Recalling Ronald Reagan, a pragmatic compromiser on taxes

One of President Ronald Reagan’s many gifts was his ability to reduce complex ideas into simple, easily communicated slogans. So his critique of government got reduced to “Government is not the solution to our problem; government is the problem.”

But in his political practice, President Reagan was a negotiator and a compromiser, and nowhere was this more evident than in his tax policies. When his Economic Recovery Tax Act of 1981 proved to have cut taxes too much, and to have generated a deficit that seemed too large at the time, projected to reach 6% of GDP by 1983, President Reagan negotiated and signed into law the Tax Equity and Fiscal Responsibility Act of 1982, which increased federal taxes significantly.

Too many of today’s devotees of President Reagan remember his slogans but not his pragmatism or his willingness to negotiate and compromise.

The current tax debate questions why billionaire investors like Warren Buffet pay a lower effective rate of income tax than their secretaries. The explanation is that investment managers receive most of their compensation as capital gains or dividends now taxed at a maximum rate of 15%, while ordinary income from labor is taxed in brackets of 10%, 15%, 25%, 28%, 33%, and up to 35% for taxable income in excess of $379,150.

The lower preferential tax rate for income from capital, compared to income from labor, can only be explained and justified as a reflection of underlying values of a capitalist economic system which values capital investment more highly than labor. The so-called “Bush tax cuts” enacted in the first term of President George W. Bush reduced the top ordinary income rate of 39.6% and the top capital gains rate of 20% down to their current levels, contributing to unprecedented budget deficits and record national debt.

Not many Americans remember that in 1986 President Reagan negotiated and signed into law a tax reform act that taxed income from capital and income from labor at the same top rate of 28%, effectively taxing all personal income the same regardless of how earned. That is nearly twice the current top rate on capital gains and dividends. The Tax Reform Act of 1986 also increased corporate taxes, limited the deduction for interest paid on borrowed money by individuals, and shut down the most common tax shelters through a limit on passive activity losses.

The Tax Reform Act of 1986 is widely regarded as the high water mark of tax reform in the United States, and a model of what is possible in moving towards a simpler and fairer tax system through bi-partisan negotiations. Unfortunately that compromise broke down after President Reagan left office, and the unequal tax rates returned for income from capital compared to income from labor.

But as the United States again tries to negotiate tax reform to achieve a simpler, fairer tax system, Republicans in particular should recall the pragmatism and willingness to compromise of the President they most admire, and not just his slogans.