Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)

Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) is a major U.S. tax law enacted to reduce the federal budget deficit through revenue-raising measures, spending changes, and tighter tax compliance. Passed early in Ronald Reagan’s presidency, TEFRA reversed parts of the prior year’s Economic Recovery Tax Act of 1981 (ERTA) and remains, when adjusted for inflation, the largest tax increase in U.S. history.

Key takeaways

• TEFRA was designed to close tax loopholes, strengthen enforcement, and raise revenue without broadly increasing statutory income-tax rates.
• It rescinded some ERTA provisions that had not yet taken effect.
• The law tightened enforcement (withholding and penalties), raised excise taxes (notably cigarettes and telephone service), and altered business tax breaks.
• A lasting non-tax provision—often called TEFRA Medicaid—permits states to extend in-home Medicaid services to certain children with disabilities regardless of family income.

Background and purpose

In 1981–1982 the U.S. experienced a sharp economic slowdown often described as a “double-dip” recession. Revenues fell and the federal deficit rose to a then-record $110.7 billion in 1982. TEFRA, shaped in Congress by Sen. Bob Dole as chair of the Senate Finance Committee, aimed to raise revenue largely by closing the so-called “tax gap” (unreported or underreported income) and by reversing selected tax cuts from ERTA.

Major provisions

The act touched individuals, businesses, and federal programs. Key measures included:
* Stronger enforcement and compliance: increased penalties for noncompliance and steps to reduce underreporting.
* Withholding requirements:
* Automatic 10% withholding on dividends and interest paid to individuals without certified tax ID numbers.
* Withholding on payments of pensions and annuities.
* Crackdowns on underreported tip income for service workers.
* Changes to business tax benefits: elimination or limitation of some ERTA-era breaks (for example, restrictions on accelerated depreciation).
* Excise tax increases: the federal cigarette tax was temporarily doubled and the telephone service tax was tripled.
* Revisions to Medicare and Medicaid payment and reimbursement rules to reduce program costs.

TEFRA Medicaid

One of TEFRA’s most durable provisions allows states to extend certain Medicaid-covered in-home services to children with disabilities irrespective of family income. This provision expanded options for care outside institutional settings and remains influential in state Medicaid programs.

Notable and unintended consequences

• An obscure provision forbids those “trafficking in controlled substances” from claiming most business tax deductions. Decades later this clause affected the legal cannabis industry, which cannot claim many ordinary business deductions under federal tax law.
• The act’s overall fiscal effects were debated. The Reagan administration projected TEFRA would raise roughly $98 billion over three years while producing larger spending cuts; critics disputed those estimates and questioned net fiscal impact.

Political and historical context

TEFRA represented a political compromise: it rolled back some earlier tax cuts to address a surging deficit while pushing for spending reductions. Its association with Sen. Bob Dole and its reversal of parts of ERTA made it a flashpoint in conservative politics. The law illustrates how fiscal pressures and economic downturns can shift tax policy priorities.

Bottom line

TEFRA combined enforcement, targeted revenue measures, and programmatic changes to reduce the deficit risk in a severe recession. Its mix of withholding rules, excise-tax increases, altered business tax treatment, and Medicaid reforms had broad and lasting effects on taxpayers, businesses, and state health programs.