Economic Recovery Tax Act of 1981 (ERTA)

A federal tax law passed by the U.S. Congress to encourage economic growth by providing crucial tax cuts

What is the Economic Recovery Tax Act of 1981 (ERTA)?

The Economic Recovery Tax Act of 1981 (ERTA) was a federal tax law passed on August 13, 1981 by the 97th U.S. Congress as a big move to encourage economic growth by providing crucial tax cuts. The legislation was also known as the “Kemp-Roth Tax Cut.” It was signed into law by then-President Ronald Reagan.

 

Economic Recovery Tax Act of 1981 (ERTA)

 

Summary

  • The Economic Recovery Tax Act of 1981 (ERTA) was a federal tax law passed on August 13, 1981 by the 97th U.S. Congress as a major move to encourage economic growth by providing crucial tax cuts.
  • The legislation was also known as the “Kemp-Roth Tax Cut.” It was signed into law by then-President Ronald Reagan.
  • The main objectives of the ERTA were to provide tax cuts to stimulate economic growth, capital cost recovery of fixed investments in plant, equipment, and real estate, providing incentives to increase savings in the economy, and so on.

 

Main Objectives of the Economic Recovery Tax Act of 1981

The Economic Recovery Tax Act was enacted into law, keeping in mind the working principles of supply economics. The basic idea behind it was that providing tax cuts, especially for the higher income tax groups, would lead to more money in the hands of the wealthy and the businesses. It would help increase the potential for more and more investment and economic growth, as the higher income groups are able to spend on capital investment and economic growth.

The benefits of these tax cuts would then “trickle down,” i.e., pass on to the average and lower-income group citizens. A flourishing economy would increase employment opportunities in the economy and increase consumer expenditure, thereby increasing the purchasing power of the overall economy.

The main objectives of the ERTA were as follows:

  • Providing tax cuts to stimulate economic growth
  • Capital cost recovery of fixed investments in plant, equipment, and real estate
  • Providing incentives to increase savings in the economy

 

What was the Accelerated Cost Recovery System (ACRS)?

The Accelerated Cost Recovery System (ACRS) was a major component of the Economic Recovery Tax Act of 1981. The ACRS’ main purpose was to change the way depreciation is accounted for, i.e., deducted to provide tax concessions. Such a way of providing tax concessions was crucial to reduce the tax liabilities of businesses and corporations. The move, in turn, enhanced investment and economic growth.

The Accelerated Cost Recovery System’s depreciation changes were later repealed by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFR). The TEFR was later amended in 1986 into the Modified Accelerated Cost Recovery System (MACRS).

 

Tax Cuts under the Economic Recovery Tax Act of 1981 (ERTA)

The tax cuts under the Economic Recovery Tax Act of 1981 (ERTA) were as follows:-

  • The accelerated cost recovery system (ACRS) accelerated the depreciation tax reductions and changed the way depreciation was accounted for to reduce taxation.
  • Indexing individual tax brackets, with a 23% cut in individual tax rates
  • The top tax rate cut was from 70% to 50% over three years.
  • The lowest tax rate cut was from 14% to 11%.
  • The real estate tax exemption was increased to $600,000 from $175,600 to promote capital cost recovery.
  • All working taxpayers were to establish Individual Retirement Accounts (IRAs). The move was intended to increase savings in the economy.
  • A 10% exclusion on income was introduced for two-earner married couples up to $3,000.
  • Taxations on windfall profit gains were reduced.
  • There was a reduction in the capital gains tax from 28% to 20%.
  • The ERTA indexed for inflation as well.

 

Consequences and Effects of the ERTA

The ERTA, to some extent, did work according to the underlying supply-side economics principles. However, some consequences were dire to the economy:

  • Due to the massive decline in tax revenues, the federal deficit increased significantly.
  • The overall consumer spending did not increase despite the tax concessions.
  • By the end of 1982, the U.S. unemployment rate reached an all-time high of approximately 11%.

While there were some initial positive effects of the ERTA, the act was ultimately a failure to the Reagan presidency.

 

Additional Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Alternative Depreciation System (ADS)
  • Budget Deficit
  • Expansionary Monetary Policy
  • Fiscal Policy

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes!