Ronald Hoover's Tax Bill Jude Wanniski August 10, 1982

Executive Summary: President Reagan has removed all doubt that he is fully committed to enactment of the $100 billion tax bill now before Congress. The steep stock market slide reflects the increased probability that the Reagan-Baker team at the White House will succeed. Rep. Jack Kemp is leading Reagan's original conservative constituency in opposition. But House Democrats have a vested political interest in seeing Reagan destroy GOP chances in November; the more clearly the President identifies the bill as "Reagan Republican," the more Democratic votes he will get. A Dow of 700?

Ronald Hoover's Tax Bill

Until the afternoon of August 4, there were widespread doubts in the political and financial communities about Ronald Reagan's commitment to the tax bill he had embraced. There was speculation that he did not have his heart in this biggest tax increase in peacetime history, but that his advisors had boxed him into supporting it. If so, perhaps he wouldn't turn on the steam as he had in his long string of successful legislative battles, and its chances of passage would be drastically reduced. The Democratic leadership, having helped hook Reagan on the tax bill, also worried that a lack of enthusiasm on his part would kill the bill's chances and let him and the GOP slip the hook. So they goaded him into swallowing it, insisting that he would have to take an aggressive role if the unpopular legislation were to pass in this election year.

On Wednesday the 4th, all doubts were removed when the White House revealed that Reagan would roll up his sleeves to get the bill passed. The President, in meetings with Democratic and GOP leaders, displayed downright enthusiasm for the struggle ahead. From his vantage point, the federal deficits were running out of control and causing the steepness of interest rates and weakness in the economy. His high command had made a deal with the Democrats which would net $3 in spending cuts for every $1 in tax increases, a good bargain in the President's mind, even though the Democratic commitments seemed vague and elusive. Any notion that the Federal Reserve's monetary policy might be the cause of the problem was brushed aside by the President. The Fed was successfully bringing down inflation, wasn't it, by its policy of slow, steady increases in the money supply? There was no room for doubt here. If he could gain his tax increase, the Democrats would have to come across on spending, or the President and the GOP would have a campaign issue, rallying the American people under the fiscal integrity banner.

The revelation of Reagan's determination was hardly a tonic to the financial markets, the supposed beneficiaries of all this fiscal responsibility. The Dow Jones Industrial average sank almost 13 points on the 4th, most of the plunge in the last hour of trading as news of Reagan's final conversion to Austerity came out of the afternoon leadership meetings. One thing Wall Street has learned about Reagan and his chief-of-staff, Jim Baker, is their awesome ability to squeeze what they want out of Congress. At one point in the AWACS struggle in the Senate last autumn a head count showed the White House down 49-to-15. Washington has not seen the likes of the Reagan-Baker team since the days of LBJ and Sam Rayburn. The tax bill would have to be crammed down the throat of an unhappy House of Representatives, with Jim Baker making no secret of his willingness to see 38 Republicans go down the drain in November if that's the price necessary to win. After all, Baker knows he will need Democratic support in the House, and he would have to play to their awareness that if the tax bill is defeated, it will not be as easy to defeat Republicans in November.

The leader of the opposition to the tax bill is Rep. Jack Kemp, chairman of the House Republican Conference. As with the widespread doubts about Reagan's commitment to the tax bill, there have also been doubts about Kemp's commitment against it. If Kemp were merely to stake out his opposition ground and not be too vocal about it, the White House believed he would not be difficult. The first alarm came on July 28 when Kemp and Rep. Bob Walker of Pennsylvania circulated a letter among their GOP colleagues asking for signed support for opposition. The letter drew 75 signatures, not enough to block House agreement to go to conference with the Senate-passed bill, and Baker put out word of White House confidence in the ultimate outcome. Indeed, because they also needed Kemp's aggressive aid in getting the unpopular foreign-aid bill through the House, they continued to treat him affably. But it was already clear that with Kemp upping the ante on the tax bill, Reagan would have to gear up and then some, and that Kemp would have to be handled. He would have to be isolated.

On Friday, July 30, that problem became more complicated when Kemp lunched with Lyn Nofziger in Washington and agreed that it would take a formal opposition to challenge the White House on the tax bill. Nofziger, one of Reagan's earliest political allies, had left the White House early this year after having been isolated himself by Jim Baker. Now, he was aghast at the track Reagan had been placed upon and the prospects for political disaster for the GOP in the tax bill. Nofziger suggested a meeting of Reaganites who agreed that the President was making a great mistake, people who had been with Reagan in helping win the Republican nomination in 1980 when the architects of the current economic policy were allied with George Bush, John Connally and Jimmy Carter. Every element of Reagan's original bedrock constituency, in fact, was opposed to his position on/the tax bill, and only a few key individuals, like Sen. Paul Laxalt, remained with Reagan through his conversion.

As it happened, August 4 was also the day Kemp and Nofziger decided to have this meeting of Reaganites, at 6:30 p.m. on Capitol Hill. At 3:30 p.m., Kemp was called into the "woodshed," the Oval Office, where it became clear to him that Reagan's commitment to the tax bill was complete. At 4 p.m., GOP congressional leaders met at the White House uniting behind the President, with the exception of Kemp, on the tax bill. At the meeting, Laxalt more or less accused Kemp of disloyalty to the President, which the White House reported to the press corps. The story was framed in a way to suggest that this was only one bad boy in the family and bad boys go to the woodshed. Kemp left with the impression that if he made a big deal out of his opposition, he would play into Democratic hands and be responsible for Republican losses in November.

He had only an hour and a half to ponder these spankings, accusations and warnings before the Capitol Hill meeting with the Reaganites, hardly enough time to feel or emit a sense of isolation. By 8:30 p.m., when the meeting of about 30 political and intellectual leaders broke, it was clear that Kemp had accepted the responsibility of leading the campaign against the tax bill with total commitment, which in a larger sense is a struggle for the soul of the Republican Party, which is how Rep. Newt Gingrich of Georgia put it. The strategic duel would be between Kemp and Baker, with the future of the Reagan presidency at stake. From this standpoint, those in the meeting could feel that they were not being disloyal to Reagan. They had decided to do this out of friendship and loyalty to him, believing he was about to make a profound and fundamental error from which his presidency might not recover.

Of course, above and beyond these feelings for the Reagan presidency is the conviction that the economy is in no condition to absorb the body blow of the tax increase. Adoption of the package would be horrendous even if the unemployment rate were not 9.8 percent, but with the economy continuing to shrink, and with it the tax base, adoption now implies a pyramiding of problems. Monetary and fiscal uncertainty would heighten, taking the financial markets down some distance from current levels.

Defeat of the tax bill, on the other hand, might finally force attention on monetary policy. Kemp's visibility in a winning effort would at least enhance prospects of being heard on monetary reform. As it is, for the remainder of this fiscal fight, discussions of Fed policy are on the back burner. The Senate Democratic petition to Volcker to target interest rates is at least an opening wedge for discussion in the wake of a tax-bill defeat — although the targeting of interest rates could revive inflation.

The chances of defeating the bill are improved the longer it can be delayed. There is a small chance of the Senate defeating the conference report sometime around August 17. The Senate only passed the Finance Committee bill by three votes the first time around, with no Democratic support. Senators Goldwater and Weicker, who didn't vote then, have said they would oppose it now. Senators Schmitt and Helms, who voted for it, have now indicated opposition. But Baker's techniques work best in the Senate, where he might be able to work deals with conservative Democrats to pull them into the support column.

So it is in the House where there is the most realistic chance of beating the bill. Almost all the House Republicans supported the Budget Resolution that committed them to tax increases and spending cuts, but they can now oppose the tax increase on the grounds that they have seen none of the vaunted Democratic support for spending cuts, and these must precede their support of tax hikes. This is how Kemp so easily collected 75 signatures on his July anti-tax letter. If the Democrats would somehow agree to massive spending cuts as a way of triggering this GOP support for tax increases, the economy certainly wouldn't be helped one whit. Only a few years ago it was Keynesian doctrine among liberal and conservative economists that unemployment should be met by spending increases and/or tax cuts to pump up aggregate demand. The very idea of cutting spending and raising taxes in the current environment would have been derided by the same economists who are now backing it with enthusiasm. Herbert Stein, for example, became celebrated for his full-employment budget doctrine, which embodies the "scientific" application of the Keynesian doctrine. Yet Stein is now popular at the White House for his support of the President's fiscal program, which flies in the face of Stein's full-employment thesis.

Deficits used to be welcome in recessions because they provided counter-cyclical sources of aggregate demand. Stein now tells Business Week of August 16 that deficits reduce the economy's growth potential by preventing "a strong rate of growth in productivity." Business must invest in plant and equipment to increase the nation's productivity, says BW in elaborating Stein's thesis, "But to do that, companies need a pool of savings on which to draw. And that is the rub. While deficits put more money in consumers' hands, they drain the savings pool."

The Business Week cover story, in fact, is a tortured attempt to stand Keynes on his head in marshalling support for the tax boost. MIT's Paul Samuelson is quoted as saying "Deficits do not have the same expansionary kick they had back in the '40s, '50s, or '60s." He "explains" that as deficit estimates escalate, uncertainty about future economic policy increases, and this gets reflected in higher interest rates. Therefore, "you lose in housing, autos, and other interest-rate-sensitive industries. It is a catch-22."

"In the middle of a severe recession," says BW, "neither economists nor politicians would have advised raising taxes or cutting spending. Now, however, many economists are recommending just that."

But despite such heresies from the likes of Samuelson and Stein, Keynesian doctrine has not been repealed to the extent we can say a cut in spending has no impact on aggregate demand. Spending cuts will weaken the economy at this stage almost as much as the proposed tax increases because of the effects on demand. To the extent Reagan is successful in squeezing more spending cuts out of the Congress in order to woo defecting Republicans back to support of the tax bill, he will doubly succeed in deepening the recession. My suggestion two months ago of a 700 DJI average if the tax bill were to pass now seems realistic, perhaps optimistic.

The bad news continues to pile up. On August 6, the President announced he was postponing his California vacation in order to drive for the tax bill, which sent the Dow to its 27-month low. The more the President identifies himself and the GOP with the tax bill, the more congressional Democrats can afford to vote for it. Liberal Democrats would especially love to vote for the bill because it incorporates several "tax reform" ideas they have been trying to get through Congress for decades. The "three Martini" lunch provision was first put on the block in 1962 when Kennedy was President and his Assistant Treasury Secretary for Tax Policy was Harvard's Stanley Surrey. In fact, according to Norman Ture, most of the provisions of the Reagan tax bill were pulled off the shelf at Treasury by career bureaucrats who had been students of Surrey. In other words, Tip O'Neill would have no trouble rounding up Democrats to vote for the tax bill as long as he knew it would cut politically against Reagan and the GOP. He would probably feel the President should be able to deliver a majority of the House Republicans before the Democrats could supply the needed votes for passage. But if Reagan went so far as to make a television appeal for support, Democratic leadership might be satisfied that the GOP would take all the political heat in November, even if more Democrats than Republicans voted to support the bill in the House. Such an appearance by Reagan would be so grotesque — an election-eve appeal for tax hikes from the President who had pledged the opposite — that Reagan himself would resist the idea if Jim Baker told him it was necessary. If he did, it's difficult to see how his presidency could recover, and he would take on the lame duck aura that surrounded Jimmy Carter for the last two years of his term. It would be the last straw.

The nomination of Martin Feldstein as the new chairman of the President's Council of Economic Advisers is no help. A commercial Keynesian in the Stein-Greenspan mold, Feldstein won the job by his public opposition to the third year of the Reagan tax cut. Unless Kemp is successful in winning the fight against the tax bill, we can be sure Feldstein will soon be joining Stockman, Baker et al in trying to persuade the President that he must "postpone" the next installment of the tax cuts.

Finally, the White House announcement August 9 that the President had succeeded in turning Lyn Nofziger inside out — that instead of leading the anti-tax movement with Kemp he would coordinate the pro-tax movement with Reagan — underscores the determination and brilliance of Jim Baker in this "struggle for the heart and soul of the Republican Party." That he could so easily turn Nofziger around in an attempt to isolate Kemp suggests that the financial markets have every reason to be anticipating another Reagan victory.

How has this happened to Ronald Reagan? The question comes up again and again, and the only answer that makes sense is, "Little by little." If you surround yourself with people who defer to the same theorists that dominated economic policymaking in the Nixon-Ford-Carter administrations, it's only a matter of time before the President converts his entourage or vice versa. Jim Baker has made sure the President would be isolated in this process and that Reagan would be the transformed.

The transformation conforms to the recipe for "Boiled Frog," which allegedly came out of France: If you take a frog and drop it into a pan of boiling water, it will instantly feel the pain and leap out. But if you put it in a pan of cool water and turn up the heat ever-so-slowly, a degree at a time, the frog never notices the change from moment to moment and is eventually overcome. The only difference here is that President Reagan has been "baked."