Twenty
Counterpoint: The Improbable Triumph of Tax Reform

As Congress finished its budget cycle, a half-year late, another issue reached its crisis point. On April 18, 1986, Chairman Packwood broke off the deliberations of his Senate Finance Committee on a bill to reform the tax system by lowering rates and reducing preferences. The bill, President Reagan's prime domestic priority, was being picked apart by the senators, who kept restoring benefits that Packwood proposed to eliminate.

Because it was "revenue neutral," supposedly neither raising nor lowering the deficit, the Tax Reform Act of 1986 might not seem integral to the battle of the budget. Yet tax reform rearranged the landscape for all future efforts at deficit reduction by eliminating many preferences that might have been targets for the budgeters. As a model of what is conventionally termed the "public interest" (fewer exceptions and lower rates) in battle against "special interests" (holders of preferences), tax reform also poses the major issues about our political system that are raised by the budget battles. Can Congress govern? Can it overcome myriads of private interests by imposing on them its own version of a public interest?

Preferences as Policy

We have seen that tax "breaks" or "loopholes" or, in more neutral tones, "preferences," are both easily criticized and a normal part of government. In addition to (or in place of) raising revenue, tax laws may include provisions providing relief from taxes for people who act in socially desirable ways. Using tax provisions as an instrument of policy, furthermore, may accomplish purposes that other legislation, such as appropriations, cannot. Tax advantages may be used as leverage, attracting

investment or providing the margin that allows a family to buy a home. At the same time, use of the tax code rather than direct spending can have strange consequences. It is hard to imagine housing subsidies that increase with a person's income being approved as an appropriation, yet this deduction costs billions and is politically sacrosanct.

The government manifests its preferences through the tax code as one of a number of instruments of public policy. Nothing wrong (slimy, sleazy, even faintly illicit) there. Tax legislation may suffer even more seriously than other policy making from common difficulties of the legislative process: complexity obscures choice from all but the directly interested; committees are "captured" by special interests; politicians help groups in return for groups helping them.

Although some U.S. citizens say that taxes should be levied for revenue purposes only, other countries do not practice this doctrine. Everywhere, taxes are used to regulate behavior—whether through sin taxes on commodities that elites believe bad for the masses or by exemptions, such as those relating to the arts, that elites believe good for themselves. Taxation is a major instrument of public policy.

Many of the tax code's preferences are based on notions of equity. Imagine, if you will, a simple income tax with no preferences. Taxpayer A is a young man with an income of $20,000 living by himself in a rented villa. Taxpayer B is a blind, old-age pensioner who supports his wife and two disabled children in their family home on an income of $20,000 a year—from disability and pensions. In a nonpreferential system, A and B would pay exactly the same tax. Equity would appear to require not simplicity but complexity so that B ends up paying less than A.

Can the amount of tax expenditures be known? Yes and no. Yes, it is possible to estimate roughly the loss of revenue to the Treasury from provisions such as accelerated depreciation, or deductions for medical expenditures, or not counting fringe benefits as income. No, it is not possible to estimate accurately. When tax process provides incentives, motivations are involved. How is one to know whether the taxpaying entities concerned, once blocked in a certain direction by abolishing or reducing a preference, will not take action to counter the expected loss of income? As the common scare story goes, to cut the mortgage interest deduction will reduce home starts, driving the housing industry and the entire economy into a slump that reduces revenues. Exaggerated, perhaps, but some backfire is possible. To estimate the synergistic effects of preferences on incentives may well be beyond existing capabilities.

Most returns—about 60 percent—do not itemize deductions. Yet in 1984 over 38 million did itemize. Over 10 million, most with incomes under $30,000 per year, claimed deductions for medical or dental expenses. Deductions for other taxes were claimed by 38 million; 27 million

claimed for home mortgage interest; 35 million for charitable contributions. Out of $359 billion in itemized deductions, about $281 billion, nearly 80 percent, were claimed in those categories. The bulk of tax preferences are for categories that are hard to stigmatize as special interests.^[1]

Because preferences are worth more at higher incomes in a progressive tax system, a large part of the deductions goes to a comparatively small number of taxpayers. In 1984, about 12.7 million returns (13 percent) claimed about half of the deductions. They paid a slightly larger share of the taxes.^[2]

No instrument of public policy is good for all purposes. The dilemma involved in extensive use of tax preferences is well known to observers: individual and collective rationality are at odds. Though the vast bulk of tax preferences originates in the desire to achieve some self-evident good—locating industry in areas of high unemployment, increasing the supply of vital commodities, fulfilling the dreams of home ownership—the collective consequences of reducing taxes for these items may be undesirable. The number of preferences, the fact that they have been adopted at different times and hence may work at cross-purposes, and their high rate of interaction with each other and with existing provisions have led to a complex code. The large amounts by which preferences reduce the revenue base require higher marginal tax rates. Worst of all, to the taxpayer this combination of complexity and cost leads to delegitimation of the tax process; most people suspect other people of cheating. The very language used—"loopholes" and "gimmicks"—suggests that it has become morally suspect to make legal and proper use of those statutory provisions deliberately designed to encourage such behavior.

What, in fact, was meant by "reform"? Essentially three things: lower rates, fewer brackets, and fewer preferences. The key words were "fairness" and "simplification." "Fairness" is used in the sense that people would be treated, if not equally, then proportionally to their financial condition. The existing system was held to give some people opportunities that others could not enjoy. Why should cattlemen, or oil drillers, or union members (with good health benefits) get special treatment? To those who disliked a progressive tax, the flat tax—one rate for all—seemed fair. Ronald Reagan had long been in that camp; while lecturing for General Electric in the 1950s, he had described the progressive income tax as "created by Karl Marx." "It simply is a penalty on the individual who can improve his own lot; it takes his earnings from him and redistributes them to people who are incapable of earning as much as he can."^[3]

Fewer brackets—either one (a flat rate), or three (as in the Bradley-Gephardt proposal), or some number much less than the then-existing

fourteen—sounds simpler, as does reducing the number of preferences. Actually, the appearance of simplification was deceptive. In practice, most people calculate their tax from tax tables; and no matter whether the amount owed for a particular taxable income was calculated from three or thirty brackets, the table would look no different. Also, the vast majority of taxpayers were using only a small number of the available preferences, some of which (like nontaxability of fringe benefits) required no individual effort. Yet filling out tax forms was still a bother; people did not like hiring experts to protect them from the IRS. The populist appeal of simplification was power: a simpler system would make people less dependent on experts. Rich people could afford to hire experts; the common man could not. In the same vein, simplification promised openness, a more transparent system. But simplicity and fairness, as tax experts know, are at odds. For fairness requires distinctions that complicate tax returns.

Which was better for economic growth, targeted preferences or lower marginal rates? The theoretical debate—selective versus universal incentives—merged, as usual, into empirical differences: one side found marginal rate reduction to increase individual incentives and the other claimed selective tax preferences to encourage investment to be superior. Tax preferences to aid industry became a contested concept. Some market-oriented politicians began to see tax preferences as subsidies that distinguished unfairly between different industries, a question only market competition should decide. There was no single obvious truth, but multiple truths.

The Origins of Tax Reform

The first step toward radical change is to delegitimate the existing system. A very good job of this was done by all sectors of opinion from the mid-1960s through the mid-1980s. Those who thought domestic government was far too big naturally thought they were paying too much for it. Those who approved in general of various governmental programs protested that the system taxed the poor too heavily and the rich not enough. The criticism's harsh edge developed from the growing feeling that "other people" were not paying their proper share. Between charges that the system was morally corrupt in favoring the well-to-do and economically irrational in encouraging businesses to seek tax losses the existing tax structure had few defenders.

But where were the centrists who usually can be counted on to defend the nation's institutions? Those actively involved in making tax policy, like former Representative Barber Conable, now head of the World Bank, believed that the tax code was complicated for a good reason:

almost every provision existed in response to a cry for equity from some deserving group. But they lost support.

In a heartfelt statement to his Senate colleagues explaining how he became converted to tax reform, Senate Finance Committee Chairman Robert Packwood insisted that tax preferences were moral. In order to appreciate the position of many experienced legislators on tax preferences, as well as to empathize with their moral defensiveness, Packwood's words in describing witnesses at a tax hearing are quoted at length.

But, indeed, everybody in this country belongs to some special interest….

Blue Cross-Blue Shield, a nonprofit medical insurance group that exists in all of the States. They are, at the moment, not taxed. They very frankly said, "If we are taxed, we are going to have to raise the premiums for all of our subscribers."

Is that greed? Is that evil? Were they malevolently motivated because they did not want to have to increase the premiums that they charged to all of their subscribers? Are they a special interest?

Another witness: Bread for the World. This is a low-income, poverty group interested in feeding the poor throughout the world.

The Children's Defense Fund. An extraordinary organization that has done extraordinary things in this country in the last 10 years. A greedy, special interest?

The Coalition on Smoking and Health. They are trying to alert this country to the continued dangers of smoking.

Common Cause. Of all the groups that, I think, to themselves might deny being a special interest, it would be Common Cause although they often allege that others are guilty of that. They testified.

Environmental Action.

Hale House. That wonderful, wonderful organization in New York that Dr. Lorraine Hale founded that takes care of narcotic-addicted newborn babies that have become addicted and abandoned because their mothers were addicted. She had a problem with the tax bill. Greedy, special interest?

Next is the umbrella group that represents almost all charities in this country. They were worried about charitable contributions….

The solar lobby. A wonderful group of people who are trying to encourage the use of solar energy. We have solar tax credits in the law now, and they were afraid those might disappear.^[4]

Preferences, Packwood argued, in our opinion, correctly, were mostly about worthy causes.

This party of balance found its voice drowned out by the cacophony of criticism. Therefore, the very desire of its adherents to legitimize American institutions led the centrists to worry that, whatever the cause, the tax system no longer commanded support.

The idea of a broader-based, lower-rate income tax has been in the

air since the end of the Second World War. Among economists and tax lawyers, it had two main sources of support: liberals and libertarians. As tax preferences proliferated, Professor Stanley Surrey, an author and a Treasury official, mounted a campaign to have preferences called by what he considered their right name—tax expenditures.^[5] Joseph Pechman and other economists joined in the criticism with calculations showing that tax rates could be much reduced if revenues were not siphoned off through these tax expenditures.^[6] They hoped to make support of government programs more sustainable both by requiring a vote on subsidies and by keeping rates down. Pechman and his colleagues (at the Brookings Institution and throughout the liberal academic community) worked during two decades for reform, never suspecting that their most powerful ally would be, of all people, Ronald Reagan.

Preferences, to libertarians, were subsidies that distorted markets and at the same time increased the scope of governmental intervention. Far better to remove preferences so as to lower tax rates and simultaneously to lessen governmental intervention while enhancing the performance of the private sector.

The contemporary story began on August 5, 1982, when Senator Bill Bradley and Representative Richard Gephardt introduced their Fair Tax Act. Just as President Reagan liked to tell about how he cut back his acting schedule when tax rates became nearly confiscatory during the Second World War, Bradley, a basketball star, couldn't quite get used to being a "depreciable asset."^[7] He, too, had considered how to reduce his taxes and, on behalf of the players' union, taxes of other athletes as well.^[8] Bradley won a seat on the Senate Finance Committee in 1980 and began to immerse himself in tax provisions. At the same time, from his seat on House Ways and Means, Gephardt began to view tax preferences as a means of promoting special interests. The tax system, he thought, had gotten out of hand:

It is all vivid to you because you see the storm window manufacturer coming and saying, "We've got to have this credit for storm windows in order to have a good energy policy for the country." And you see it go in the code, and you see the regulations written three years later … and when you watch all that I think you begin to question what we're doing.^[9]

Sometime in 1983, according to David Stockman, Secretary of State George Shultz, also a noted economist, had suggested a flat tax to the president. Perhaps the president was too far out of touch to see that the idea was unfeasible. In any event, he is reported to have scribbled a note to Secretary of the Treasury Don Regan on the back of an article on the flat tax saying the idea was a good one.^[10]

Earlier that year, Jack Kemp met with a number of intellectuals

identified with supply-side economics—Paul Craig Roberts, an economist with a year in the Treasury;^[11] Lewis E. Lehrman, a business man who had narrowly been defeated for governor of New York; Jude Wanniski and Alan Reynolds, economic consultants; and Irving Kristol, professor at New York University, editor of The Public Interest, and an intellectual leader among neoconservatives. Kristol suggested that Kemp back the Bradley-Gephardt bill. "We all came to the conclusion," Kemp recalled, "that Kristol was right, that Reagan and Kemp should endorse Bradley-Gephardt. That would have thrown the Democratic Party into a state of real confusion because Mondale was getting ready to talk about a surtax [to reduce the deficit] and Bradley and Gephardt were talking about growth and jobs—just what supply-siders had been talking about in the 1970s."^[12] The campaign group in the White House was leery of the proposal. But that was not to be the end of it.

Following the president's lead, and his own distaste for the jumble of preferences in the tax code, Secretary of the Treasury Don Regan wanted the chief executive to come out for a flat tax in the 1984 State of the Union message. Chief of Staff James Baker asked Regan to hold off, however, on the grounds that any precise plan would call needless attention to details, anger some people, and might subject the president to premature, possibly harmful criticism. Mondale's talk about an excise tax was target enough. Don Regan agreed to hold back, but he and the president wanted at least to signal their intent in his State of the Union message on January 25, 1984. They may have laughed when he sat down at the presidential piano, but they sang along when they heard the melody. "For the first time in a generation," Senator Edward Kennedy, hardly a Reagan idolater, boomed out as the Senate was considering tax reform in June 1986, "the impossible dream of tax reform is on the threshold of reality, and it is our responsibility to make it happen."^[13] Getting from ironic laughter to a sing-along took two and a half years.

The Politicians Try Tax Reform

The secretary of the Treasury assembled a team of specialists to work out a policy from which to start, a trial balloon to cause reactions that would produce information about budgetary and political feasibility: Is there enough latitude in preferences to allow for lower rates, and, if there is, might there be sufficient support?

Despite the president's decision to postpone the Treasury report until after the 1984 elections, politicians with similar programs were motivated to act. On April 12, Senator Bradley and Representative Gephardt announced a petition drive to mount public support for their fair tax. A few days later, the new Populist Conservative Tax Coalition, chaired by

Richard Viguerie (a political operator who sparked use of mass mailing and computerized telephone techniques) announced a drive to garner a million signatures for a 10 percent flat tax.^[14] The symbols used—"fair" and "populist conservative"—showed possible signs of political coalition. If fair is populist and populist is conservative, maybe the two sides can get together. But not at 10 percent!

On April 26 Representative Jack Kemp and Senator Robert Kasten introduced their "fast tax." Like Bradley-Gephardt, Kemp-Kasten would have eliminated deduction of state and local taxes, repealed the investment tax credit, raised personal exemptions, and continued the housing deduction. Kemp-Kasten was flatter—24 percent as opposed to 14, 26, and 30 percent—and provided larger preferences for investment.^[15]

During the year other proposals emerged. They ranged from a consumption (cash flow) tax, to across-the-board reductions in tax preferences (base-broadening), to a flat tax—essentially, the Hall-Rabushka scheme for a 19 percent flat rate on all business and personal income with a large personal deduction to get poor people off the rolls.^[16]

As the presidential campaign warmed up, Senator Bradley tried in vain to convince Walter Mondale that it was essential to increase the perceived fairness of the tax system before trying to raise revenues that would reduce the deficit. Nevertheless, Mondale chose to focus on the deficit, and proposed raising taxes.^[17] The Democratic party platform, along with castigating the existing system and criticizing President Reagan for taking from the poor to give to the rich, pledged itself generally to broaden the tax base and shift the tax burden.^[18] BY contrast, the Republican platform came out for a "modified flat tax."^[19] Following its president, the Republican party pledged that "tax reform must not be a guise for a tax increase."^[20]

During summer 1984, top Treasury officials met to review tax reform proposals.^[21] In response to assertions that wholesale reform "would never fly on the Hill," Secretary of the Treasury Don Regan replied that "I don't want to hear about the politics of it. If we worry about the politics, we'll never get anything done."^[22]

The idea of a flat tax was dropped because the rate would have to be too high. A close adviser to the president recalls that at 19 percent, "it would mean a lot of increases for a lot of people." Instead, the Treasury tax staff, trading tax preferences for lower rates, came up with personal rates of 16, 28, and 37 percent and a corporate rate of 28 percent. Ronald Pearlman, who succeeded John "Buck" Chapoton as assistant secretary for tax policy, felt that the disparity between the top rates for individuals and corporations was so large it would encourage the movement of resources, so he lowered the individual and raised the corporate rate. "If we're so close," Don Regan asked and advised, why "can't we get to 15,

25, and 35 percent?" Now the top personal rate, coincidentally, would be just half of the 70 percent rate in force when the Reagan administration took office. Lowering the individual rates meant raising the corporate rate to 33 percent, still substantially below the 46 percent rate when Reagan became president.^[23] Following a series of hearings in which House Ways and Means member Charles Rangel (D-N.Y.) provided vivid examples of how large a proportion of income was taken from the working poor, the Treasury plan was modified to keep many of this group from being taxed at all.^[24]

The 262-page Treasury report on "Tax Reforms for Fairness, Simplicity, and Economic Growth" that appeared after the November 1984 election pulled few punches: business taxation was "deeply flawed"; its subsidies to favored industries "distorted choices"; tax shelters for the wealthy "undermine confidence in the tax system." What more could tax preferences, with their accompanying high rates, be accused of than discouraging "saving, investment, invention and innovation"?^[25]

The price for reducing corporate and personal tax rates was high: eliminating the low rate for capital gains (which, however, would be indexed) and wiping out the investment tax credit, accelerated cost recovery system, deductions for state and local income and sales taxes, and for parts of fringe benefits. In sum, personal taxes would be cut by $148 billion while business taxes would rise by $165 billion.^[26]

If one picked a bunch of tax economists and lawyers at random, gave them the constraint of revenue neutrality, and told them to come up with a large-scale reform, Treasury 1, as it was called, would be it. Treasury 1 bespoke a commitment to free-market economics, supporting enterprise as a general concept rather than for particular industries.

But not without a struggle. The assistant secretary of the Treasury for economic affairs argued strongly in favor of retaining tax incentives for capital investment. Secretary of the Treasury Regan ruled against him.^[27] Indeed, after much debate and not a little soul searching, his other assistants persuaded Regan to go for evenhandedness by having capital gains taxed at the same (now higher) rate as ordinary income. Reagan was told that indexing the original investment against inflation would better protect the investor who saw his stake reduced in value by years of inflation.^[28]

Treasury 1 raised howls from the business community and cries of glee from Democrats. After debate within the White House, the president chose to treat the plan as Treasury's, not his, but a good start. On December 7 (perhaps the losers saw it as another Pearl Harbor) President Reagan praised the Treasury plan as among "the best proposals for changing the tax system that have ever occurred in my lifetime." And, in his State of the Union message on February 6, President Reagan

sought to get Congress on the move by issuing a call for "historical reform."^[29]

Words of caution were heard. Don Regan, who had become chief of staff, said Treasury 1 was written on a word processor and could be changed. Republican members of the House Ways and Means Committee urged the president not to allow tax reform to divert attention from the deficit. Undersecretary of the Treasury Richard Darman agreed.^[30] Still, the president, waxing eloquent in his State of the Union speech, had spoken of "restoring fairness to families" by increasing the personal exemption and exempting the poor. Why, Congress could "pass, this year, a bill … making this economy the engine of our dreams, and America the investment capital of the world."^[31]

There were the usual charges of presidential misunderstanding, only this time from the other side. Despite Reagan's reassurance that capital formation would be protected, Jack Albertine, president of the American Business Council, complained that the man in the White House did not seem to realize that increased taxation of capital gains was part of the Treasury plan.^[32] A group of ninety-seven House members wrote to the president protesting against the higher rate for capital gains.^[33] Lobbyists for the Independent Sector, representing nonprofit groups, and charitable agencies spread concern about the effects of lower rates on donations. As the chorus of protests swelled, White House efforts to distance the administration from commitments to specific provisions created doubts of its commitment to reform.

Politicians and public officials were full of folk wisdom about why nothing much would be done. California Democrat Fortney H. (Pete) Stark, chair of the House Ways and Means Subcommittee on Select Revenue Measures, observed that "leveling the playing field"—a congressional term for reducing tax breaks, so that individuals and industries were treated alike—meant that "the guys who are going to go down are going to fight like hell." His prediction in November 1984 was that "Congress in the middle of something like that never does anything courageous." Stark was seconded by Representative Gephardt, who observed, "My experience in politics leads me to believe that people who are about to lose something tend to be more effective than people who are about to experience a continuation of the status quo even though they don't like it." As the committee's chief counsel, John J. Salmon put it, "There are only big cats and dogs left and they bite."^[34]

No one could be more experienced than Wilbur Mills, chairman of Ways and Means from 1958 to 1974. He summed up the difficulty: "There's no constituency for tax reform. People who've got deductions don't want to give them up, and, while most people might be better off, it's hard to convince the public." Indeed, it is, if only because various

segments of the general public want different things. Various polls taken in 1982, for instance, revealed strong support for both a flat tax of 14 percent for everyone, with no preferences, and a progressive income tax. Public opinion analyst William Schneider concluded that, although the public was dissatisfied with the tax system, the people were also reluctant to depart from it.^[35] In a more refined analysis of opinion, on particular provisions studied over many years, John Witte (author of the best study of the political aspects of the income tax) concluded that dissatisfaction with the system as a whole is overcome by a lack of support for alternatives. Item by item, Witte finds, contrary to his initial expectations, that the internal revenue code is exquisitely sensitive to whatever public preferences exist.^[36]

In mid-1985, starting with the view that paying taxes is hardly a popular activity, Everett Carl Ladd (executive director of the Roper Center for Public Opinion Research) nevertheless found no "populist groundswell" for reform. In a Los Angeles Times poll in January 1985, 59 percent agreed that the present system was unfair, but the same proportion believed they had personally paid the right amount of tax; from that Ladd concluded that "there certainly isn't what I would call significant resistance to the present tax structure."^[37]

In the face of "instant obituaries" for tax reform in Business Week and other publications, Ronald Reagan began to reassert that he was serious. He and his people were "totally dedicated" to tax reform, the president told a reporter at his press conference. Worried that the reform would be used to raise taxes to reduce the deficit, Reagan said also that "we're not sending them [the spending budget and Treasury 1] up there [to Congress] as a package that somehow people can begin trading between one and the other."^[38] If tax reform turned out to be a tax increase, he might well lose on both counts as his supporters deserted him on the increase and his opponents raised the ante for taxing high incomes. Accommodation would become impossible.

For months Senator Bradley, whose own proposal resembled Treasury 1, had said he would wait for the State of the Union message before lending his own weight to the enterprise; he wanted to see how strongly the president came out for reform. Praising the speech as a major step, Bradley raised the level of commitment: "He's [Reagan's] got to go directly to the people if he's going to counter the special interests."^[39] House Ways and Means Committee Chairman Dan Rostenkowski also told everyone in sight that the president's "got to take the heat with the rest of us. A list of lofty principles is not enough."^[40] Rostenkowski's ally on Ways and Means, Don Pease (D-Ohio), made the quid pro quo clear: "We won't get any place unless President Reagan is willing to invest a lot of his personal time, energy and political capital in trying to get it

through. If we don't get a signal he's trying to do that, I think the committee will not go through the motions."^[41] Democrats and other politicians wanted the "great communicator" to rally the public against the lobbyists.

In spite of what the New York Times called "an extraordinary personal effort" by Reagan^[42] to generate that support in speeches and in meetings, he failed. The very fact that he kept trying despite lukewarm response, however, meant that it was worthwhile for others to keep trying. Had President Reagan just sat there waiting for others to take the lead, tax reform would have languished.

New Senate Finance Chairman Robert Packwood was no fan of reform: "I do like to use the tax code for incentives," he told anybody who would listen. "I sort of like the tax code the way it is."^[43] But other potent people saw promise. Packwood's new chief of staff to the Finance Committee, William M. Diefenderfer III, saw a chance to broaden the appeal of the Republican party. Diefenderfer characterized himself as one of the "many [who] feel we need a major occurrence [like tax reform] to have the average guy say, 'yes, indeed, the Republican Party is my party.'"^[44] Similarly, Dan Rostenkowski, the strongest supporter of tax reform among House Democrats, argued strenuously with skeptical colleagues stressing that "our first order of business is to reduce rates for the people. That's a good Democratic position for us to be in…. I'm sure Ronald Reagan is going to try to steal that thunder."^[45]

Rostenkowski Delivers

In regard to philosophy, Dan Rostenkowski thought it wrong that working people, like his own daughter, had to pay so much in taxes. Aware that a person of his background, who plays politics with such evident relish, might not be thought of as embodying the national interest, Rostenkowski explained that "I want to be a patriot, too. It sounds like corn but, if we get no credit at all on this tax reform bill, my God, we're elected to do what's right."^[46] Rosty and Reagan had come a ways since 1981, when they competed for votes with the commodity tax straddle.

Credit or not, the Ways and Means chairman's prestige depended on passage of some sort of tax reform. Rostenkowski had not fared too well in past years. Badly beaten by the across-the-board tax cuts of 1981, having to dodge the House floor to pass TEFRA in 1982, he had eventually consolidated his influence in his committee and on tax policy but not in a way that won him much credit as a leader or innovator. Rostenkowski was looking for a winner. Tip O'Neill had announced his retirement. Would Rosty run for Speaker against James Wright of Texas? "I'd like to see the kind of tax reform plan the House can produce

first," he responded. "Winning a big fight over a tax bill can make you do just about anything."^[47]

On May 28, President Reagan gave a major address from the Oval Office outlining his revised tax reform proposal. He appealed to common feelings: "Well, how many times have we heard people brag about clever schemes to avoid paying taxes or watched luxuries casually written off to be paid for by somebody else—that somebody being you? I believe that in both spirit and substance, our tax system has come to be un-American."^[48] Reagan's appeal could have been dismissed as just more fine words from a master wordsmith. Instead, Rostenkowski, in the Democratic response, echoed the president's rhetoric and laid claim to its Democratic heritage:

Trying to tax people fairly: That's been the historic Democratic commitment…. My parents and grandparents didn't like to pay taxes. Who does? But like most Americans they were willing to pay their fair share as the price for a free country where everyone could make their own breaks.

Every year politicians promise to make the tax code fair and simple, but every year we seem to slip further behind. Now most of us pay taxes with bitterness and frustration. Working families file their tax forms with the nagging feeling that they're the biggest suckers and chumps in the world….

But this time there's a difference in the push for tax reform. This time, it's a Republican president who's bucking his party's tradition as protectors of big business and the wealthy…. If the president's plan is everything he says it is, he'll have a great deal of Democratic support.^[49]

The chairman ended by asking his audience to "write Rosty"—or their own legislators—to show their support.

Rosty got 75,000 letters and a lot of praise in the media. The public response was not enough to convince other politicians to go along, but it was enough to reinforce Rostenkowski's personal commitment to producing a bill. The two speeches put Reagan and Rostenkowski in a public alliance that ensured tax reform would stay on the agenda, for now politicians would have to take public stands "for" or "against."

Responding to the attacks on Treasury 1, Treasury made a series of compromises in a new plan, dubbed "Treasury 2." It protected oil and gas interests at the insistence of the Texan Treasury Secretary, James Baker. It gave bigger breaks to upper- than middle-income taxpayers. Capital gains rates went down instead of up; state and local taxes no longer would be deductible. But it eliminated taxes for families of four with incomes of $12,000 or less, cut the highest corporate rate to 33 percent, and kept the Treasury 1 individual rate structure (15/25/35).

For Rostenkowski, Treasury 2 was not acceptable, but it was a starting point.

During the summer Ways and Means held voluminous hearings, searching for possible soft spots in group resistance. Public support for the reform effort remained "tepid."^[50] "I scheduled five town meetings on tax reform across Arkansas during the August recess," Democratic Senator David Pryor noted. "We averaged 200 to 250 at each meeting and I got no support. All that people wanted to talk about was the $2 trillion debt."^[51]

Cross-pressured particularly on state and local taxes (which New York's Governor Cuomo had made a crusade for his state's large delegation) and worried about the deficit, members of the House wondered out loud why they should bother with reform at all. Representative Byron C. Dorgan's (D-N.D.) retort—"no matter what people are hearing from back home" an "outrageously complicated and unfair" tax system had to go—was about the best plug that reform got.^[52]

The first stage of Ways and Means' effort reached its climax during markup on October 15. Chairman Rostenkowski was beaten 17 to 13 on an amendment that proposed expanding (by $4.8 billion over five years) the deductions banks can take for reserves to cover bad debts. Here ended revenue neutrality at a time of deficits. Rostenkowski was angry. Bank lobbyists, waiting in droves outside the committee rooms, were so joyous (in poring over a tally of the vote that was not supposed to be released until the next day) that one of them shouted, "We won, we won."^[53] That rankled. Were these representatives, servants of the people, really at the beck and call of the monied interests? "If I were a bank," advised Representative Fortney Stark who had been a banker, "I wouldn't start to spend that money."^[54]

The Ways and Means chairman decided to wait rather than immediately attempt to reverse the bank amendment.^[55] He believed the pressure for tax reform was essentially negative; as columnists Birnbaum and Murray put it, "Anyone who stood in the way of reform would be tagged in the press as having sold out to special interests; that was a harsh label few were eager to accept."^[56] Congressmen had to be flogged into action by the press; and failures in public, ironically, might raise press condemnation to a level that would overcome interest-group pressure. So Rostenkowski decided to let the vote "hang there," to "let them stew in it for a while."^[57]

The committee worked on other provisions while the members stewed. Rostenkowski was trying to keep within the limits of his informal understanding with Reagan: that if he hit the president's targets for rates and if the bill were revenue neutral, the president would hold fire

while retaining the right to suggest changes after the bill left the committee. They shared an interest in establishing that some bill was likely to pass if they could do so, then the changes not made would seem like benefits to the lucky nonvictims. The leaders' timing was everything. If opposition became too vocal, opponents might seek to kill reform then and there. Concessions at the right time, however, would give former opponents a stake in the bill.

On October 21, Rostenkowski made his crucial move. The New York bloc was adamant about preserving the state and local deduction; even representatives of low-tax states opposed its elimination. Tax reform's ideological opponents, like James Jones, a believer in incentives for capital formation, had allied with the New Yorkers in hopes that, with state and local deductions preserved, there was no way to get lower rates and the same revenues. After realizing they could raise revenues by lowering the brackets, so the middle and top rates applied to more income, Rostenkowski and his staff decided to cut a deal on state and local. They secretly gave in to the New Yorkers in return for support on the rest of the bill. Then Rostenkowski used that agreement, and pressure on the amendment's sponsor, Ronnie Flippo (D-Ala.), to compromise on the bank issue. He won 14 to 7.^[58]

Treasury would be upset about state and local, so Rostenkowski concealed the deal as long as possible. Because this was a provision his committee Democrats had been particularly loath to lose, however, they were relieved and encouraged.^[59] "I was always going to give you state and local taxes," Rostenkowski told a surprised colleague. "If you were," Thomas Downey (D-N.Y.) responded, "you deserve an academy award."^[60] Representative W. Henson Moore (R-La.) agreed: "I have seen a master politician at work."^[61]

After eight days of meetings, begun November 15, the committee Democrats agreed on a bill. It had a fourth and top bracket (38 percent), a higher top corporate rate (36 percent), and tougher depreciation provisions than in Treasury 2. Some House Republicans particularly objected to a provision that raised the personal exemption for nonitemizers more than itemizers (they called this antifamily; in essence, it favored poorer over richer families). The Ways and Means plan also maintained existing deductions for medical expenses and nontaxability of employer-paid health benefits.^[62] For these reasons, the administration was hesitant, hoping that some other bill could emerge from the House. Rostenkowski's version passed Ways and Means (28 to 8) on December 3, 1985; but only five Republicans supported it.^[63]

Without endorsing either the majority committee bill or the Republican alternative, President Reagan asked for a "positive vote" in the

House. However, Republicans—feeling cut out as Ways and Means Democrats caucused, believing Baker and Darman had ignored them while attending to Rostenkowski, and opposing reform anyway—were seething. Amid threats about who Ronald Reagan would not campaign for in 1986, James Baker and Richard Darman arranged to shuttle Republican House members over to see the president. "I hope you won't let me down," Reagan told them. He wanted it any way he could get it, whether the final plan was more Republican or more Democratic, and assured legislators that problems would be fixed in the Senate.^[64] Minority Leader Robert H. Michel (R-Ill.) found his members strongly opposed—"They don't want to vote for this turkey just to get to conference."^[65] "The phrase the 'Senate will fix it up' is the moral equivalent of 'I'll respect you in the morning,'" commented Bill Frenzel (R-Minn.) of Ways and Means.^[66]

A number of Democrats also disliked the bill's treatment of federal pensions, including their own. As the rule for the bill came up for debate on December 11, they rose to denounce it. They were joined by oil-state Democrats. Seizing their opportunity, Republican leaders quickly mobilized their whip organization to beat the rule. They succeeded, 223 to 202, as only fourteen Republicans voted allow consideration of their president's greatest legislative priority.^[67]

"If the President really cares about tax reform," Tip O'Neill rubbed it in, "then he will deliver the votes. Otherwise, December 11 at 12 noon will be remembered as the date that Ronald Reagan became a lame duck." Unless the president assured him of at least fifty Republican votes, the Speaker wouldn't bring the bill back to the floor.^[68]

With Darman and Baker at his side, President Reagan engaged in a personal lobbying effort. "I just can't accept we would let this historic initiative slip through our fingers," the president told House Republicans.^[69] Aside from telling them, personally, he did care about their views, the president gave GOP congressmen written assurance that he would seek to reduce the top 38 percent personal rate voted by Ways and Means (for the incentive faction); increase the personal exemption to $2,000 for everyone (for the family order faction); and provide more generous deductions for business (for the capital formation faction). Reagan succeeded in getting seventy Republicans to vote for the rule bringing up the bill on December 17, whereupon the Ways and Means plan passed on a voice vote.^[70]

Speaker O'Neill had his written statement ready when the vote took place: "Democrats tonight have rescued tax reform from the jaws of big business Republicans. We have delivered on our historic commitment to tax fairness. Only the Republican Senate can stop tax reform now."^[71]

Like the target bear in a shooting gallery, Richard Darman observed, "It [tax reform] gets hit, it rises, pauses, turns a bit—and then it keeps going."^[72]

Packwood's Conversion

In the Republican Senate there was deep concern over shifting huge tax burdens to companies that were already facing hard times. Would the country be better off, senators wondered, if individuals paid lower taxes, but there were no (or ill-paid) jobs?^[73]

And what about the deficit? Fifty senators, including seven members of the Finance Committee, wrote to President Reagan on March 4 requesting him to delay the tax bill until there was agreement on reducing the deficit.^[74] According to the originator, Senator Rudy Boschwitz (R-Minn.), who, Dole said, spoke for a majority, the Senate would "neither consider nor debate" the tax bill until the second round of Gramm-Rudman had been settled.^[75] On April 9 the Senate voted (72 to 24) in a nonbinding resolution to delay the tax bill.^[76]

Republican Senator Grassley expressed the sentiment of many when he argued that "the country would be better off if we would pass a one-sentence bill saying we're not going to change the tax law for five years." Yet, without wishing to go forward, Congress couldn't quite get itself to go back. "Tax reform," Grassley continued, "has taken on a life of its own."^[77]

Members of the Senate Finance Committee held a private retreat on January 24 and 25. They started by deciding not to begin from the House bill, which most considered put too great a burden on business. "The Ways and Means Committee has always been close to the people," Senator Moynihan explained. "Finance has always been a committee close to industry."^[78] Even so, the group agreed that their bill should be revenue neutral and should move tax burdens from individuals to business.^[79]

In March, before Finance began its markup, one episode gave meaning to such shadowy terms as "the street" and "the market." The activities of the tax committees are carefully scrutinized by those who will be affected by them. At the request of Baker and Darman, who were convinced that tax-free municipal bonds enable wealthy individuals to escape taxation, Senator Packwood suggested making such bond income subject to a 20 percent minimum tax. At once, trading in municipal bonds stopped. The crisis was overcome by a joint statement from Packwood and Rostenkowski stipulating that such a provision, if enacted, would apply only to new but not to old bonds.^[80] That revenue raiser was the first, but not the last, revenue raiser dumped when markup began on March 24.

Discovering that it was not easy to reconcile lower personal and corporate tax rates with the demands for exemptions for specific industries, Senator Packwood proposed eliminating the deduction for excise taxes on many commodities, such as alcohol, tobacco, and telephones. Easy money in the tens of billions, or so it seemed. But soon Democratic party critics of such taxes as unfair to people of low income were joined by the industries involved in forming the (inevitable) Coalition Against Regressive Taxation. It purported to show that the income tax reductions for low- and middle-income taxpayers would be effectively wiped out by higher excise taxes. That proposal and, with it, $62 billion in revenues also evaporated.^[81]

After three weeks of bargaining on provisions, Senator Packwood suddenly announced on April 18 that, rather than kill the bill by continuing on as they were, he was suspending his committee's markup.^[82] What had happened? Compared with his initial proposal, based on the administration's version, Finance Chairman Packwood had already given up $10 billion in tax preferences over five years. There followed a series of votes on such issues as foreign taxation, private pensions, and tax-exempt bonds, amounting to some $19 billion more.^[83] Packwood himself had sought to keep preferences for the lumber industries—so important to the depressed economy in his home state of Oregon. He thought it fair play to allow each committee member to keep his first priority preferences. It turned out, however, that, if these were granted, secondary and tertiary priorities then moved to the top of the list.

When Senator Chafee (R-R.I.)—joined by Moynihan, Bradley, Mitchell (D-Maine), and Assistant Secretary of the Treasury Roger Mentz—tried to delete a preference for builder bonds issued under governmental auspices, Packwood opposed the suggestion as contrary to what he called the "tradition of subsidies for housing." It lost 7 to 10. When Chafee joined the fray by moving to dilute Packwood's proposal to tax trusts established by parents for their children, the latter protested on grounds of revenue loss. "That," Chafee retorted, "hasn't seemed to slow anyone else down. If you can't fight them, join them, and it's a big crowd to join."^[84] Chafee also wanted to preserve a Preference for federal retirees that would cost an estimated $7 billion in revenue.^[85] By then, $25 or $30 billion had been used up.^[86] "I think our low point came," recalled Senator Moynihan, when we solemnly concluded that the depreciable life of an oil refinery was five years, an absurd idea for so permanent a structure."^[87] But the final straw came when Senators Durenberger and Moynihan garnered sufficient votes to restore the deductibility of state and local taxes. As Moynihan graphically described the events in a newsletter to his constituents: "Packwood … recognized that our amendment would be followed by dozens more. His proposal was in ruins. He banged the

gavel and announced there would be no more votes that day, and no more meetings until further notice. Tax reform was promptly pronounced dead."^[88]

Although he believed that tax preferences were a creative use of the tax code for worthy causes, Senator Packwood was nonetheless intrigued with the concept of a low-rate, broad-based tax. Back home, as he traveled around Oregon, the senator had begun to ask how far down rates would have to go before the other person lost interest in preferences. Though proposals on rates varied, they centered around 25 percent.

At the same time, Packwood had reviewed a list of witnesses coming before his committee, thinking "they all have a preference and they can't conceive how they can act without that preference."^[89] Something was very wrong when business had become addicted to preferences and Congress couldn't stop feeding that addiction.

After adjourning the Finance Committee, Packwood went to lunch with Bill Diefenderfer, who had come to serve as chief of staff in order to help with the tax bill; both were appalled at the way things had gone. The publicity about an orgy of special interests embarrassed them.^[90] Packwood's reputation, in both the short-term currency of Washington judgments of influence and the long-term judgment of history, was in danger.^[91] Up for reelection, he was not looking good in the newspapers.

Three weeks of exhausting efforts in markup had ended up with more of the same. But what would happen if they seized the ideological high ground with a truly radical proposal, cutting rates to 25 percent, challenging all their colleagues so to speak to give up their preference for preferences? Maybe something would emerge that would credit the Senate and make their work worthwhile. At the worst, Packwood could gain political credit.^[92] "We looked at each other," Packwood recounted, "and I said, 'Why not give it a try?'"^[93] If they were going to lose, they might as well lose, as Moynihan put it, "in the cause of the most extraordinary tax bill in our history."^[94]

That afternoon, Packwood and Diefenderfer called the top tax expert in Congress, staff head of the Joint Committee on Taxation, David H. Brockway, who, if anybody could, would know whether a 25 percent rate was feasible. "Dave," Packwood asked, "draw us a series of tax plans that sets the rate at 25 percent." It developed that 25 percent would work only by eliminating the deduction for state and local taxes. Packwood ruled that out as politically impossible. But a 26 percent or 27 percent rate might make it.^[95]

On Tuesday, April 22, Packwood asked the five committee members he had reason to believe would support tax reform—Republicans Chafee and Danforth, and Democrats Bradley, Mitchell, and Moynihan—to

meet in his office. (The Chernobyl disaster was in the headlines, so nobody paid any attention to them.) Packwood told the group what they already knew; if everyone promoted his own interests, that was the end. The president wanted a bill. Everyone had given up on reform. What was there to lose? They agreed to try.^[96]

Every morning as they met, Moynihan would deliver his "Grace Report," noting that W. R. Grace and Co., whose chairman led a crusade for reducing waste in government, had paid taxes to Quadafi's Libya but received a half-million-dollar refund from Uncle Sam.^[97] A couple of tax plans ending up with 26 or 27 percent rates were presented at a private committee meeting on Thursday, April 24. The faithful five told Packwood they liked it. They needed only five more of the committee's twenty members to go ahead.^[98]

The "core group," as they called themselves, made three choices. One was to peg the rates at 15 percent for families up to $42,300 in income and 27 percent above that. A second was to adopt the president's proposal for a $2,000-per-person exemption, easing the burden on families, especially low-income families who would not have sufficient taxable income to remain on the tax rolls. The third, suggested to Moynihan by New York tax attorney Donald Shapiro, was to distinguish between "active" and "passive" income (passive meaning essentially paper gains and losses by people who do not personally participate in a business), in order to tax the passive part. This provision alone, by killing most real estate tax shelters, would bring in $50 billion over five years. (Introduced by Moynihan and Chafee in 1983, Moynihan narrowly missed getting the provision into a 1984 tax bill and promptly put it in the hopper for 1986 as S. 956.) Its size gave the core group hope of avoiding an attack on highly popular deductions like mortgage interest.^[99] But it would hit up the wealthy who used lots of tax preferences "almost exclusively," thereby making the package as a whole better for the middle class and making up for the big cut in the top rate.^[100]

Meeting long into the evening on Saturday, May 3, and finishing on Sunday, May 4 (absent the usual lobbyists), the core group, with Treasury Secretary Baker's encouragement, finished designing its bill.^[101] A key to the proceedings was that Chairman Packwood—who, some members felt, had previously taken too much for his state's lumber interests—now was willing to reduce preferences for home builders.^[102] "It was like a poker game," Packwood remembered. "Everyone anted up to make the pot worthwhile."^[103] Amid the usual senatorial doubts—tax reform was "comatose and in intensive care" (Senator Heinz), "very silly … public interest is about zero … die on the floor" (Senator Durenberger)—the Finance Committee reconvened.^[104]

Between May 5 and May 7, the Finance Committee bargained out a bill. As it met, Finance had an entirely new attitude. First, Russell Long had decided to back the core group's plan, with a few exceptions, and was rallying his allies.^[105] Second, Packwood, making a few strategic concessions in advance, won approval for a rule that, during the formal markup, any amendment would have to be revenue neutral.^[106] "That," Senator Pryor judged, "was the critical moment in this bill. After that it was a totally different game. Each of us knew that with any amendment, you'd have to find the money to pay for it."^[107] Various industries—oil, gas, mining—got some back in return for slightly higher rates and some sleight-of-hand. But the bill remained largely intact.

After the new bill passed unanimously in committee, every member stood up to applaud Chairman Packwood. Although by no means was every member in favor, none felt able to oppose so impressive a measure. Moynihan reports that a large gathering of lobbyists in the basement of the Dirksen Senate Office Building "broke out in hissing."^[108]

In a long speech to the Senate explaining how all this had come about, Chairman Packwood gave credit to Bill Bradley and others who had seen the wisdom of returning to the earliest philosophy of the income tax so that America would once again be "a place where people may make investments or may give to charity because they are motivated by the charity or because they think the investment is a good investment."^[109] Packwood did not predict a capitalist renaissance, but otherwise the thought could well have come from Ronald Reagan.

The day after the Finance Committee acted, the world looked different; tax reform had gone from "silly" two weeks earlier to now unstoppable. the Wall Street Journal spoke of it as an "overwhelming likelihood."^[110] "It's the 15% and the 27%," Senator Lloyd Bentsen (D-Tex.) stated. "It's very dramatic. That's what brought me over."^[111] "That's the locomotive," Senator David Pryor (D-Ariz.) agreed.^[112] Even Senator Boschwitz, who earlier had threatened to hold up the tax bill, was all for it. "What we had then," he explained, "was tax complication. What we have now is tax reform. I am left breathless by this bill."^[113]

Obstacles remained. The provision that drew the most criticism from the public, as well as from the mutual fund industry, was the restriction on individual retirement accounts.^[114] Was the IRA a spur to saving, a boondoggle for the rich, or both, or neither? Finance Committee Chief of Staff William Diefenderfer said it wouldn't be so easy to amend the bill on the floor because the proposer would have to take over $20 billion from someone else's preferences to replace revenue losses. He'd rather use the money to lower taxes across the board.^[115] Governor Cuomo of New York, supported by Republican Senator D'Amato, objected to

changes in the sales tax deduction.^[116] Senator Dole suggested the transition rules be written to raise revenue in the first two years, reducing the deficit.^[117] Such an increase would risk conservative defection. But it, and the sales tax issue, could wait for conference with the House.

Asserting that tax reform was not yet "unstoppable," Dole joined Packwood and White House strategists in calling for a "clean," that is, unamended, bill. Changes should be saved for conference. Packwood claimed that thirty-two senators had agreed on a "no amendment" strategy, and President Reagan seconded that at a breakfast meeting with senators on June 5.^[118] Inevitably, some senators objected to being treated like a lesser breed, namely members of the House who traditionally were restricted by closed rules to prevent amendments to revenue bills. Yet the ethos of the clean bill proved so strong that no one wanted to be the first to offer an amendment that would be struck down in the name of reform. In order to break the ice, Senator Robert Stafford offered an amendment, later withdrawn, in which any person who reached age seventy-five and whose hair had not turned white wouldn't have to pay taxes.^[119]

The fact that Packwood had thirty-two votes against any amendment helped; just as important was a requirement that reduced revenues had to be "paid for" somewhere else. Where did that offset device come from? Of all places, Gramm-Rudman-Hollings!^[120] Thus by voice vote the Senate rejected a bid by Senator Alan Dixon (D-Ill.) to retain the sales tax deduction. He lost support because he proposed to pay for the change by disallowing a small percentage of all deductions, including portions of the state and local tax deduction. The leadership did allow the Senate to signal the conference committee by voting 76 to 21 in favor of a nonbinding resolution requesting conferees keep the sales tax deduction.^[121]

Another key vote was on IRAs. That was partly a class issue: whether the users were deserving (poorer people) or undeserving (richer people). When evidence from returns (two-thirds were in the $75,000 to $100,000 income bracket compared to one-fourth between $30,000 to $40,000 and little below that^[122] ) showed that most of the IRA users earned over $75,000 a year, the attractiveness of IRAs waned. The 1981 argument that IRAs increased savings had also been under heavy attack from many economists, who claimed it only attracted money from taxable to tax-free accounts.^[123] Yet the users remained a huge and politically very active group. Liberal Senator Dodd (D-Conn.) joined conservative D'Amato to sponsor an amendment to retain IRAs, paid for by a higher corporate minimum tax and individual taxes.^[124] The crucial vote to table their amendment was 51 to 48. The intense interest of IRA investors was

shown by the fact that all nine Democrats and nine of the eighteen Republicans running for reelection supported retention. Senator Steven D. Symms (R-Idaho) had received more than 900 letters a week, most of which were handwritten and therefore more meaningful than the usual, organized, preprinted postcards.^[125] Packwood had secretly to promise to support Senators Gramm, Gorton, and Evans on a sales tax amendment in order to get their votes to beat the IRA amendment.

To mollify IRA backers, a sense-of-the-Senate motion calling for its own conferees to assign the "highest priority to maintaining maximum possible tax benefits for IRAs" was passed 96 to 4. The language of the amendment—the conferees are advised to act "in a manner which does not adversely affect the tax rates or distribution by income class" of the tax bill—explains why IRAs were not rescued.^[126]

Another serious challenge to the bill—because it threatened what Dole called the "glue"^[127] holding it together, namely the top 27 percent rate—came from a proposal by Senator George Mitchell, a member of the core group, to add a top rate of 35 percent. Despite the fact that Mitchell raised the old battle cry of the liberals, progressivity, the liberal leader in the Senate, Ted Kennedy, stuck to the no-amendment strategy.^[128] Senator Packwood won its rejection (71 to 29).

The next day found Packwood hiding from view as the Gramm, Gorton, and Evans sales tax proposal got turned down.^[129] Naturally they were furious, but, when the no-amendment strategy showed signs of unraveling a week later, Packwood came up with $1.6 billion in alternatives to pay for a compromise restoring 60 percent of sales tax deductability in states (like Texas and Washington) that had no income tax.^[130]

Good sentiments cost little, so the Senate passed a resolution (95 to 1) urging the conference committee to give the middle class a better break.^[131] There was no specification of incomes. That provision fit an emerging pattern: amendments came up, they were defeated, and then the Senate adopted position-taking instructions to conferees that they should protect the very interests they were engaged in bashing. As during House debate, the promise was that things would be "fixed in conference." It would be quite a conference. The Senate plan had two brackets instead of four, and its low bracket was much lower than in the House plan. There were differences in many other areas. Yet, compared to the existing code, the similarities between the House and the Senate bills were more dramatic than the differences.

The Senate voted 97 to 3 for tax reform. "Motherhood" could hardly have won more votes. Almost no one, apparently, wanted to be left out of this historic occasion.

Life and Death

Asserting that "those who are waiting for a battle of the tax titans are likely to be disappointed," Dan Rostenkowski and Robert Packwood agreed that they wanted to make reform come true. And President Reagan, speaking at Dothan, Alabama, reminded everyone how he had unswervingly pursued the objective of a big reduction in tax rates paid for by an offsetting decrease in tax preferences, despite public indifference and cynical politicians. "The president's reappearance, center stage, as a main actor in the tax reform drama," Congressional Quarterly reporter Eileen Shanahan suggested, together with a supportive press conference by Chief of Staff Regan, augured well.^[132] But Regan was not a conferee.

The House had a much higher top rate (38 percent instead of 27 percent) and higher business taxes. Those two provisions allowed the House to give more tax relief to the broad middle class and not, for example, eliminate deductions for state sales taxes. The House was committed to its distribution, but senators were leery of taxing business more than they already had (the 27 percent top rate had been crucial to Senate passage). What to do? Rostenkowski moved first, announcing on June 27 that he would "be willing to shoot for the Senate's top rate as long as we approach the House's after-tax income distribution."^[133] Birnbaum and Murray report that "Rostenkowski's concession set the direction for the conference."^[134]

The conference, which began July 17, used revenue estimates by the Joint Tax Committee (JTC). Because these estimates were static, that is, based on current conditions remaining the same, they could be questioned. Yet it was easier to agree on static assumptions than on which way the world would change. By using JTC numbers, conferees could avoid the numbers games that bedeviled budget politics.

Unfortunately, JTC numbers themselves kept changing. On July 24 the staff revealed that the Senate bill actually fell $21.2 billion short of revenue neutrality (the decimal point suggests a spurious precision). Oops. Someone's taxes would have to make up the difference.^[135]

The Senate made a couple of attempts to recoup the shortfall, but neither won much support among House conferees. They did, however, accept some of the Senate's individual deduction repeals, particularly the "passive loss" provisions. The House counterproposal then added about $23 billion in business taxes to the Senate bill, thus taking around $142 billion from that sector, a considerable comedown, they said, from their original $160 billion. If senators insisted on further protecting corporate tax preferences, Representative Rostenkowski said, bargaining in public, "their choice is to either shift more of the tax burden to the

middle-class income family or to raise the rates for both individuals and corporations." But many senators weren't willing to increase business taxes. "If ever," Senator Malcolm Wallop (R-Wy.) declared, "there was a dead body leaving the morgue, this is it."^[136] Such a proposal, Republican John Chafee of Rhode Island insisted, "would be absolutely rejected." Various senators expressed fear of job losses.^[137] At the same time, House conferees insisted on maintaining the deduction for state and local sales taxes, as well as for income taxes.^[138]

The conference stalemated. Under the headline, "Tax Reform: Last Lap or Last Legs," the New York Times asked the conferees to "put national interest first." The paper wondered whether "they understand … how much blame they will suffer if the opportunity is lost?"^[139]

By August 12 the conferees had made some progress. Searching for revenues, the House had moved toward the Senate's tougher provisions on IRAs and agreed also to eliminate separate, preferential treatment of capital gains. But they still wanted more business taxes and refused to give in on state and local taxes. They rejected Senate claims that $17 billion could be raised by tougher IRS enforcement.^[140]

At an impasse, Russell Long convinced the conferees to empower their chairmen to meet privately seeking an agreement. Word of heated exchanges leaked out.^[141] "Yelling at each other," "questioning motives," "pretty nasty," were some of the phrases used.^[142] Yet the chairmen made considerable progress, moving toward slight increases in the top rates for individuals and businesses.

Fate, or perhaps an unwarranted reliance on estimates, intervened. Economic changes, or rather CBO estimates of future economic growth, had altered sufficiently to suggest an additional $17 billion was necessary to achieve revenue neutrality. "Danny and I looked at each other," Packwood recalled, "and he said 'I wish we could blame each other.'"^[143]

Frustrated, the two chairmen considered giving up. Packwood lashed out at the JTC staff, the bearers of bad news. Yet if they gave up before the August recess, the whole package might unravel as members caught flak at home. They tried again. Each threw some items in the pot that mattered greatly to some of their conferees but not to majorities.^[144]

Following twenty hours of meetings, Senator Packwood announced in the early hours of Saturday, August 16, that he and Representative Rostenkowski had reached agreement.^[145] To agree, Packwood had to abandon one of his strongest backers, Senator Danforth, on a $3.5 billion defense contracting issue. In total, the chairmen made up the missing $17 billion with $10 billion in business taxes and $7 billion more from individuals.^[146] Taxing business $124 billion more than current law, it turned out, was very close to President Reagan's original proposal.^[147]

House conferees thought the tax cut to people with incomes between

$50,000 and $100,000 (middle class?) was too small. President Reagan wanted the top 28 percent rate. And all sides needed more money. They got some with a faster phase-out of some exceptions. And they squared the circle by creating a 33 percent marginal rate to last until a payer's average or effective rate reached 28 percent. So the brackets went 15–28–33 (from around $100,000 to $200,000) and then back to 28 percent! This "bubble" would prove hard to defend, for richer people seemed to get to pay less. "I think," said Senator Wallop, tax reform's "become an obsession!" "I want a bill, Packwood wants a bill," Chairman Rostenkowski exclaimed. "It's an emotional thing with us."^[148]

In the end, only two Senate members (Wallop and Danforth) and one House member (Bill Archer, R-Tex.) voted against the conference report. Members were held until 11:00 p.m. on Saturday, August 16, so there would be a solid conference report to which they could return, rather than promises that might be picked apart by lobbyists. Left for "transition rules" was $5 billion; congressmen, especially conferees, could thus buy local favors.^[149] This is either unconscionable (the rules should apply to all or to none) or a modest sop to constituency interests. Take your pick.

Senator Bradley, an original proponent of tax reform, played a unique role in running back and forth between House Democrats and his Senate colleagues. House Republicans appear largely to have been ignored.^[150]

Amazement was one reaction: "It simply accomplishes what nobody believed was possible," said Fred Wertheimer, president of Common Cause. "It takes a huge chunk out of special interest after special interest who were not paying their fair share."^[151] "They said out there it couldn't be done. Well, well," Rostenkowski cried, "we've done it." The sense of triumph in Congress mingled with a sense of achieving historical change. "None of us," mused John Sherman of Rostenkowski's staff, "will ever work on a piece of legislation that grand again."^[152]

Under the heading of "A Reagan-Style Bill," Peter J. Kilborn of the New York Times described it as "less Republican than … Populist … and … less traditionally conservative than … the expression of the Reagan … credo [of] low individual taxes and small government." If this legislation passed, Kilborn concluded, "Ronald Reagan will have earned himself a place among the handful of presidents who have nurtured fundamental change."^[153]

Maybe so, but the grandeur of change was little consolation for some of those affected. A series of headlines in the New York Times expressed second thoughts: "Realty Woes Seen in Tax Bill: Property Values Could Decline";^[154] "Educators See Great Harm";^[155] "Danforth Promises Determined Battle";^[156] "U.S. Tax Bill May Force New York to Cut Housing and Public Works."^[157]

House Republicans sounded ambivalent: Minority Leader Bob Michel said his own feet were "firmly planted in mid-air." Jack Kemp spoke of "a moment of truth for the Republican Party. Is it going to be a party of tax breaks or a party of the people?" Kemp's populist theme did not appeal much to Bill Frenzel, who termed the reform "anti-growth, anti-savings, and anti-capital formation." Representatives from both parties repeatedly observed that their constituents were lukewarm or cynical, believing that no matter what was said, most people would end up paying higher taxes.^[158] And yet it was hard to oppose "reform"—the public might be skeptical at heart, but all the voices in public debate and the pressure from the press would mock opponents.

In what was described as the best speech of his career, Richard Gephardt urged House colleagues to remember "the good parts" of tax reform: taking millions of poor people off the rolls, imposing a stiffer minimum tax so the wealthy and the profitable would have to pay, and reducing rates for the middle class. But Majority Leader Jim Wright spoke against the bill saying that its revenue neutrality failed to reduce the deficit. "It's like a big drink of bad whiskey," the Texan told fellow Democrats. "It makes you feel good now, but you wind up with an awful hangover." Wright, however, in deference to O'Neill and perhaps to his own prospects of replacing the Speaker, would not lead a fight against the bill.^[159]

On September 18, with release of the final version of the tax bill to be voted on, the transition rules were made public. Although legislators claimed more than a thousand requests had been denied, many were granted. The costliest, at one-half a billion dollars (brought up by Charles Rangel of the House Ways and Means Committee and strongly seconded by Senator Moynihan, an unwavering supporter of reform), provided relief for investors in existing low-income housing projects. Also, colleges, sports stadiums from Buffalo to St. Louis to San Francisco, Chrysler, General Motors, Phillips Petroleum, and other companies were able to hold on to existing tax breaks. No doubt this swayed some votes.^[160]

Institutional and party loyalty won out. Representative Bill Archer told a meeting of House Republicans that he planned to offer a motion on the floor to send the tax bill back to conference with instructions to reinstate some popular deductions such as IRAs and sales taxes that had been restricted or diminished in August. Normally, the most senior Republican member of Ways and Means who opposes the bill—the ranking Republican, John Duncan of Tennessee, supported it—would have the right to offer the recommittal motion, and Archer was it. The Republican leadership understood, however, that "it would be very embarrassing, at the least, for this No. 1 domestic priority of the President's to be rejected by House Republicans." So Michel offered a preemptive motion

to recommit the bill to the conference committee with no instructions, a motion that, stripped of enticements, was sure to fail. Phillip M. Crane of Illinois wanted to challenge Michel, but Archer refused; "there's no challenge to his leadership. If he wants to offer the motion, more power to him.^[161]

After a rare speech from the floor by Speaker O'Neill—he said tax reform was "the decision of a lifetime" to make good the promise of the 1952 national Democratic party platform, when he had first run for office, and that "justice requires the elimination of tax loopholes which favor special interests"—the House first voted against recommittal by 108 votes (Republicans gave a bare 92 to 86 margin) and then provided a decisive 292 to 136 majority.^[162] It was, as Secretary of the Treasury James Baker said, a victory for bipartisanship: there were 176 Democrats and 116 Republicans in favor and 74 Democrats and 62 Republicans against.^[163]

On September 27, by a vote of 74 to 23, the Senate passed the final bill. "As an unbiased observer," an early political advocate of a low-rate, broad-based tax, Bill Bradley, offered his judgment: "I'd say this is the most significant tax bill since 1954 and maybe since 1913" (when the amendment making the graduated income tax constitutional was passed).^[164] Larger effects resulted from 1981's ERTA, but 1986's tax reform was a more dramatic and improbable victory.

If it was a triumph for "the people," the people didn't know it. In CBS-New York Times opinion polls of probable voters, a plurality of Republicans and Independents favored the bill, but Democrats were opposed. Just over one-half of Republicans and Independents and over two-thirds of Democrats polled thought people richer than themselves would benefit. Small majorities of all three identifications thought that people poorer than they were would benefit most.^[165] These results laid bare the profound public suspicion of politicians and the tax code.

On October 22, 1986, President Reagan signed tax reform into law. He took pride in giving the nation "the lowest marginal tax rates among major industrialized nations." He called it "fair and simple." Now, "fair" is in the eyes of the beholder, but most people did agree; whether it would be simple, even with the qualifier "for most Americans," was doubtful.

An Integrative Solution

When Senator Packwood was asked who deserved credit for passage of tax reform, he replied, "God, I think."^[166] Although it will be hard to improve upon this definitive source, the reader will have to put up with some less inspired explanations.

Following a headline that neatly summed up the matter—"How Tax Bill Breezed Past, Despite Wide Doubts"—Stephen V. Roberts of the New York Times quite properly began by asking why many legislators voted for it despite their qualms. Representative George E. Brown, Jr., a California Democrat, was typical: "I'm going to vote in favor of the bill. But I have severe reservations about it. I did not find any support for the bill out in my district, and I don't want to make too many of my constituents mad at me."

Speculating on what might have been the strongest factors in resolving these doubts, Roberts emphasized leadership, especially President Reagan's. He argued the president succeeded in defining the issue. "Moreover, Mr. Reagan made tax reform his clear priority for his second term. He 'isolated the one thing he wanted to do,' Mr. Gephardt noted, and did not clog the agenda with other plans. As a result, leaders in both parties felt compelled to support the measure." The Speaker, for example, told House Democrats that if they blocked the bill, they would be giving Mr. Reagan "a club to hit us over the head with from now to November." Roberts also claimed that Rostenkowski's reputation as "a man who remembers his friends and gets even with the rest" did not hurt.^[167]

None of this explains, however, why leaders "felt compelled to support" tax reform. The Speaker, for example, did not feel compelled to support aid to the Contras, or the MX, or defense spending. Reagan's insistence that tax reform stay on the agenda obviously was critical. But if he succeeded in defining the issue, why could he do that on tax reform but not on other matters? Because neither Republicans nor the public at large seemed to care about reform, why was it a club to hit Democrats?

Whatever might be said of President Reagan's or Dan Rostenkowski's leadership, or Speaker O'Neill's institutional loyalty, or Senator Packwood's instant conversion—none of it explains why they all differed on so many issues but worked together on tax reform. Nor, whatever their degree of cohesion, can it explain why tax reform struck so responsive a chord among so many otherwise disparate politicians.

Writing in the Congressional Quarterly, Eileen Shanahan gave an institutional explanation:

what really made the legislation happen was the conviction, right across the political spectrum, that both lower rates and cutbacks in special preferences were necessary not just to get a bill through Congress but to deal with a troubling cynicism in the body politic.^[168]

Certainly, the devotions of many senators, including Packwood, Moynihan, and Bradley, were based on feeling that the legitimacy of the tax

system had been undermined and had to be shored up, by drastic change if necessary.

Yet many good things, supposedly necessary to legitimize the political system, do not come to pass. This book is about one of them: budget balancing. Surely the deficit was as great or greater an institutional concern than the tax system. Why was tax reform easier to manage?

Normal political analysis involves looking and seeing who is helped and who is hurt by a proposal. If it passes, those who were helped must be stronger than those who were hurt; if it fails, then vice versa. Perhaps a proposal will pass after modifications to gain allies. This approach is always useful, but with tax reform we have a problem: the people who ended up doing well—the general public and the working poor—had not been beating down the doors for tax reform. Does this make the standard analysis irrelevant? No, but it is only partially useful.

Answering "who got what" cannot tell us why tax reform got on the agenda or why it would not go away. It can help us understand why tax reform was not stopped: unlike the various "three-legged stools" of deficit reduction, it did not penalize everyone equally; like the successful deficit reductions, it isolated minority voting blocs.

Who Wins and Who Loses: Tax Preferences

Let us begin with what was not cut. Start with the overwhelmingly popular homeowner deductions for mortgage interest. Although this has been criticized on the grounds that richer people with more expensive houses and higher marginal rates benefit more and that tenants are discriminated against, which is true, the will of the people is overwhelmingly in favor. No lobbying effort was needed because no one could imagine antihomeowner legislation. (Second homes, however, are more controversial.) It is politically unfeasible to eliminate the mortgage deduction.

Employer-paid fringe benefits—health plans, insurance, pensions, meals—have been a favorite target of economist reformers. Senator Bradley might argue that "a fringe benefit is not a free good. It leaves all of us paying a higher [tax] rate than we would otherwise."^[169] Senator Durenberger might argue that setting a cap on tax-free fringe benefits would make consumers more cost conscious; for example, while tax reform was being debated, medical care costs rose far faster than the low rate of inflation. Durenberger also might hope that the need for revenues would compel his colleagues and "some of the selfish corporate and union interests to abandon this open-ended tax subsidy for the richer corporations."^[170] Others might argue that fringe benefits were income-in-kind, no different than other things money could buy. But recipients did not think so.

Just to make sure, the health and life insurance industries launched a massive advertising and lobbying effort against the Treasury's original proposal. More than nine hundred lobbyists reportedly were involved, including the AFL-CIO, NAM, the U.S. Chamber of Commerce, the American Council of Life Insurance, the Business Roundtable, Blue Cross-Blue Shield, and more. Senator Packwood was vehemently opposed to taxing fringe benefits.^[171] When Representative William Gradison visited union plants in his Ohio district to drum up support for tax reform, he was told that proposals to tax fringe benefits and to deny deductions for personal safety equipment and union dues made members believe "it would cost them." A union official reported that "it is very difficult to find support for tax reform on the shop floor."^[172] Supported by organizations and voters across the political spectrum, fringe benefits remained unscathed.

A centerpiece of the Reagan administration's tax reform, estimated to release $149 billion over five years to pay for lower rates, was an end to deductibility of state and local taxes, taxes most people pay. The Treasury viewed these deductions as a subsidy from low-tax to high-tax states. High-tax, high-services states feared that the end of deductibility would cause richer people to move, thereby lowering state revenues. Governor Mario Cuomo of New York took the view that this reform "punishes states that are trying to provide essential services in the face of massive federal spending cuts."^[173] It turned out, however, that low-tax states were not eager to give up their benefits, though smaller, in return for the dubious advantages of such competition. Almost all state and local lobbies united against limiting deductions. That in itself was not enough; they also liked revenue sharing, and it went under in 1986. But voters cared a lot more about taxes than about revenue sharing. Even more important, there was no way to build a majority for tax reform without the big state representatives for whom state income tax deductibility was life or death. If those guys joined with the capital formation types, no bill. Finally, only the sales tax deduction was shaved.

"Don't tax poor people." With this injunction, Joann S. Lublin of the Wall Street Journal aptly summed up the prevailing ethos uniting politicians otherwise as far apart as Ronald Reagan and Ted Kennedy. By increasing the personal exemption, the standard deduction, and the earned income tax credit, six million households would be dropped from the rolls. And for good reason. Largely because ten years of inflation had eroded the value of the standard deduction and personal exemption, people with low incomes found themselves paying much higher rates than they could afford. Because Reagan beat the Democrats on the 1981 tax bill, it cut rates rather than raising exemptions, so the poor had received barely any relief. Whereas in 1979 a family of four started

paying income tax at $1,200 above the poverty line, by 1984 they began contributing at $1,500 below that line. A single parent with three children who earned $8,000 in 1979, just above the poverty line, paid $481 or 6 percent of income in federal tax. By 1984 that person was earning $11,456, a 43 percent increase in nominal income, but had to pay $1,384 or 12 percent in federal tax.^[174]

Tax reform would become the major egalitarian initiative of the Reagan years. Just as exempting poverty entitlements from budget cuts and Gramm-Rudman-Hollings was widely supported, so also redressing the increased tax burden on the poorest elements of the population had wide support in both parties.^[175] Here we have not a powerful group but one that had wide sympathy from everyone else. Because recent policy trends were so negative, the norm of "fair shares" required redress. But it was also true that, if poor people had not been helped, no bill would have passed. Liberal Democrats would have defected and combined with business advocates, thereby constituting a majority.

Consideration of reducing tax preferences for business was heavily influenced by the growing perception that it was morally wrong and politically indefensible for large corporations to pay little or no taxes, even though they were using perfectly legal measures designed to enhance economic growth. Parallel with tax reform and urged by mounting deficits was enactment of a stiff minimum tax of 15 or 20 percent that applied after a company had used its tax preferences. Although the data on individual companies had long been available, it took Robert McIntyre to drive home the point with horror stories of huge profits and no tax payments. Trained by Ralph Nader, operating on a modest budget of $150,000 a year or so provided by unions, McIntyre churned out data showing that huge companies—General Dynamics, International Telephone and Telegraph, Transamerica, Boeing, etc.—paid no net tax. "We named names," rather than using aggregate statistics as was common, he said, "and that made all the difference." McIntyre claimed that of 275 firms he studied from 1981 to 1984, 50 paid no net tax. "Despite $568 billion in pre-tax domestic profits," he concluded, "these 50 companies received net tax rebates totaling $72.4 billion." Fortune magazine published his blacklist. Congressman Matsui testified that McIntyre "made a big impact, gave us the fuel … for tax increases on the business community. I'll bet every member used his statistics in speeches back homes."^[176]

Real estate developers, syndicators, and investors took the biggest hit from tax reform. In addition to the long-standing view among economists that the triple subsidization of housing—deduction for mortgage interest, local taxes, and artificial tax losses—had led to overinvestment, thereby reducing the prospects for other industries, there was a growing

distaste for what was called "passive" investment. Limited partners in real estate syndicates had invested in large part to generate early losses to offset against their other income, without actively participating in the business. Whether the active-participation distinction made economic or moral sense—most investment was passive—it still placed the real estate industry on the defensive. When the Senate proposed to eliminate or severely restrict passive losses, as well as most other aspects of real estate preferences, including long-term depreciation, the reaction of the industry was well conveyed by President Wayne Therenot of the National Realty Committee—"Terror and disbelief," but "at least our people have nice big buildings of their own to jump from."^[177]

The attack on the Treasury proposal by the National Association of Realtors, with its 600,000 members, was direct: Reform was "anti-savings, anti-investment, and anti-home ownership."^[178] But it wouldn't wash. Before long, real estate lobbyists were scrambling to lengthen the phase-in provisions so as to cut their losses.^[179] Sensing the prevailing scheme of values, they also changed their tune. Real estate lobbyists claimed that poor people would suffer; increased rents would overwhelm tax cuts. Why, a mere 2.7 percent increase in rents would wipe out the envisaged tax reductions. Unfortunately for the realtors, those legislators who cared most about the poor were not convinced. "Whatever benefits [poor families] do receive," said the skeptical Representative Rangel, "it's an afterthought of the whole process.^[180]

This is one time when it is easy to draw simple conclusions. All preferences used by large numbers of people, with the exception of state and local sales taxes, were retained. The overall package was shaped by the need to isolate the losers; thus, they were limited to many businesses and, essentially, those individuals who had used breaks to pay taxes substantially below the average level for their incomes. The reforming impulse, strongest within Treasury, to create a purist code designed only to raise revenue in a neutral manner was overcome by democracy: tax preferences for large numbers of people evidently are judged equitable; thus, such social purposes may be subsidized through the tax system.

"Equity," however, is not graven in stone. Social forces shape its meaning. In 1986, as in 1984 and 1982, it was widely considered "fair" to increase taxes on business. In 1986, equity demanded reducing taxes on the working poor as well as exempting the poor from automatic spending cuts. In 1980 and 1981, equity mattered less—or meant something different. That should remind us that there is a politics of defining such public interest concepts as fair shares, or how to encourage economic growth—a political trend that ran for business from 1979 to 1981 and against it from 1982 to 1986.

The distributional politics of tax reform was identical to the politics of deficit reduction. Big interests, such as mortgage deductions and untaxed fringe benefits, were protected just like social security, essentially a majority in itself. At the same time, any package that angered the ideological right and left would go nowhere. No proposal, for instance, that combined a flat tax with higher business taxes could ever have passed because protectors of both the poor and the corporations would have united against it. Instead, the costs were imposed on business alone.

Business interests were not, however, simply left standing in a game of musical chairs. At first they failed to mobilize. No one anticipated that Treasury 1 would really be the tax specialists' baby, that they would simply be let loose on the Code by Don Regan. Neither the president's commitment nor the legislative elites' desire to do something important was expected by the lobbyists.

In the usual way of the world, that is, accidentally, tax reform proved well crafted to split business interests. First, entrepreneurs as individuals would get lower rates. Second, within industry, Paul Huard, vice president of NAM, said with an evident sigh, "We're like the guy with one foot on each side of a barbed wire"; the fence divided industries that would gain from lower rates from those that would lose from lower tax preferences. The business community, he continued, with admirable foresight, hoped to avoid "degenerating into a pack of wolves tearing at each other's tax." For "if that happens, … Congress, will walk all over us and pick the bones off the carcass.^[181] And so it did.

On the grounds that if you can't beat them, join them, a variety of business groups came together in TRAC (Tax Reform Action Coalition), which proposed to support the president's plan while trying to reshape it to be more helpful for capital accumulation.^[182] No one wanted to challenge a popular president, nor did anyone see Reagan as antibusiness. The full-fledged war-against-Reagan tactic tried by the Chamber of Commerce in 1982 on TEFRA was not most businesses' style. Besides, it had not worked.

"Up until four weeks ago," John Malloy, a senior vice president of DuPont noted in June 1986, "we didn't think there was going to be a tax bill."^[183] When the politicians moved, they did it for their own reasons, particularly the desire to avoid blame for failure, reasons that businesses could do little about. At that point, a mutual fund lobbyist put it well: "Prayer is our no. 1 strategy. I advise my fellows to go to the church of their choice."^[184]

The amazing saga of tax reform should alert us to the possibilities of rapid change. The dean of business lobbyists, Charls Walker, was philosophical about being locked out of tax reform: capital formation might

yet come back into fashion; he would have a chance to get his back. With one thing Walker says we could not agree more: "This isn't the last tax bill."^[185]

Politicians' ability to turn on business might seem like proof of their independence, thus confirming their ability to deal with the deficit. They do have some independence, important in evaluating our political system. Yet independence from individual interest and independence of mind differ greatly from independence from majority control. Politicians rarely buck aware majorities. On tax reform they did not. By definition, it was revenue neutral; its distributional consequences would be no worse than a wash. By contrast, deficit reduction was a negative-sum game.

Spending and Tax Reform: Two Radical Changes Compared

Such a radical change would not have been possible without Ronald Reagan as president, if only because no one would go to all that trouble only to face a veto. Reagan's role was far more positive than that, but it was not the role normally assigned to him: a "great communicator" with massive popularity. Although Ronald Reagan in the first two years of his second term was the most popular president since the origins of polling in the 1930s, that did not translate into an unbroken series of victories. On the contrary, he continued to be challenged: winning, only by great effort, small sums for his Central American policies; suffering major reverses on South Africa and defense spending; and failing to gain approval for most aspects of his domestic agenda. Whatever political realignment might be in the making, President Reagan was certainly not its beneficiary. How, then, in the midst of substantial dissensus over public policy and acrimony over many things (such as William Rehnquist's nomination for chief justice of the Supreme Court) were majorities, backed by the president, mobilized in favor of radical change in taxing? What did President Reagan do to facilitate radical tax reform?

His most important actions lay in a willingness to impose costs on his own followers in order to achieve a larger objective. Without transferring taxes from individuals to business, tax reform would indeed have been an impossible dream. On one side, such a president must be popular enough with his own followers and strong enough inside his own administration to make his preferences stick. On the other side, the president must be able to envision a larger benefit for which smaller ones might be sacrificed.

The president wanted a limited domestic government supported by a larger economy that operated under market incentives. Though a friend of business, Reagan believed that tax-induced investments, in general, were bad for enterprise. Low rates, on the other hand, were

good. He believed as well that it would be very difficult to raise rates again once they had come down. Low tax rates would be seen as—and Reagan surely would present them as—a promise to the American people. He may have realized that, save in wartime, Congress never raised the basic rate. Indexing assured it would not go up by bracket creep. Since 1981 revenues had been raised by eliminating preferences, and that might have continued. But tax reform wiped out most preferences anyone could imagine touching, in return for lower rates. What a deal! Reagan got a tax system that better fit his ideology, one that would be much harder to modify than the one he inherited. He traded short-term dissatisfaction among his constituents for a long-term policy structure that fit and favored his ideals. With revenue increases made even harder to achieve, Reagan's opponents might even be forced to admit the need for spending cuts to deal with the deficit.

Tax reform might have failed if Democrats had shared Reagan's calculation. But many of them, like Bradley and Gephardt and Robert McIntyre and Joseph Pechman, believed the new situation would make revenue increases easier. A broader tax base, they believed, meant more revenues could be raised with smaller rate increases. Smaller increases, if needed, might be easier to get. Maybe. We doubt it. Here, though, as with GRH and the Budget Act of 1974, the parties judged the strategic situation differently, based on differing visions of what the public really wanted.

The immediately preceding years had taught everyone lessons in advanced stultification. GRH and tax reform were designed to do for Congress what tariff and bank reform had done in prior times—restore both the reality and the appearance of effectiveness by reducing the clout of external interests while at the same time simplifying congressional consideration of controversial matters. The struggle over the fairness of the tax code has deflected attention from the main expected beneficiaries of reform—Congress and the president.

Moderates pushed aside severe doubts about the desirability of the policies contained in these reforms in order to defend Congress's capacity to govern. Whatever the results, no one could say that Congress was not in control.

Although reform as a restructuring to reduce overload has its attractions for those who identify with Congress and the presidency as institutions, what was in it for the more policy-minded? How could adherents of a lesser and greater spending role for government, domestic or foreign, or a more or less progressive tax, come together? As the host of a radio talk show asked one of us, is this a "liberal" or "conservative" tax reform?

Tax reform is a classic example of what Mary Parker Follette, early

in this century, called an "integrative solution": liberals feel they have helped the poor far more than they have advantaged the rich. Economic conservatives believe they have shored up free enterprise in a way that will compensate for the loss of spurs to investment. Moderates believe that to show Congress is able to govern will reinforce social order sufficiently to cope with the disruption invariably caused by large-scale change.

Now, most policies try to have something for everybody. Tax reform worked in part because of what it gave: distributional benefits to liberals who cared most about distribution; economic incentives to conservatives who cared most about market systems; legitimacy to moderates who cared most about the perceived integrity of the political system.

Because deficit reduction is so heavily minus-sum—each side ends up feeling like losers—there is no way to do much without angering enough interests to block a proposal. One can either think of the problem in terms of organized groups or just look at the polls: either way, $150 or $180 or whatever the current billion in deficit reduction is nowhere to be found. Politicians wanted deficit reduction even more than they wanted tax reform. But the constraints, against spending cuts and tax hikes, were overwhelming. The politicians blamed each other's hypocrisy or lack of courage, and in doing so they missed the point.

In a democracy politicians must balance two roles: exercising their own judgment and representing the public. The dilemma is as old as democracy itself. On many issues it does not arise because either active participants or citizens—or both—pay small attention to the result. When the dilemma does arise, politicians do follow their own judgment more than we or they might believe; but they will not take actions seriously disapproved of by majorities of the American public. In tax reform our governors stretched the boundaries of the constraints set by American democracy in the 1980s. On the deficit, they were locked in by the same constraints. They could not solve the deficit and still represent that huge, contentious, energetic, bewildered, and contradictory "interest group" called the American people.

Because it paid each side in the currency it valued most, tax reform became a positive-sum game; each side thought it ended up better off than it started. The president's insistence on tax reform, Congress's frustration and desire to show that it could govern, and the ability to appeal to the three major ideologies helped overcome the usual obstacles. Gramm-Rudman-Hollings tried to combine similar factors—presidential insistence, congressional concern with governance, and a widespread appeal—to solve the deficit problem; that is why it passed. It failed to work, however, because GRH did not really give anything to anybody.

Each faction's stake in GRH was negative; it would not help them, but it would hurt others. If we ever reach the point where political factions are more eager to hurt each other than to help themselves, then our political system really will be in trouble. When hatred and feuding override self-interest in living together, a polity becomes like Lebanon.