If Congress manages to pass President Biden's big budget package this fall with most of its spending and tax changes intact, it will represent the biggest shift in federal fiscal policy in 40 years.
If it happens — still a big if — it will be because Congress can circumvent its usual rules and process tax-and-spending measures via a process called reconciliation. That process is a powerhouse capable of major disruptions and changes in government because it offers protection from filibuster. Reconciliation bills can pass with a simple majority.
That is why Biden and his allies, House Speaker Nancy Pelosi and Senate Majority Leader Chuck Schumer, think they have a shot at raising trillions in tax revenue over the next 10 years to pay for their spending priorities. Democrats propose to raise the needed revenue through borrowing as well as through more robust revenue collections thanks to a beefed-up IRS.
But the bulk of it would come from tougher tax treatment and higher tax rates on corporations, investors and others whose annual income exceeds $400,000.
If they succeed, they will be using reconciliation to reverse the direction of federal tax policy, which has brought down the top tax rate and made other changes that benefit corporations and the wealthy over the past four decades.
And they will be doing it with the same process that was used to set that direction four decades ago when first-year President Ronald Reagan used reconciliation to achieve his "revolution" in federal fiscal policy in 1981.
Polls have shown Americans support higher taxes on corporations and the wealthy
Tax increases are rarely popular. But polling this summer has generally found the public supportive of higher taxes on "corporations and the wealthy."
At the same time, reports surfaced that show that mega-corporations and ultra-rich individuals pay little or nothing in federal income tax.
For example, in June, ProPublica published a trove of tax data leaked from the IRS that showed such prominent billionaires as Tesla founder Elon Musk and Berkshire Hathaway investment guru Warren Buffett paid little income tax in relation to their vast income gains — in some years paying none at all. Buffett, who has campaigned for some Democratic candidates, has famously said he should not be paying a lower rate than his secretary.
ProPublica said the data showed Amazon founder Jeff Bezos realizes billions each year in asset appreciation (such as rising stock prices) and yet can keep his taxable income so low that one year he qualified for the child tax credit (which he took).
The data, which was not authorized for publication, covered 15 years and thousands of wealthy taxpayers.
And in June, The New York Times reported that tax laws allowed top managers in the private equity industry to prosper to the tune of billions without paying significant taxes relative to their gains. Audits, the newspaper found, were almost nonexistent.
All this feeds into a widening perception that the major moves in taxation over the last several decades have consistently benefited the higher income groups and particularly those with the greatest accumulated wealth.
There's a growing realization of what has changed in the tax code
The Nobel laureate economist Joseph E. Stiglitz wrote in 2016 that:
"Snowballing changes to the tax code ... over the past 35 years have prioritized tax cuts and subsidies focused on those at the top, placing a greater tax burden on the rest and causing neglect of critical public investments."
Corporations have accomplished some of this tax avoidance by incorporating overseas or realizing some of their profits "offshore." One prospect for revenue-seeking legislators would be an attempt to curtail these practices and reap a tax bonanza.
It is also possible the eventual legislation will address the "step-up in basis" policy by which inheritors of property escape taxation on its appreciated value. Such a move has raised objections from rural interests, even though the Biden administration has pledged to protect family farms.
It will be hard to get every Democrat in the Senate and virtually every one of them in the House of Representatives to accept the compromises and disappointments sure to be found in an eventual deal. But difficult as this is, the president and his party would have no shot whatsoever without the reconciliation process.
And that process got its start as a major mover of federal fiscal policy in 1981 with Reagan's first budget. It set a pattern that would dominate for the next 40 years, culminating in the most recent tax cuts enacted under former President Donald Trump.
Reagan slashes tax rates — and sells the idea of supply-side economics as an elixir
Much of the attention at the time went to the deep cuts Reagan proposed to social spending programs as well as his historic increases in spending for the military. But just as important as where the money was going was a radical reversal on the revenue side: Reagan proposed not just lowering the federal income tax but slashing it by 10% in year one and by another 10% in each of the next two years as well.
At the time, the top marginal tax rate (on the last dollar earned) was still 70%, an echo of the World War II taxes that had risen over 90% on paper and remained there in the peak Cold War years. Of course, few people paid anything like that rate, and those who were subject to it could find ways to reduce their tax exposure.
But Reagan had become convinced that the high marginal rate, as much as the weight of the tax burden overall, was the problem. In his view, it penalized success, impeded economic growth, dampened the nation's entrepreneurial spirit and weakened its work ethic. He spoke of it as much as a moral issue as a material one.
The 10% cuts were "across the board," as he liked to say, implying they were of equal value to all. The dollar value of the cuts was, of course, far larger for those with larger incomes. Moreover, the tax law changes that accompanied the rate cuts made it easier for individuals and corporations to "write off" various forms of income and spending to lower their tax bills further. The tax rate for capital gains, money made from successful investing, would come down from 28% to 20%.
Reagan did not get everything he sought in this initial foray against high taxes and progressivity. The Senate trimmed the third year of the tax cut from 10% to 5%, and it would take a second bill, the Tax Reform Act of 1986, to pull the marginal top rate all the way down to 28%.
But Reagan's tax cuts in 1981 constituted the strongest move away from progressivity in the income tax since the tax was initiated in the Civil War.
They were the culmination of rising anti-tax sentiment in the late 1970s, when some states adopted tax limitations by popular referendum. That spirit was kept alive in the decades to come by groups such as Americans for Tax Reform, led by activist Grover Norquist. Starting in 1986, Norquist has challenged candidates for office to sign his "taxpayer protection pledge" not to raise taxes. The great majority of Republicans have signed.
Reagan pared back progressivity
Reagan was able to reverse what had been a decades-long commitment to at least the look of progressivity. He could do it in part because his 1980 election coattails enabled his party to capture control of the Senate for the first time in a quarter century. Moreover, while Democrats still had a House majority, their ranks included scores of members from Southern and Midwestern districts that had also voted for Reagan.
When the budget resolution passed in that summer of 1981, 63 House Democrats joined all 190 Republicans in backing it. And when the tax package came to its critical votes in July, dozens of Democrats sided with Reagan and the Republicans rather than their own leadership.
In 1982, Democrats added to their majority in the House and negotiated some revenue increases with the Senate and the White House. And in Reagan's second term, momentum built quickly for a tax overhaul that would combine still lower marginal rates with new business taxes and a paring back of tax preferences and other "loopholes." The new overhaul's main appeal to Democrats was that it exempted far more middle- and lower-income earners from the income tax altogether.
The Tax Reform Act of 1986 was hailed as a bipartisan wonderment, winning support from bipartisan majorities in a Republican Senate and a Democratic House. Reagan signed it into law, praising the new top rate of 28% and turning a blind eye to the new business levies.
But effects of the act had scarcely begun to be felt when policymakers began chipping away at them. Preferences and other specific provisions for industries or other activities were reinserted in the tax code as lobbying and popular demand took their toll. The top tax rate started creeping back up in the budget compromises of 1990 and 1993, reaching 39.6% in the presidency of Bill Clinton.
Nonetheless, the Clinton years saw a robust economy created in part by the personal computer and the burgeoning internet economy. That in turn drove stock prices to historic highs. The higher tax rates on income and capital gains brought new highs in federal revenue collections, and by 2000, the annual federal budget was remarkably close to being balanced.
The Congressional Budget Office even projected a surplus in the coming years of the new century, large enough to start paying down the national debt (which still amounted to less than $6 trillion at that time).
Deficits and debt rose faster after 2000
But the idea of running a surplus and shrinking the debt did not inspire much political excitement. Instead, when newly elected President George W. Bush took office in 2001, he swiftly moved to cut taxes, and a Republican Congress went along. Soon the top rate was back down to 35%, even as spending raced higher for the wars in Afghanistan and Iraq. The potential surplus never materialized, yearly deficits got bigger again and the debt grew apace.
President Barack Obama came into office in the midst of an economic free fall from the financial crisis of 2008. His first rescue package included a lot of spending and new borrowing, and some relatively marginal cuts to payroll taxes many did not even notice in their paycheck stubs. In his second term, the top marginal tax rate went back up to 39.6%.
Trump arrived in 2017 and promptly prioritized another general overhaul of the tax code, which was again enacted using reconciliation. The Tax Cuts and Jobs Act of 2017 was intended to spur growth and seemed to do so in 2018 when the economy expanded by nearly 4% (a rate not matched again in the latter two years of Trump's term).
Trump's overhaul, eagerly supported by Republicans in both chambers, reduced the top tax rate to 37% for individuals (and reduced the rate for six lower brackets as well), dropped the corporate rate from 35% to 21%, and exempted the value of estates worth up to $11.2 million from the estate tax (the exempt amount had been about half that) while providing numerous other breaks for banks and other industries.
The Trump cuts were projected to add up to $2 trillion to the national debt over 10 years. And indeed, federal revenues, especially from corporate taxes, plummeted immediately.
The net effect of Trump's cuts, on top of the second President Bush's, has been more than sufficient to counteract the smaller moves toward more revenue under George H.W. Bush, Clinton and Obama.
Tax cuts are generally popular, but Trump's package delivered disproportionately to corporations and the wealthy in a way that voters may have noticed. Having risen largely on his appeal to wage earners and the working class, perceptions of that skew helped Democrats recapture the House in 2018 and were often cited during the presidential primaries in 2020.
That leaves Biden with the double challenge of reducing future deficits while also addressing inequity in the sharing of the tax burden.
It's the dual mission of the tax portions of the reconciliation bill now taking shape in the tax-writing committees: to raise enough revenue to prevent the new spending from adding too much to future deficits. But Democrats also want to make sure whatever new revenue they raise comes from corporations and high-income individuals — the categories that have benefited most from the tax trends that began with Reagan's 1981 reconciliation breakthrough.