Economic Recovery Tax Act of 1981 (ERTA)

Overview

The Economic Recovery Tax Act of 1981 (ERTA), also known as the Kemp–Roth tax cut, was the largest tax reduction in U.S. history when enacted. Signed into law early in President Ronald Reagan’s administration, ERTA implemented broad cuts to individual and capital taxation, accelerated deductions for business investment, and introduced inflation indexing for tax brackets.

Key takeaways

• ERTA substantially lowered marginal income-tax rates, with the top rate falling from 70% to 50% over three years; the lowest bracket moved from 14% to 11%.
• The law reduced the capital-gains rate (from 28% to 20%), eased rules for employee stock ownership plans (ESOPs), expanded Individual Retirement Account (IRA) eligibility, and raised the estate-tax exemption.
• Tax-bracket indexing was added to protect taxpayers from “bracket creep” during high inflation.
• The legislation was motivated by supply-side economics—most prominently associated with Arthur Laffer—which argued that lower tax rates would spur investment, job creation, and ultimately higher tax revenues.
• The immediate aftermath showed rising federal deficits and weak short-term responses in investment and consumer spending; Congress reversed some provisions the following year with the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982.

Major provisions

• Large across-the-board reductions in individual income-tax rates, phased in over three years.
• Capital-gains tax reduced to encourage investment.
• Accelerated depreciation/expensing rules to make business investment more attractive.
• Easier establishment and use of ESOPs and expanded access to retirement accounts (IRAs).
• Indexing of tax brackets to inflation, helping prevent automatic tax increases due to rising nominal incomes.

Economic rationale

ERTA was rooted in supply-side theory: cutting taxes—especially on higher-income earners—was expected to increase incentives for capital formation and work effort, boosting productivity and growth. Proponents argued that these gains would “trickle down” to the broader economy and could even raise tax revenues over time.

Short-term effects and policy correction

Despite the tax cuts, the U.S. economy did not immediately experience the robust investment and consumption growth proponents predicted. The early 1980s recession, tight monetary policy to control inflation, and a sharp decline in tax receipts produced rapidly expanding federal budget deficits. In response, Congress enacted TEFRA in 1982 to roll back or modify parts of ERTA to reduce the deficit. Economic recovery began thereafter, complicating attribution of growth to any single policy.

Long-term impact and debate

Growth resumed in the mid- and late 1980s, and supporters credit ERTA (alongside other policies) for part of that recovery. Critics point to the surge in federal debt during the Reagan years—the national debt grew substantially—and to growing income inequality. Nonpartisan analysis (e.g., Congressional Research Service reviews) has concluded that reductions in top marginal tax rates over long periods have not shown a clear positive effect on overall economic growth or productivity, though they are associated with increased wealth concentration.

Conclusion

ERTA was a landmark tax overhaul that reshaped U.S. fiscal policy by sharply cutting tax rates, encouraging investment through accelerated deductions, and instituting bracket indexing. Its immediate fiscal consequences—rising deficits and a subsequent rollback of some provisions—highlight the trade-offs between tax reduction goals and budgetary constraints. The act remains a focal point in debates over tax policy, economic growth, and inequality.

Selected sources

United States Congressional Budget Office; U.S. Department of the Treasury; Congressional Research Service.