Executive Summary: The political struggle over tax policy in the Reagan White House has altered the political landscape as the Great Monetary Debate makes its way to center stage. At last, the administration seems to have painted itself into a corner where it is forced to deal with money. Jack Kemp's victory as Horatio at the Bridge elevates his unspoken power potential, intensifying his opposition and support as he emerges as Reagan's heir apparent. The supply-side object is to persuade the power brokers that there is no alternative to monetary reform, that it comes sooner or later, as a result of 1984 elections. Jim Baker, although the apparent big loser in the tax debate (drawn in by David Stockman), is not seen as a "Bush agent," but his own man, a potential supply-side ally in the drive toward gold. The administration has fallen behind the "power curve" and is threatened with becoming dominated by the "in basket" a la Jimmy Carter. Only gold can prevent the failure of the Reagan administration and those aboard.
Behind the Power Curve
As a general, almost iron-clad rule, the major policy debates in Washington, D.C., are not resolved on the basis of logic, reason, evidence or rhetorical skill, except perhaps in the Oval Office. Below the level of the President, who is the only person representing a national constituency, sides are chosen on the basis of political power, the power to alter fortunes and careers. This isn't a cynical observation, but a blunt recognition of the workings of the politcal marketplace. "Hitch your wagon to a star" is a pretty way of putting it.
Politics, after all, isn't mathematics. In college political science debates, you learn that you often do better arguing the side you disagree with, and once begun, can be swept away by your own arguments. The same is true in Journalism School, when you are assigned to write two editorials, pro and con, and in Law School, which prepares you explicitly for the adversarial role. When the physical scientists are drawn into political questions, they are no purer. In 1969, during the great anti-ballistic missile debate in the U.S. Senate, the liberals one day produced a list of 10 eminent physicists who said the ABM would not work. The following day, Sen. Henry Jackson flourished a list of 10 equally noted scientists who said it would work.
It has been no different in the Great Tax Debate that continues to occupy the Reagan administration and it will be no different in the Great Monetary Debate that is making its way to center stage. The most obvious example is that of David Stockman's rapid transformation from Supply-Side to Old Guard, almost from the instant he was handed the budget portfolio. According to his job description, he would get credit only for a balanced budget. Supply-side tax and monetary reforms were more than distractions at OMB. They constituted a burden as he dealt with the power circles on Capitol Hill and in the bureaucracy in the zero-sum games that are built around the federal budget. He found it much easier to win friends and influence people by making traditional arguments and avoiding the unorthodox, and even easier to get along if he opposed his old allies on the Supply-Side.
The President's tax legislation passed the Congress on July 29 and was signed into law a week later. Even as Reagan was signing the bill, in the open air at his California ranch, Stockman's chief economist was working on a memo outlining the arguments for "revenue enhancements" in order to balance the budget, Larry Kudlow, the paradigm of the bureaucratic gunslinger, had hitched his wagon to Stockman's star, and he and his chief would chew up the next six months with brillant maneuvering that kept their fiscal agenda in focus. The supply-siders, who expected the Great Monetary Debate to begin on the heels of the tax bill 1, were caught napping, and only a last-minute burst of activity by Jack Kemp and those whose wagons are tied to his star pulled the President back from the precipice. The Wall Street Journal's front-page article of February 2, "How Reagan's Instinct Finally Overcame Push By Aides to Lift Taxes," provides a rough outline of what went on, but it would take a book to do the story justice.
Our interest, though, is in the fallout, which we hope would offer clues to how policy will unfold in the future. There were so many people on the losing side of the tax debate that it will take an unusually long time for the smoke to clear. As the Journal story indicates, "Some of those who supported higher taxes are even saying they think they were wrong." And Treasury Secretary Donald Regan adds that 'There are a lot of guys trying to get off the hook."
Yet Regan himself has done some squirming. In the last days of the debate, Regan and Kemp were the only two figures in the entire government, executive and legislative branches, visibly opposing the Stockman tax scheme. At the very last moment, Regan capitulated to the "New Federalism" power play that Stockman and Kudlow had activated as a screen for the tax increases. When his Treasury Secretary caved, the President himself seemed to wilt in that direction and official Washington thought it was all over.
The big "winner" seemed to be James Baker III, the Reagan chief of staff who orchestrated the play. Baker and his White House protege, Dick Darman, and Stockman and Kudlow, are said to have been the basic tax team. Other Baker loyalists, Buck Chapoten at Treasury and David Gergen, White House communications chief, were of course heavily involved.
The Stockman-Baker relationship was critical to the undertaking. Baker, who has an almost negligible grasp of the economic debate, last year was mesmerized by Stockman and Kudlow and their glib-ness and put himself into their hands. When Stockman's revelations in the Atlantic Monthly emerged, Michael Deaver and Edwin Meese were ready to have Stockman bounced. But Baker could rationalize Stockman's rejection of supply-siders as the result of an honest intellectual pilgrimage. "Maybe it is 'Voodoo economics' after all," Baker is said to have joked at a sub-cabinet meeting. It would be comforting to George Bush's campaign manager, Jim Baker, to know that the voters made a mistake in choosing Reagan's supply-side promises over his man. If the supply-side caused him personal defeat as campaign manager, he was not going to let it defeat him again as chief-of-staff, especially now that one of its most brilliant exponents, Stockman, had conceded its failure.
It is important to note in this analysis that Baker would have done exactly the same thing if George Bush had died of boredom last August. Paul Craig Roberts, while he was still at Treasury carrying the supply-side tax banner, interpreted Baker's hand in support of Stockman as a move to undermine the supply-side idea and with it the presidential aspirations of Jack Kemp. Roberts spread the message far and wide among the Conservative Coalition elements, who could read in the newspapers of Baker's support of tax hikes as evidence of Roberts' thesis. At a closed January 21 "conservative caucus" in Washington at the Mayflower Hotel, which I attended, speaker after speaker denounced Baker, Gergen and Darman as "advance men for the Bush campaign," "Bushmen," etc., and jesting that Reagan was a "prisoner of Pennsylvania Avenue" and "the only thing wrong with the administration is that Ronald Reagan is not a team player."
In the very hours that this meeting was taking place at the Mayflower, a few blocks away at the White House the U.S. Chamber of Commerce delegation was talking the President out of the tax increases. As a personal favor to the Chamber people, Ed Meese had arranged their access to Reagan. When the meeting unraveled Baker's carefully stitched together plan, he was furious with Meese and everyone else in the White House who had participated. But Meese, who had not uttered a word against the tax scheme at any of the meetings where it was arranged, could now be portrayed as having been on the winning side. Why not? At the margin, he made the difference.
Jack Kemp the previous week had single-handedly turned Reagan against the argument that tax increases were needed to narrow the budget deficits Stockman was projecting. "Jack is right," the President told a meeting of House GOP leaders, Regan, Stockman and the White House heavy hitters. "I have never understood the difference between 'crowding out' by Federal borrowing and 'crowding out' by federal taxing."
At that moment, the New Federalism ploy became Stockman's fallback position to raise taxes. This was a breathtaking example of the power Baker and Stockman could amass at a moment's notice. A few weeks earlier, the "New Federalism" concept was gathering dust on one of Martin Anderson's shelves, something to get done in 1983, perhaps, or in a second term when all the big problems are solved.
When Reagan unveiled the plan in his State of the Union Address, reporters and Democrats asked quizzically why now? California Gov. Jerry Brown's reaction was typical. He didn't know if it was a good idea or a bad idea. All he knew was that given the magnitude of the nation's economic problems, it was a "trivial" proposal. He is correct. The scheme, though, slung together in 48 hours at OMB, was just another of Stockman's Trojan Horses, this time to get behind the President's defenses. The President likes the concept and always has. This became the reason to raise taxes, not "crowding out." These programs would go here, those programs would go there, and while the shell game developed, taxes would go up to pay for it all and $30 billion or so would stick to the federal budget.
The President, though, took the bait neatly and left the hook. Now the White House has the blasted New Federalism program to push with Congress and the states and we get nothing, Stockman might well be saying. Treasury Secretary Regan, by the way, explains that he didn't abandon the supply-side, he only supported the excise taxes as a way of paying for the New Federalism, which is his way of saying he took the bait and the hook. Larry Kudlow has had the brass to call the supply-siders at the moment of defeat and insist that he fought the tax increases behind the scenes, that he "tried to keep Stockman from making a fool of himself."
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The big "winner" as these things go was, of course, Kemp, who owes Donald Regan a debt of gratitude for leaving him to play Horatio at the Bridge. Indeed, Kemp's win was almost embarrassing in magnitude and he has been almost apologetic in dealing with some of the vanquished. He is now easily the most famed member of the House of Representatives since Richard Nixon tangled with Alger Hiss. And he is viewed on the political grapevine, especially as a result of the tax fight, as Reagan's heir apparent, the "frontrunner" in the next presidential sweepstakes, whenever that is.
That day may be a long way off and a thousand things could happen to prevent it from happening, but the potential is so palpable that all of Washington is aware that it bears upon every major calculation, if only minutely. In a town where political power is paramount, Kemp is at a higher level now than he was a month ago, both in terms of allies and adversaries. Senator Bob Dole, chairman of the Senate Finance Committee, has almost made a career out of gambling against supply-siders and losing. His contempt for Kemp has always been barely submerged by his wit, but he now wears it openly and angrily. He and Senator Domenici of New Mexico, the Senate Budget Chairman, have committed themselves to raising taxes; not to balancing the budget or cutting spending or bringing down interest rates. They are determined to bring down Kemp and the Supply-siders, not because of any conviction or belief, but because of political power.
At the same time that the intensity of feeling has built against Kemp in the Senate, it has flowed to him in the House of Representatives. A 46-year-old member of the "Lower Body" is not supposed to be able to put the "Upper Body" in the shade, and this counts for Kemp in the intramural politics of Congress. In addition, Kemp's House colleagues don't want to campaign this fall as tax boosters and they are relieved that he saved them from that fate. There has been a suspicion that the Senate Republicans, few of whom are up for re-election this year, were blandly willing to get tax hikes over and done with this year.
The fiscal issue is not quite yet off the stage. Stockman et al are still trying to get the minimum corporate tax beefed up and are selling it as a "face saver" to those who lost the big one. There are continuing appeals from Dole for more of this, and there are veiled threats from Domenici that he may refuse to bring the administration budget to the Senate floor unless more taxes are raised; Domenici has indicated he will oppose cuts in categorical-grant spending.
For the most part, though, Washington seems ready for monetary policy, if only because the administration has finally painted itself into that corner. There's nothing more left to talk about. When Kemp on January 14 issued a press release calling for Paul Volcker's resigation as chairman of the Federal Reserve Board it did not find its way into the Times, the Post or The Wall Street Journal, possibly because so many members of the House had already done so that it wasn't deemed "news." But within a day or two, somehow everyone knew about Kemp's position and the discussions on the Sunday talk shows seemed to get around to whether Volcker should resign or not. Uniformly, the opinion was that he should not resign, but that he had better do a better job. (Senate Majority Leader Howard Baker, who doesn't seem to have the foggiest idea of just what it is the Fed is supposed to do, urged that the President and Volcker "sit down together" and work things out.)
What we are now going to get is a thorough review of monetary policy. But if you remember that arguments and evidence don't count in these major policy debates, what is actually going to happen is a re-examination of the political landscape vis-a-vis monetary policy. The level of discourse on policy itself will likely be even less intelligible than it was on tax policy (Senator Baker acknowledged on "Meet the Press" that he knew of no theory that posited a tax increase during a recession, but that he was for one anyway.)
Instead, we will lurch along on the basis of a mysterious political calculus that changes weekly, sometimes daily. On Thursday, January 28 the financial markets soared giddily against the backdrop of Secretary Regan's sudden public rebuke of Volcker. On Monday following, the markets swallowed Regan's and Stockman's honeyed praise for Volcker on the Sunday talkies and plunged back into sullenness. Why should Citibank continue to hold back its prime rate if the cavalry is not going to come to the rescue? (Was it coincidental that the bond market slide that began at Thanksgiving was arrested on January 14, the day Kemp called for Volcker's resignation?)
Professor Friedman and the St. Louis Fed are suddenly crowding the pages of The Wall Street Journal with op-ed articles about monetarist nit-picks having to do with M1B. The monetarists are suddenly very attentive. (As the British say, the knowledge that you are about to be hung in the morning concentrates the mind wonderfully.) But Donald Regan and Jim Baker and R. Reagan are not reading the articles. Everyone is watching everyone else to see what happens next. Congress, at least, is out of this play, and will occupy itself innocently chewing on the New Federalism.
The object is to persuade either Donald Regan or Jim Baker that they will remain behind the power curve, as will the entire administration, unless there is an international monetary reform based at least partially on gold. It is assumed the President is receptive, but that he would need the support of Regan or Baker, and on the evidence to date, if Baker, then Regan. The failure of the Reagan administration to get ahead of the power curve translates GOP into losses in November and a one-term presidency for Reagan and his team. The 1984 election would be hinged on money and the gold standard, and the supply-siders say Kemp would win in a landslide.
The outlines of this scenario, which have surely occurred to the players already, suggest the im-plausibility of President Reagan amiably watching the economy deteriorate around him for three more years while Volcker tracks M1B with precision and Kemp magnifies the supply-side campaign while girding for battle. As the President has recently demonstrated, if he does not get the support of his Cabinet, he will go it alone with Kemp. We will have gold either before the 1984 campaign or after it, and the odds favor before.
Being behind the power curve is a very bad place for the White House to be, as Jimmy Carter discovered. Governance revolves around the "in basket," and when you wake up, as chief of staff, you learn that another crisis has developed over night and you still did not get on top of yesterday's. What's worse, you lose all sense of a strategic design, a concept of how the world political economy fits together and what it might take to get it to stop sputtering. Policy becomes patchwork.
As odd as it may seen, the supply-siders (again, save Roberts) retain their confidence in and respect for Jim Baker precisely because they see him as being driven by his own ambition to succeed as this President's chief of staff. He will never, ever understand the economics of monetary policy, nor should he be expected to. But he can and will come to understand the politics of monetary policy and understand that change could put him ahead of the power curve, although he may never understand exactly why.
It is, after all, occurring to the power politicians that as their own power has been slipping away, an instrument of great power — monetary policy — is being frittered away. It is not aimed at bringing down interest rates, or ending the recession or lowering the unemployment rate or even bringing down the inflation rate. None of these goals are the goals of present monetary policy, which is solely dedicated to maintaining Professor Friedman's current definition of meaningful "money" along a specified track.
This policy will change not when new arguments are heard on why this is obsolete policy or when evidence is presented on why it will not work any better next year than last. It will change when people with power calculate that they have no choice politically, that they can not even hide from the issue. If this were not a democracy and the issue could not be tested at the source of political power, the future of the U.S. and world economy would not seem as promising as it does at the present moment. But it is, and it does.
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1 See Jude Wanniski, "Now Money", the Political Economy in Perspective, Polyconomics, Inc., Morristown, N.J., August 5, 1981.