There has been a great deal of discussion about the tax proposals of Cain and Perry, including several diaries here where individuals attempted to compare how they’d make out under these new tax codes. And surprisingly, many are negative about them. So it’s worthwhile to look back at the last time we pretty much stood the IRC on its head.
People aren’t stupid. It’s human nature to want to pay as little taxes as possible, ( sorry, libtards) and given enough incentive, people will actually make economic decisions that are strongly influenced by the tax code.
Before Reagan’s reforms, and the two packages of laws known as TEFRA and ERISA, the maximum tax rate was 50%. And if you lived in high tax places like NYC, where you got hit by state AND city income taxes, it wasn’t hard for a dual income household to find themselves in a marginal combined 60% top tax bracket. You didn’t have to be a CEO, a hedge fund operator, a master of the universe, to find yourself in the top tax bracket.
The GOOD thing about that was that for every dollar you could deduct off your return, the governments subsidized 60%. So, if you could turn that investment into a deduction, 60% of the “cost” was a freebee.
Second homes were great for this. Then the real estate partnerships took off. First, the public ( registered) deals, then the smaller, and more agressive, private placement deals.
Interest, expenses, and depreciation of the properties combined to generate these wonderful losses.
Early on, before the shady operators started to juice these deals, to the point that they had no chance of ever being viable, it was possible to invest, say, $10,000 in an LP, ( usually being a portfolio of aparftment complexes and/or shopping centers) and get a 3,4, or 5 to 1 write off over a few years.
IOW, in a given year you could pay an extra $10k to the government, or you could invest it, and get to deduct, ( simplifying here to illustrate the point) $10k off your income for each of the next 4 years. If your tax bracket was 50%, then each year you saved $5000, over 4 years, $20,000, so even if every property in the portfolio disappeared into a sinkhole, you couldn’t lose. And if, later on, they sold the properties for a profit, even after you paid the taxes, well, you were way ahead of the game.
They couldn’t keep the prospectuses on the shelves. These deals were sold out, way oversubscribed. They were lining up to hand you the checks. And why not. In the early years, these were awesome.
I myself invested $20k in the early 80’s in Balcor I. This was a very conservative public partnership. ( Jerry Reinsdorf, who now own the White Sox, was then head of Balcor.) Because I was one of the earliest investors, ( losses are accrued from the date of your investment), over the first 4 years, I received losses ( deductions) of $90k, saving me about $55k in combined income taxes. And later on, when the partnership was liquidated and the properties sold off, after taxes I netted about another $75,000.
And as the news spread, more and more people started putting deals together. Prices for the underlying properties took off..shadier operators, “sharper pencils” got into the game, and the abuses began.
The 1986 tax changes wiped out these deductions. Completely. Totally. No longer could you use them against earned income. And thus the underlying value of these deals collapsed. As did a good portion of the commercial real estate market. Prices dropped, IF you could even find a buyer.
And Wall Street, ever creative, invented NEW types of deals, so that the losses could be used to “shelter” some income. And thus was born PIGS and PALS, “passive income generators” and “passive activity losses” respectively.
And everyone’s tax return suddenly got a lot more complicated, and cost a lot more to have prepared. And forget about filing on time..because you almost never received the 1099’s and the partnership returns from the general partner until well into the following year ( if ever)
The point being, if you haven’t already figured it out, is that ANY dramatic restructuring of the tax laws will effect people in different ways. Some will make out like bandits from day one, others may well feel substantial pain, and cost.
That’s why Perry’s proposal, to allow people to compute their taxes either way ( and I trust that window will be open only for a few years) is both wise and fair.
Reagan’s plan was superb. It triggered tremendous economic growth and expansion in the country, creating millions of jobs. Yet for the first few years, until about 1990, it clobbered the real estate market. Individual home prices fell about 20% on average across the board. And commercial property suffered even worse. And investments that prior to 1986 seemed golden now were severely tarnished and impacted.
So stop with all the attempts to analyze, deconstruct, and whine about these two proposals. The tax code is an abomination, a travesty. It needs to go, now.
The main advantage of BOTH proposals ( Cain and Romney) is that once in force, it will be almost impossible for Congress to tinker with it, raise it, or slip in loopholes, as now happens all the time.
In the early 80’s, before Reagan’s reforms, there was a popular, made -up IRS form, called the 1040 SIMPLE. It was printed on a postcard, and consisted of only two lines.
(I can’t find a facsimile, so I’ll just type them below)
IRS FORM 1040 SIMPLE
PUT DOWN EVERYTHING YOU EARNED, MADE, RECEIVED______
SEND IT IN___________________________________________