Outline of a Budget Deal Jude Wanniski November 16, 1995

The impasse between the President and Congress over the budget may soon be broken. The solution began to appear yesterday when Senate Majority Whip Trent Lott indicated an opening in the dispute over numbers generated by the computers at the Congressional Budget Office and the U.S. Treasury. The deal would involve a Republican concession on economic assumptions in exchange for a tacit acceptance by the Democrats of a full restoration of the capital gains promise in the House GOP Contract With America. This would mean bringing back to life the prospective indexing of capgains, which was aborted by the GOP leadership, including Speaker Newt Gingrich, in order to stay within the CBO’s more stringent economic assumptions. Gingrich was forced to accept the killing of indexing because of the tepid support it received among Republican Senators on the Finance Committee, including the two presidential candidates -- Bob Dole and Phil Gramm. The Senators threw it over the side in order to use the money “saved,” about $22 billion over seven years, for relatively inconsequential tax breaks.

The GOP firebreathers in the House have so far refused to consider concessions to the Democrats on the CBO budget assumptions. They have objected on the grounds that the extra $350 billion projected by the Treasury computers were engineered in order to produce funds for social spending. The differences in the economic assumptions are trivial -- a 0.2% rosier projection on Gross Domestic Product and a 0.1% rosier outlook on the Consumer Price Index. But even tiny base line assumptions compound into big numbers over a seven-year stretch, when we start with a $5 trillion economy. The House Republicans should understand that the price they are paying for their principled stand is an economy that will grow much more slowly because of the death of indexing. They don’t immediately see this because the computers that generate both sets of numbers are incapable of understanding the impact of capgains indexation on economic growth. 

Since indexing was killed, the divergence of capital values on the NYSE and NASDAQ demonstrated the relative importance of indexation to young business. The blue chip Dow Jones industrial stocks have climbed steadily toward the 5000 mark, which it should now easily reach. At the same time, the capital hungry NASDAQ stocks have taken a beating. The mature companies that have most of their capital gains behind them will benefit most from the 50% exclusion on capgains, plus the changes in depreciation schedules and costly corporate welfare R&D subsidies. Indexation is far more important to capital formation at the level of incipient business and new high-tech enterprise that will need several years to mature. To new enterprise, the compounding of the inflation premium over several years of maturation exceeds the benefits from a 50% exclusion. We’re not simply talking about the Microsofts and Intels. We mean the flow of capital right down to Ajax Mousetrap Co. in the South Bronx. Reviving indexing could mean the difference for 50,000 or so new incorporations next year, a few of whom would eventually become blue chips. It is easy to see why Republican Senators, who are far more influenced by blue chippers, would so casually kill indexing in order to give a break to Octopus Inc. 

In fact, this was the original impetus behind the founding of Empower America, bankrolled by Ted Forstmann of Forstmann, Little & Co. and a few of his entrepreneurial friends. There are lobbying groups in Washington for every kind of business, but none for unborn businesses. Jack Kemp, a director at Empower America, has been meeting with Republicans on Capitol Hill and working the telephones all week trying not only to figure a way to break the budget impasse, but also to do it in a way that revives capgains indexation. 

The markets are certainly sanguine about the general prospects of seeing a reconciliation sometime soon. The crisis over the debt limit is resolved, with the President having decisively won that round. Gingrich still looks a little silly blaming what amounts to his personal defeat on the President’s refusal to talk to him on Air Force One. The New York Daily News covers its front page this morning with a caricature of Newt as an infant in diapers, bawling his eyes out next to a headline: CRY BABY. On the other hand, Republicans now have a clear opportunity to win back public approval of the way they are handling the budget, by sending up Continuing Resolutions to get the government back to work until the President realizes he has to stop vetoing them. The President is already overplaying his gloat. If Gingrich would finally acknowledge that he has made a few mistakes himself in his handling of the matter, the way would be clear for him to force the kind of deal on the White House that his friend Kemp is urging. The Speaker should be able to persuade his hot-blooded revolutionaries that the revival of indexation, one of the Crown Jewels of the Contract, is worth splitting the difference with Clinton on the budget assumptions. The deal would give the President a small but significant cash pie of his own to cut up, thereby again demonstrating his relevance.

A bit of a philosophical hurdle has to be leaped to satisfy House Budget Chairman John Kasich, and the other GOP firebrands who are bent on shrinking the nominal size of government. The deal described gives up some of that ground to the President. Kasich, a champion of the capgains provision, would at least see that the deal as described clearly shrinks the relative size of government. 

The President has now had to cancel his Japanese trip in order to work this out. If this outline of a deal makes sense, there is no reason why it could not at least be secured by Thanksgiving. That’s something to shoot for.