| Signed | August 13, 1981, by President Ronald Reagan |
| Public law | 97-34, often called Kemp-Roth |
| In one sentence | The largest rate cut in the history of the income tax, with inflation indexing to make it stick. |
| Still with us | Indexing; a top rate under 50%; the fixed-period depreciation system and section 179; the unlimited marital deduction; the annual gift exclusion; the research credit |
Why it happened
By 1980 inflation had been pushing wage earners into higher brackets for a decade without any real increase in income — “bracket creep” — and the top rate on investment income was 70%. Jack Kemp in the House and William Roth in the Senate had proposed a 30% across-the-board cut in the late 1970s; it became the center of Reagan’s 1980 campaign and his first-year program. The House was Democratic, and the bill passed with the votes of conservative Southern Democrats after both parties added provisions in a bidding war for those votes.
What it did
- Rates cut 23% over three years — 5% on October 1, 1981, then 10% and 10% — with the top rate dropping from 70% to 50% all at once on January 1, 1982. The bottom rate fell from 14% to 11%. The 1969 cap on earned income was no longer needed and was repealed.
- Indexing, from 1985. Brackets, the personal exemption and the standard deduction would rise with inflation each year. Of everything in the law this is the piece that lasted longest without change: bracket creep ended and has not come back.
- Capital gains to 20%. With the 60% exclusion applied against a 50% top rate, the maximum rate on long-term gains fell to 20% for sales after June 9, 1981.
- ACRS depreciation. Useful-life depreciation was replaced with four fixed recovery periods — 3, 5, 10 and 15 years — and a new section 179 let a business expense $5,000 of equipment outright. The idea of fixed classes survives as MACRS; section 179 is $2.5 million today.
- The IRA for everyone. Any worker, pension or not, could deduct $2,000 a year. (The 1986 law took this back for higher-income people with a company plan.)
- Estate and gift tax. An unlimited marital deduction from 1982; the exemption raised in steps from $175,625 to $600,000 by 1987; the top rate cut toward 50%; the annual gift exclusion raised from $3,000 to $10,000, the base of today’s $19,000.
- Marriage penalty relief through a deduction for two-earner couples of up to $3,000, and a charitable deduction for people who did not itemize. Both were repealed in 1986.
- The research credit, at 25%, which has been extended, changed and finally made permanent in 2015.
What it meant
Every taxpayer’s marginal rate fell by about a quarter over three years, and from 1985 on a raise that only kept pace with inflation stopped pushing people into a higher bracket. A two-earner couple got a new deduction, and anyone with a job could open a deductible IRA. A small business buying a $20,000 truck in 1982 wrote off $5,000 immediately and the rest over five years, and a family business could pass $600,000 to the children, and anything to a spouse, free of estate tax.
The deficit that followed is the subject of the next page. Some of what was enacted in 1981 — faster depreciation scheduled for 1985 and 1986, a 15% exclusion for interest income, the full phase-down of the estate rate — was repealed before it ever took effect.