Bulls & Bears on the Internet Jude Wanniski May 3, 2000

This will be the first of a continuing series on the forces that are bearing down, and up, on the New Economy. Of course, these are political forces, as the Old Economy has a vested interest in slowing the New by using its political weight in the three branches of the federal government and in states and municipalities as well. In my conference call today, which will replay through May 10, I suggested that we use Warren Buffett as the perfect example of a man who has made a great fortune the old-fashioned way and lately has been losing a great fortune the old-fashioned way, and does not like the New Economy at all. Tongue-in-cheek, but serious nevertheless, he recently suggested a 100% capital gains tax on assets held less than one year! If such a measure were to pass into law, capital would dry up immediately for infant industry. The Old always will try to defend itself through Security measures that attempt to defeat its opposite, Risk-Taking.

The best news we can report today is that Senate Majority Leader Trent Lott, a member of Senate Finance, has asked the committee staff to draft legislation to cut the capital gains holding period to three months from its current twelve. He did so in response to the argument that the market sell-offs approaching April 15 both last year and this year were the result of middle-class taxpayers having to sell shares at distress prices before their gains qualified for the lower tax rate. I’d mentioned the problem last week at dinner to Jim Treffinger, the Essex County Executive, who is running in the Republican primary for U.S. Senate in New Jersey on June 6, to fill the seat being vacated by Frank Lautenberg. Treffinger understood the problem immediately and the following day wrote a letter to Lott urging the cut to three months. Meanwhile, I talked to Sen. Bob Torricelli, a Democrat who I backed in his Senate race in 1996, precisely because he understood the power of the capital gains tax to inhibit economic growth and productivity -- breaking with his party line on the issue. As of this morning, Lott and Torricelli plan to co-sponsor a bill that Lott, as a member of the Finance Committee, will introduce. I’m told by Lott’s staff that he wants to do it this way to show how serious he is about solving this problem now and not waiting for a new administration. It is not a pro-forma measure on his part. Torricelli also would like to append an exclusion for the first $2,000 of a family’s capital gains each year, an idea that had been part of a measure he co-sponsored last year, with Republican Paul Coverdell of Georgia, which was bottled up.

House Ways&Means Chairman Bill Archer now is stirring the pot on a major piece of tax legislation he will try to push through the House, but there are very slim chances of comprehensive tax legislation making it past a Clinton veto this year. Vice President Al Gore, representing the forces of Security, will oppose any “risky schemes,” but probably would not resist this seemingly innocuous measure. The partisan fights on capgains have been on rate cuts, which are said to benefit the rich, not the holding period. A three-month period would be magnificent for the New Economy, liquefying capital as it is needed most in the infant industries. The other factor pushing in that direction is the burgeoning Treasury surplus in FY2000 -- still officially $180 billion, but almost certainly $240 billion, swollen by economic growth and the capital gains tax receipts. At some point, Gore’s political advisors are going to suggest he play down the risks of tax cuts in this area, or fall further behind in his contest with Texas Governor George W. Bush. Torricelli, chairman of the Senate Democratic Campaign Committee, is in a good position to make this work this year. I’m more encouraged on this issue than on any I’ve seen in this area since capgains was cut to 20% from 28% in 1997, a great boon to entrepreneurial capitalism.

Internet taxation, on the other hand, is a bear of an issue. Everyone in both political parties is for an extension of the tax moratorium this year, which in itself tells you why the moratorium itself is meaningless. The New Economy coalition is asking Congress for comprehensive protection from taxation, which would mean a reaffirmation of the Constitutional principle against interstate taxation. As our Karen Kerrigan pointed out in our conference call today, the “nexus” issue is the central one facing e-commerce. State governors led by Utah’s Mike Leavitt, mayors, and large retailers like Wal-Mart who have a presence in every state, are drawing up battle lines in the courts that will provide an incessant harassment of the dot.coms from myriad angles. The issue will not be decided conclusively until cases reach the Supreme Court. Karen points out that there will be plenty of federal and state judges willing to agree that it is not fair to slap a sales tax on Wal-Mart when it sells you a book and not slap one on Amazon, because it only has a physical presence in Washington State. There is enough complexity to feed trial lawyers on these issues for a long time, and meanwhile the risks of clouds appearing over the entire industry will roll in at a steady pace.

Will the House Judiciary Committee under Chairman Henry Hyde deal with these issues in a comprehensive way? Probably not. Congress will “punt,” Karen believes. So have the two putative presidential nominees, Bush and Gore, who are trying to avoid taking sides on this messy issue, wanting to be loved by both Old and New economies. My best guess is that the New will advance without major setbacks this year, meaning continued swings in the Internet stocks, but with the NASDAQ finishing the year nicely above where it is now. The Old, by the way, is not an illegitimate force. It must be accommodated. The issues produce all kinds of odd opinions. We have one client who favors a zero capgains tax, for example, but as a value investor opposes a three-month holding period at the current rate.

These forces bearing down on the Old and New economies are not all we worry about. The weakness in the overall market is clearly connected to the victories of the Old Economics on monetary policy. All our old supply-side allies, unable to explain the behavior of the market in their distinctive models, are drifting back into monetarism. The WSJournal editorial page now worries about “inflation” on the horizon amid concerns about the “money supply.” Arthur Laffer, who taught me about efficient markets and the irrelevance of the monetary aggregates now is arguing the market is inefficient because it does not realize the monetary aggregates are too high. Larry Kudlow has joined Laffer in seeing an inflation bubble in the market resulting from the Fed’s cautionary printing of cash in advance of Y2K. The Dallas Fed President, Robert McTeer, the one regional president we could count on to resist interest rate hikes to fight a non-existent inflation, now thinks he sees inflation, with gold off 9% from its $300 level earlier this year. The WSJournal news department has been suckered by the argument that the inversion of the yield curve is a result of a shortage of 30-year bonds, so it has decided to make the 10-year bond its “benchmark.” Because the shorter term has a higher yield, this only makes it easier for the Fed to see more inflation on the horizon. Suddenly I have a picture of Casey Stengel managing an early New York Mets game where the players made one bonehead play after another: “Doesn’t anyone here know how to play this game?”