Tax Reform Act of 1986

The Tax Reform Act of 1986 is the last time comprehensive tax reform was enacted in the U.S. At the time, it was considered one of the most significant pieces of legislation ever passed, according to

The act implemented a tax code that re-enacted much of the Internal Revenue Code of 1954; however, the significant changes made to the 1954 tax code led to the code being renamed the Internal Revenue Code of 1986.

During President Ronald Reagan's State of the Union Address in 1984, he said he was asking the secretary of treasury to develop and present a comprehensive plan to simplify the tax code. According to, Reagan wanted the law to be simple, fair and broad-based and included the following features:

  • It had to be revenue-neutral, neither adding nor subtracting from federal revenues. It instead would focus on broadening the tax base and reducing rates.
  • It had to be neutral regarding distribution, not favoring certain economic groups.
  • It had to close major tax loopholes, such as tax shelters.
The act contained features that were appealing for Republicans and Democrats, and the fact that the law did not cater to lobbyists' wishes was seen as a triumph for the American people.

The most significant changes featured in the Tax Reform Act of 1986 included the following:

  • The act equalized the rate of taxation on long-term capital gains paid by individual taxpayers with the top rate of federal income taxation imposed on individuals. This was a significant change because capital gains previously had lower rates of taxation than ordinary income from labor and investments, such as wages and dividends. Before 1986, these lower rates on capital gains led wealthy taxpayers to structure their finances to maximize the portion of their incomes earned in the form of long-term capital gains.
  • The act reduced the use of tax shelters—devices taxpayers used to generate deductions and tax credits. Congress enacted Section 469 of the Internal Revenue Code, known as the "passive loss rules"—losses from passive tax shelters and losses from operating rental real estate only can be used as a deduction, or credit, against profits from other passive tax shelters and real estate. This largely eliminated taxpayers' use of tax shelters, which had, until 1986, significantly reduced federal revenues.
  • The act dropped the top rate of federal income taxation of individuals from 50 percent to 28 percent. In addition, Congress reduced the top rate of taxation on corporations from 46 percent to 34 percent.
  • The act eliminated deductions for interest expenses associated with buying personal consumption goods; the only exception is interest payments on home loans. This part of the 1986 act remains an important feature of American tax law.
  • The act repealed the universal individual retirement account (IRA) deduction in favor of restricting the deduction to individuals who did not have pension coverage through other avenues, such as their employers. Before repeal, everyone, no matter how wealthy or how much they benefited from other pension arrangements, could take a deduction for contributions made to an IRA. Now, only certain taxpayers are allowed to do so.
  • The act eliminated federal income tax liability for those below the poverty line. This restored the laws as they existed in the late 1970s, when poor individuals were excluded from the obligation to pay taxes. This reform was made necessary by the effects of inflation, which increases people's nominal income and, therefore, their income taxes, despite the fact that in true economic terms they live in poverty.
According to, the tax act had two obvious failures. First, though the law closed special tax shelters for certain individuals, it did little to close many exemptions that inhibit overall economic growth. Also, much of what passed to limit special tax loopholes already is back in the system because of politicians catering to lobbyists.

Still, though lawmakers by now have undone much of what the reform accomplished in 1986, the act is an example of bipartisan support and made comprehensive changes that have been significant for the U.S.

This Web exclusive information is a supplement to Capitol Hill.