Tax-Preferred Assets and Debt, and the Tax Reform Act of 1986: Some Implications for Fundamental Tax Reform

Abstract

This paper focuses on two aspects of the tax changes enacted in the Tax Reform Act of 1986 (TRA86). First, the TRA86 phased out tax deductions for interest on consumer debt, which contributed to a marked shift in the composition of household debt. Second, the TRA86 restricted the tax deductibility of contributions to individual retirement accounts (IRAs) for some higher-income households. This appears to have contributed to, but is not solely responsible for, the shift in the composition of some households’ portfolios of tax-preferred saving incentive plans. This paper also discusses the interaction of household debt and 401(k) plans following the TRA86. The aspects of the TRA86 focused upon in this paper appear to represent examples of more typical responses to tax changes: changes in the composition of economic activity but with little change in the real level of economic activity. This conclusion is consistent with the hierarchy of taxpayer responses suggested by Slemrod (1990, 1995) and yields some potentially relevant implications for fundamental tax reform.

Keywords: Tax Reform Act of 1986, tax policy

JEL Classification: H2