates would encourage greater economic activity for both individuals and corporations. The ERTA 1981 reduced the marginal tax rates for high-income taxpayers from 70% to roughly 30%. In 1986, another significant tax reform was implemented that increased the tax relief levels.

Other features were also introduced, such as a deduction for married couples with jobs, and the deduction for donations to tax-deferred Individual Retirement Accounts (IRAs) was also significantly lowered. The ERTA also reduced taxes on the business income of companies and individuals by increasing the number of accelerated depreciation deductions, increasing the investment tax credit, and creating a variety of new investment incentives, such as a new credit for research and experimentation.

Later, the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) introduced measures that helped balance the corporate tax incentives offered by ERTA. It also removed safe-harbor leasing and cut down the accelerated depreciation benefits in ERTA, partially offsetting corporate tax reductions in ERTA.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

History

ERTA was the first significant legislation during Ronald Reagan’s presidency. When he took office, there was minimal economic growth, a high unemployment rate, and high inflation, and the US economy was in a slump due to stagflation. A method to boost the economy was suggested in the form of tax cuts. This proposal was called the Economic Recovery Tax Act of 1981.

This proposed policy adhered to the theory of supply-side economics, which states that economic policy should be centered on boosting the availability and adequacy of productive resources.

The tax cuts sparked debate and unrest due to their gigantic scope and proportion. Additionally, some people believed the resultant decrease in federal government revenues would worsen the country’s economic situation.

Objectives

The Economic Recovery Tax Act of 1981 (ERTA) was introduced to find solutions to the economic turmoil prevalent in the US at the time. It was an act to alter the Internal Revenue Code of 1954 to promote economic growth through tax rate reductions for individual taxpayers. It was enacted to review accelerated capital cost recovery of investments in plant and equipment, savings incentives, and real property, among other things.

Effects

Some effects of the ERTA have been discussed below:

After the act came into force, the portion of tax payments by taxpayers in the top percentile grew. However, overall statistical metrics between 1980 and 1983 reveal a minor reduction in the progressivity of the US tax system. This happened because, except for the top percentile, tax payments generally increased more quickly for the lower-income population than for higher-income groups. The distribution of after-tax income was increasingly unequal in 1983 than it was in 1980 as a result of changes in the pretax income distribution toward the higher income groups.

This group enjoyed a bigger share of after-tax income, even though their share of tax payments grew between 1980 and 1983. The lower income classes saw worsening conditions between 1980 and 1983, both in absolute and relative terms. The bottom half of returns saw a decrease in real after-tax income per capita, while the top half of returns saw an increase in real per capita after-tax income.

In conclusion, the rate cuts reduced overall taxes, but they had minimal impact on how taxes were distributed when compared to how taxes would have been paid in 1983 under the actual 1980 statute. In addition, economists disagree on how much Reagan’s economic strategy contributed to the 1990s boom. However, there is no doubt that his tax reform program precipitated significant changes likely to benefit the economy in the medium and long term.

On the other hand, opponents of the idea point out that Reagan’s tax cuts and the fruits of economic development disproportionately benefited the wealthiest. This significantly widened the gap between the country’s rich and poor.

Frequently Asked Questions (FAQs)

1. What happened after the Economic Recovery Tax Act of 1981?

ERTA introduced various changes, including introducing a new business accelerated depreciation scheme while lowering personal income tax rates. It boosted the investment tax credit, increased write-offs and depreciation, and cut the typical profit tax rates.

2. What was the public response to the Economic Recovery Tax Act of 1981?

It was criticized for favoring the wealthy. However, other economists argue it was fair because the ERTA tax cuts were proportional—providing equal percentage tax cuts to all income brackets. Tax reductions only unjustly favor high earners if a bigger portion of their tax burden is removed.

3. Who were the key people behind implementing the Economic Recovery Tax Act of 1981?

Republican representatives Jack Kemp and William Roth came close to securing the passage of a tax cut bill during Jimmy Carter’s administration. However, due to concerns over the growing national deficit, it was not implemented. Hence, apart from Reagan, they are considered important contributors to ERTA implementation.

This article has been a guide to What Was Economic Recovery Tax Act of 1981 (ERTA). We explain its history, objectives, and effects on the US economy. You may also find some useful articles here –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *