More Stupid Tax Code messing around

A few commenters of my last post suggested that picking at the tax code can create big problems if you don’t know what you’re talking about. I agree. Why mess with what is working as evident in the data continuously collected and reported concerning the economy. But, in 1981 they did mess with it and in a very big way and it hasn’t stopped. As the saying goes “everything changed”. Even under Clinton the share of income to the top 1% rose 6 points.
To recall, my point is that it’s not just the rates that are the problem, it’s the code.
One comment got me looking further.

Save the Rust Belt
“In general, the attempts by Congress in various bills to limit the deductibility of executive compensation caused the flood of executive stock options, and created a much bigger mess “
From a review by Peat, Marwick, Mitchell & Co.

The Economic Recovery Tax Act of 1981 is the most comprehensive tax reform
since 1954.
It affects virtually every financial planning decision. The Act creates a “new” type of stock option known as an “Incentive Stock Option” under which favorable tax treatment will be afforded to the option holder if certain conditions are met. Under current law, employer stock options are not entitled to preferential treatment.
Observations
The incentive stock option will have a significant effect on compensation planning
for all companies, and these rules may be applicable to options already exercised in 1981. Incentive stock option plans will probably become the cornerstone of executive compensation plans involving capital accumulation.

(Within this report are the changes related to the savings and loan mess. Considering today’s subprime problems, it is rather instructive as it relates to learning from history. Start on page 39 of the document.)

Thus, it was not the messing around that created stock options as a preferential means of payment. In the 1986 messing around they: eased the rules for exercise of Incentive Stock Option (ISO).

But, how was this 1981 act being portrayed by the CBO? Baseline Budget Projections for Fiscal Years 1983 – 1987 Report February 1982

The CBO baseline economic forecast shows an early end to the current recession and an acceleration of economic growth following the July tax cut.
Baseline revenue projections assume no change in current tax laws,… Under the CBO baseline economic assumptions, revenues are projected to rise from an estimated $631 billion in fiscal year 1982 to $882 billion in 1987. This represents an average growth of 6.9 percent a year, compared with an assumed average growth in nominal GNP of about 10 percent a year for the projection period. As a consequence, revenues as a proportion of GNP are projected to decline from 20.6 percent in 1982 to 17.7 percent in 1987—the smallest ratio since 1965.

Under current tax laws, the greatest growth in revenues will occur in social insurance taxes and contributions… The share of total revenues raised from this source will increase from 33 percent in 1982 to 38 percent by 1987… The share of total revenues raised from individual income taxes would decline from 47.5 percent to 45percent. Corporate income taxes under current laws and CBO’s baseline economic assumptions are projected, to increase by 46 percent, … and to maintain its 8 percent relative share of total revenues. Revenues raised from excise taxes and other sources are projected to remain at about the same level during the projection period. As a result, their relative share of total revenues would fall from 11 percent in 1982 to 8 percent in 1987.

How did this all work out? THE CHANGING DISTRIBUTION OF FEDERAL TAXES: A CLOSER LOOK AT 1980 Staff Working Paper July 1988

As reported in the earlier CBO study, total effective tax rates (the ratio of taxes from all four sources to family income) rose between 1977 and 1984 for the 10 percent of families at the lowest end of the distribution and fell for the 10 percent of families at the highest. Overall, the distribution of total federal taxes became less progressive.
Between 1977 and 1980, the total effective tax rate for all four taxes combined declined for the 20 percent of families in the bottom of the income distribution and generally rose for the 50 percent of families in the upper end, except for the 10 percent of families with the highest incomes. Total effective tax rates for other family income classes changed little between 1977 and 1980.

Between 1980 and 1984, the total effective tax rate for all families taken together dropped noticeably, from 23.3 percent in 1980 to 21.7 percent in 1984. The decline was not uniform across all income classes, however. Effective tax rates rose for the 30 percent of families at the lowest end of the income distribution and fell for the 70 percent of families in the upper end, with the size of the reduction increasing with family income. The 10 percent of families at the highest end of the distribution had both the largest percentage and the largest absolute decrease in effective tax rates.

The changes in effective rates under the individual income tax resulted largely from the Economic Recovery Tax Act of 1981 (ERTA). ERTA substantially cut statutory tax rates and increased allowable deductions, but it failed to offset the effect on low-income families of an inflation-induced decline in the real value of personal exemptions, zero bracket amounts (standard deductions), and the earned income credit.

By 1988, the distribution of combined federal taxes is projected to become more progressive than in 1984, but to remain less progressive than in either 1977 or in 1980. Although the combined effective tax rate for all families taken together is expected to drop slightly from 1980 to 1988, total effective federal tax rates are projected to be higher for families in the bottom half of the income distribution and lower for families in the top half. The largest reductions between 1980 and 1988 will be for the 1 percent of families with the highest incomes.

The question I guess is: did they know what they were doing? I suppose it depends on whether you think this results we have been living with since 1981 was intentional or not.

Just to cover the talking points:

The share of taxes paid by the 10 percent of families with the highest incomes rose by between 1.0 and 1.5 percentage points between 1980 and 1988. The increase in the share of taxes paid by this group resulted from a growth of nearly 3 percentage points in their share of pre-tax income between 1980 and 1988, more than offsetting the decline in their effective tax rate.

We changed everything.

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