Eleven
Fake Budgets and a Real Tax Hike

By the time the president gave his State of the Union address, his own forecasters were projecting a fiscal year 1982 deficit of $101 billion, rising, if policies were not changed, to $168 billion in FY85. CBO predicted larger deficits, rising more quickly. Ronald Reagan, Paul Volcker, by far the largest part of the political establishment, and, indeed, the public agreed that such deficits were unacceptable. If Carter's $60 billion deficits were bad, much larger deficits must be worse. Yet in trying to get the numbers down for the president's FY83 budget proposal, Stockman had to accept the defense buildup. The president rejected his tax initiatives. Nobody considered touching interest payments. Social security, certainly, was not for Stockman and the president to put on the cutting board. That left Stockman looking for deficit reductions out of the remaining 40 percent of the budget. By CBO's figures, the deficit was half as big as the programs available to cut.^[1] Stockman, if 1981's conclusion was any guide, hadn't a prayer of getting much of what he needed out of what was left. The administration's somewhat more optimistic-than-the-norm forecast helped only a little.

Trapped, the budget director reports,

I finally did what the Atlantic story seemed to accuse me of. I out-and-out cooked the books, inventing $15 billion per year of utterly phony cuts in order to get Ronald Reagan's first full budget below the $100 billion deficit level. As on prior occasions, I rationalized this as a holding action. When the President finally came around, we would substitute new revenues for the smoke and mirrors.^[2]

Ironically, the smoke and mirrors did not do the job they were supposed to do, but they did a job they were not expected to do. Even with phony cuts, the new budget's deficit of $91.5 billion was too high to be accepted

in Congress. Even with the phony cuts, the real cuts needed to lower the deficit to a level that was still too high were too severe to be accepted during a recession. The FY83 budget, therefore, became the first in a long series to be termed "dead on arrival." The phony numbers were not replaced by a tax increase; instead, even bigger phony numbers were used to sell a tax increase to the president.

A Stillborn Budget

Reagan's FY83 budget was met with a torrent of criticism, tempered mainly by the desire of the president's allies to leave some room for an orderly retreat.^[3]

OMB claimed that "current policy with adequate defense" would produce deficits of $147.3 billion in FY83 and $167 billion in FY84. "Adequate defense" was the Weinberger/Stockman deal that Stockman had failed to repeal: real growth of 12.7 percent in 1982, another 13.2 percent increase in 1983 and, over the entire 1981–1987 rebuilding period, an 8.3 percent annual rate of increase. Defense would rise from 24.3 percent of federal outlays in 1981 to 37.2 percent by 1987.^[4]

Entitlement savings would "restore the focus of social welfare programs on the people who need them most and … prevent overcompensation of benefits." User fees would be increased for activities that "provide direct services above and beyond those that accrue to the general public." Discretionary and other programs ranged from housing to Amtrak to job training. Tax revisions were supposed to "eliminate unintended tax benefits and remove obsolete incentives." Finally, management initiatives constituted a potpourri of savings, from will-o-the-wisp reductions in "waste, fraud, and abuse" to changes in tax collection and federal pay.^[5] The savings projected from all these means are summarized in Table 6.

The administration was proposing social program cuts of more than $58 billion by FY84. AFDC and food stamps would be cut by nearly 20 percent; the employment programs remaining under Comprehensive Employment and Training Act (CETA) would be cut in half. Amtrak, Mass Transit, and Elementary and Secondary Education assistance were all to be reduced by 17 to 20 percent. Not all reductions were targeted on the poor; Amtrak was a middle-class program (poor people ride buses); federal retirees are middle-class; and medicare savings were expected to come from hospitals and doctors as well as patients. But the overall effect of these changes did mean considerably reduced benefits for low-income groups.

Stockman's book-cooking occurred in the category called management initiatives, for example, the restraint of federal pay raises to 5 percent—a

level that few if any policy makers had expected to be exceeded, even if the formal comparability process projected larger increases. Estimates of revenues from accelerated leasing of offshore oil sites were even more dubious. Between them, pay and oil lease "savings" totaled $31 billion over three years. Increased enforcement by the IRS was supposed to yield nearly $7 billion.^[6]

The package was not, however, purely spending cuts and mirrors. More than 20 percent, including the highly controversial management initiative of withholding (just like on wages) a portion of dividend and interest income, consisted of revenue increases. These proposals—including a new minimum tax on corporations and changes in some accounting procedures—were, the CBO concluded, "heavily weighted toward increases in corporation income taxes, which account for about three-quarters of the net tax increases proposed for the 1983–85 period."^[7]

Professionals in the Treasury Office of Tax Policy had begun an effort to repair some of what they considered mistakes—simply bad policy—in ERTA. They were less concerned about deficits than about anomalies such as negative taxation of corporations; on that basis the secretary of the Treasury, otherwise an opponent of tax hikes, agreed with them.

One would hardly have guessed it from the balance in the president's budget alone, but the fact that the Reagan administration, of all things, was attacking business represented a change in the political balance. Business suddenly was on the defensive; consequently its components began trying to stick each other with the burden instead of uniting to fight all change. How does business fight a supposedly probusiness administration?

The reactions of Republican leaders made it evident that the new plan would last no longer than Jimmy Carter's January 1980 draft. House Minority Leader Michel commented, "Most of the members feel that they went along with a precipitous increase in defense spending last year, and that you can't have that two years in a row. With the kind of deficits we're looking at here, and the need to cut expenditures, you just can't leave defense out of there." Iowa's Republican Senator Charles Grassley declared, "I have spent two weeks touring twenty-seven counties in western Iowa, speaking in twenty-seven courthouses, and there wasn't a meeting where concern with the rapid escalation of defense spending didn't come up."^[8] "I don't think anybody likes the budget," said Wyoming Senator Malcolm Wallop.^[9]

Economists who previously had gone along with Reagan joined the chorus of critics. Former CEA chairman Paul McCracken declared that "there is a hard-core part of the deficit that's going to have to be covered by some additional revenue."^[10] And Martin Feldstein, soon to be Reagan's own CEA chairman, thought that "the Administration has put itself in an impossible position…. We may just have a long, flat bottom with very little growth."^[11] That he would turn out to be incorrect did not mean he would be uncertain about being correct.

Trying to rally grassroots support for his budget, the president declared that he had a plan but his opponents did not. "To the paid political complainers," he proclaimed in Indianapolis, "let me say as politely as I can, 'Put up or shut up.'"^[12] So they did. Most significantly, Senator Hollings proposed to eliminate the July 1982 tax cut, reduce taxes by only 5 percent in 1983, freeze all domestic (including social security) spending at FY82 levels, and increase defense by only 3 percent in real dollars annually. Howard Baker immediately praised Hollings's plan. Republicans such as Slade Gorton of Washington, Rudy Boschwitz of Minnesota, and Domenici began drafting possible compromises; Hollings could be used as a lever to move Reagan.^[13]

Iowa's Representative Jim Leach, a leading gypsy moth, explained:

The President's budget was dead in its tracks the day it was delivered. Conservatives rejected it on the ground that the deficit was too large, and the liberals on the ground that its priorities were askew.

As a moderate, I agree with both. The feeling here is one of lost confidence. No one elected Ronald Reagan to preside over a recession.^[14]

The President Retreats

If the president's budget was not good, Congress would have to make its own. But if it wanted to avoid Stockman's social spending cuts and management initiative fudging, Congress would have to cut defense and raise taxes just to attain President Reagan's figures—never mind reducing his deficit. A top Senate Democratic aide explained the box in which the legislators found themselves and the confinement's likely result:

If you start with wanting to have a balanced budget, anything you do that's real … it's gonna cost you. If you have honest numbers it raises the deficit. You have to cut spending more and raise taxes higher. The politicians' tendency, the whole system pushes them, to do what Stockman did, to jimmy the numbers.

Everything you have to do on the deficit is bad. It's a no-win situation for members of Congress. The president can go on TV and make speeches, but they have to vote. In the deficit era the whole budget process is just an albatross for members.

The incentive to fake it was greatest for those with most responsibility, not those with least.

The House would adopt some of that phony stuff because they had to govern. There was always this tension between the House and Senate [Democrats]. The House felt they had to govern. [Senate Democrats] said, hey, we're the minority, to hell with governing, they drove us out of office by saying they could balance the budget with tax cuts for Christ's sake!

Minorities are going to get beat on a partisan issue like the budget anyway. In neither house could they control either procedure or the votes necessary to make anything happen. No solution could occur without the majorities' support. But if the majority—House Democrats or Senate Republicans—knew what they wanted to do, it almost surely would involve pain for someone, so the minorities might as well let those who made the decision take the blame. Trying to reduce the strains within their own coalitions, the majorities, like Stockman, would be sorely tempted to jimmy either the numbers or the procedure. Because everybody was keeping score by total deficit, once one side cheated the others felt they had to as well just to keep up. Both sides would claim that had happened in 1981.

Musical Chairs

In spite of the incentives to fudge, Congress still had to find some serious deficit reductions—just to match those of Stockman. The centrist budgeters wanted to zap everybody—an equitable "three-legged stool" (social spending, defense, taxes) of deficit reduction. A general deficit-cutting mood may allow politicians to assemble a vast number of small changes that otherwise no one would trouble to put together. Recipients might accept small cuts on the grounds they could be recovered later. In 1982, however, the deficits looked so big and cuts in 1980–1981 had been large enough that any useful cuts on the deficit were sure to be resisted. Thus, everyone would oppose a broad package that hurt everyone.

Budgeters who hoped the public interest in deficit reduction would overcome interests in specific government activities, or in the private activities lost to a tax increase, faced two fundamental difficulties. First, people value what they have more than what they might have. They will object far more strenuously to giving up their benefits than the value of those benefits might suggest.^[15] Second, the pain of deficit reductions would be obvious and immediate; the supposed benefits were indirect, slower, and dubious. For both reasons, any group that contributed its fair share to deficit reduction would feel it was contributing too much and resist.

Synoptic rationality—one mind imposing order on a system—might yield a pattern of shared sacrifice. Political rationality, a process of groups bargaining and struggling, was more likely to resemble a game of musical chairs, in which the slowest (weakest) player was left standing. That was what Representative Corman had predicted in 1980, what largely occurred in 1981, and what the Democrats feared would continue: the poor, particularly the working poor, would be least able to save their place in the budget.

But politics is not just every man for himself. No one imposes order, but players do watch, help, and hinder each other. A group's success depends not only on its own resources but also on how others see it, in short, on its enemies. Therefore, Stockman's distinction between weak claims and weak clients is inadequate. If a claim is seen as questionable, opposition to the claim can render its supporters relatively weak (as befell dairymen in 1981). The elderly were strong not only because of their own resources but because they had few enemies; almost nobody opposed their social security claim.

Now, if any claim were really opposed by majorities, it probably would not be there. A program of interest only to a minority is not opposed by everybody else; the majority generally just does not care. Farmers

want farm programs; city dwellers do not object so long as they are getting something they want, say, housing or mass transit subsidies. People object not to other people getting benefits but to somebody getting too much. The normal practice of incremental budgeting, a kind of rolling agreement on resource allocations, marginally altered each year, creates notions of "fair shares." Participants are most concerned with their own shares; they will care about others' shares only if they seem to be getting out of line.

The Reaganauts justified their policies to other players by arguing that defense had fallen below its historic share and most domestic programs had risen above it. Many 1981 cuts were in programs—housing, nutrition, CETA—that had grown recently. Their share had not been ratified as normal through the passage of time. The very process of rearranging in 1981 (and 1980) created a new history. Domestic spending that survived was more obviously accepted. At the same time a new set of beneficiaries—corporations and the military—had done extraordinarily well. Nobody is entirely neutral; everybody has something to which he is committed. Politicians of the center looked for ways to reduce the deficit; meanwhile, the norms of fair shares, which inhibited taking from last year's victims, favored taking from those who had just done well. Moderate Republicans like Dole and Baker felt the working poor had paid enough; even Robert Michel was telling the administration to slow its defense increase.

These Republican budgeters' notions of fair shares, liberal Democrats' ideology, and the tax experts' disgust with the 1981 auction combined to place corporate taxes high on the deficit reduction menu. Defense also could not do as well as the president wished, but there was still broad support for a substantial increase.

Despite the recession, the rejection of social spending stimulus and fear of budget deficits that we saw under Jimmy Carter had been intensified by huge deficit projections. Even the AFL-CIO executive board, at its annual meeting in February, called only for maintaining social programs at existing levels. Labor had long supported defense spending; but the Reagan budgets forced unions to ask if they were willing to build up defense at the expense of social spending. The answer was "no."^[16]

Business interests, as an alternative target, asked how much it was worth to build up defense at the expense of a higher deficit. A wide variety of business representatives, including the National Association of Manufacturers, the Chamber of Commerce, and the Business Roundtable, felt that the military buildup was too rapid in two ways: too expensive and too fast for the defense industry to be capable of supplying new weapons at the rate demanded. Paul Thayer of LTV Corporation,

David Packard of Hewlett-Packard, and Reginald Jones of General Electric were among the leaders of major defense contractors who believed the defense increase could be slowed.^[17]

Even if the president's budget were not acceptable, assembling a majority in Congress would still be difficult. At one end were those who wanted to reduce the deficit solely through defense and tax changes, maybe even adding some social spending for sectors of the economy in bad shape (for example, housing). At the other end were those who wanted to reduce the deficit through smaller tax and defense changes and larger social cuts, particularly in universal entitlements. Speaker O'Neill led the defenders of social spending; Senator Domenici led supporters of larger deficit reduction.

The Gang of 17

On February 23, 1982, Domenici announced his own budget proposal: hold defense to a 5 percent real increase for each of the next three years; freeze discretionary spending at FY82 levels for three years, thus allowing erosion through inflation; deny federal pay raises for FY83; and freeze COLAs for benefit programs. In addition, $122 billion in new revenues would be raised, preferably by reducing tax preferences but if necessary by delaying the third-year tax cut. The administration criticized the defense and tax provisions. But the Senate Budget chairman emphasized that "the 1983 budget, like the 1982 budget, fails to respond to the perception that it is inequitable. Congress must redress that perception."^[18] Democratic budget leaders Hollings and Jones expressed interest in Domenici's proposal.

The president's staff, particularly Stockman, Darman, and James Baker, tried to get him to cut a deal with Domenici, sending a steady stream of visitors urging compromise toward the Oval Office. But Reagan had a selective ear. Just as in January he had heard the Chamber of Commerce's warnings against tax hikes but not those against defense increases, when Reagan met with economists from his advisory committee he concluded they supported him.^[19] The president also insisted that the political situation did not require retreat. "I still think the issues will be ours this year," he told Senate leaders. "What are the Democrats going to run on? Raising taxes? Bargain basement defense when our planes won't fly? Where the hell have they been for the past forty years? They've been in charge and look at the mess they've created. That's why I say, 'Draw sabers and charge.'"^[20] But not only liberals might be run through. The Democrats were going to run on the state of the economy, and that was steadily declining. For the first time in forty years, Time

reported, "highly respected business analysts" were "saying out loud the dread word, depression."^[21]

As the skies darkened, the administration's economic advisers fell into what Newsweek columnist Jane Bryant Quinn called "profound and angry disagreements [which] are not the sort of thing that engenders confidence."^[22] Martin Anderson, believing that much of what the administration could hope to accomplish it already had, departed.^[23] Paul Craig Roberts left Treasury, soon to be followed by other supply-siders. As they departed, Reagan's advisers became more united in pursuit of tax increases. Commerce Secretary Malcolm Baldrige was brought in to tell the president that the long-expected surge in capital investment was not on the horizon. The economic advisory board met again, but this time with Donald Regan, who summarized the board's advice in a March 19 memo designed to ensure that the president got the message:

The group as a whole were more gloomy than I have ever seen them.

There was agreement that the greatest barrier to a healthy and sustained recovery was high interest rates…. Most felt that large prospective budget deficits (1983 and beyond) are the primary cause for the high levels of current interest rates, and that the financial markets are convinced that deficits and prospective deficits matter, regardless of the academic debate on the subject.^[24]

If all the bad economic news were not enough, Darman prepared a memo indicating that the budget was going nowhere in Congress, and pollster Richard Wirthlin reported a large drop in public support for Reaganomics.

With all this bad news in hand, Reagan met on March 19 with Meese, James Baker, and Mike Deaver. He agreed that it was time to open discussions with the Democrats in search of a budget compromise. By a willingness to talk, the administration would blunt criticism of its intransigence. They knew the Democrats would go along; James Jones had been secretly pressing James Baker to negotiate. Reagan decided that Baker could give up $10 billion in defense and accept up to $15 billion in new taxes beyond what was then in the budget, so long as the Democrats went along with proposed domestic-spending reductions. COLA changes could be accepted as long as the Democrats were induced to share the political blame. Even other members of the administration (save Darman) were not told that Baker had been given a bottom line.^[25] Thus, David Gergen, the president's spokesman, was able to insist to reporters that Baker "had only the authority to listen."^[26]

On March 22 James Baker requested permission from Tip O'Neill to begin talks with Jones and Rostenkowski. For public relations reasons, the Speaker could not refuse, but he wanted Richard Bolling (whom he

trusted as a fellow liberal) rather than Jones to take the lead. Senate Republicans shot their way into the game on March 30. Howard Baker told Domenici to go ahead with marking up a budget resolution (that wasn't likely to be the president's) and the committee voted 16 to 1 to abandon OMB's economic assumptions and use CBO's instead. That forced Reagan and O'Neill to include the senators and established the principle of using CBO numbers for the economy. Using CBO's more pessimistic assumptions made deficit reduction more difficult, but market confidence would not be won with an OMB forecast that almost no one believed.

The negotiators became known as the "Gang of Seventeen." James Baker, Donald Regan, David Stockman, Richard Darman, and congressional liaison Kenneth M. Duberstein represented the president. Senate Republicans were Dole, Domenici, and Laxalt, with Hollings and Long for the Democrats. From the House came Robert Michel, Delbert Latta, Barber Conable, and Minority Whip Trent Lott for the Republicans, and Jones, Rostenkowski, and Bolling for the Democrats.

Designing a budget compromise proceeded on two tracks. At one level was the big picture—the balance among various types of spending cuts and revenue increases. Only the seventeen negotiators could bargain on the big picture, and, of them, only Jim Baker, representing the president, and Dick Bolling, representing the Speaker, could set a deal. Forming the second track were the concrete proposals that would add up to broad categories of deficit reduction. Here policy and political consequences had to be estimated by staff, serving their principals. Judging the consequences of various deficit-reduction measures required considering other values; therefore, the values of staff and the principals most directly concerned came into play.

On the second track, a number of players saw a chance to fix social security under the cover of the Gang's secret deliberations. Knowing he eventually was going to get stuck with the hot potato, Rostenkowski would gladly have gotten rid of it in early 1982. Jones, as a budget balancer and Ways and Means member, had double incentive to find measures that, by solving social security's imminent funding shortfall, would also reduce the deficit. Stockman wanted savings wherever he could get them; Jim Baker wanted the political problem to go away. Staff, therefore, very quietly drew up proposals to deal with the giant entitlement. The tax players also largely agreed on the need for new revenues, so the Senate Finance and Treasury tax staffs developed a series of revenue proposals. These tended to reflect their own judgments that ERTA had gone too far with business giveaways and the political attractiveness of "compliance" measures as opposed to rate increases.^[27]

After floating a series of proposals, on April 6 the administration put

together a package dubbed the "Baker plan," which claimed $450 billion in deficit reductions over three years. Revenues would be raised by $115 billion; defense increases pared by $66 billion. Domestic spending would be cut by $145 billion, including limiting and delaying COLAs.^[28] The balance, 30 percent of the total, consisted of management initiatives and savings on debt service projected to result from all the other savings. The ratio of revenues to other deficit reductions was roughly $1 to $3.

The Baker plan exempted SSI, aid to the disabled poor, from COLA cuts. The administration's negotiators emphasized they were allowing $22 billion more for discretionary programs and $16 billion more for medical, nutritional, and public assistance than in their original budget. Many of these compromises involved leaving a popular program at the FY82 budget level. Because inflation and recession meant the needs had increased, Bolling was not so thrilled by such compromise. Because the proposals helped answer Senate Republicans' notions of fairness, however, Bolling worried that Jones too might be tempted by the offer.

"Frankly," Domenici suggested on April 8, "I believe that those of us who have been negotiating could reach an agreement tomorrow."^[29] He may have spoken accurately of the majority of "Gang-sters," a fairly conservative group who valued deficit reduction above all. Domenici, Dole, Baker, Stockman, Jones, and Hollings might have been able to agree. Representing the Speaker and the Speaker's supporters, Bolling could not. The Baker plan still involved both big social cuts and a big defense buildup during a recession. "I knew we couldn't concede the things that they wanted us to concede for one vital reason," Bolling later explained. "We couldn't deliver them." Domenici also did not speak for many House Republicans. "How many people in the House of Representatives," asked Trent Lott, "would vote to cut Social Security in an election year? Maybe seventeen, and most of those retiring."^[30] Domenici was in a sense wishing away deep conflicts of ideology and political interest. But he was also putting pressure on Reagan and O'Neill, trying to create the impression that a deal was there for them to make, if only they would be reasonable.

The president and the Speaker used the same tactics on each other, each asserting that he could not be moved but playing up hints (emerging from the negotiations) that the other might begin to give in. Reagan trumpeted a hard line on the tax cut; O'Neill a hard one on social security.^[31]

Behind the public maneuvering was a residue of private distrust. Bolling and O'Neill felt they were being asked to clean up Reagan's deficit mess, which they had fought to prevent. Now Bolling was dealing with Stockman, who had lied before and, as far as Bolling knew, could lie again.

Despite this distrust, neither side wanted the blame for failure. There was also some movement. The menus of revenue initiatives produced by the Joint Committee on Taxation (April 6) and by Dole (April 7) included such good things for Democrats as a minimum corporate tax, modification of tax leasing, a cap on depreciation tax breaks in the out-years, and a 4 percent income tax surcharge. By April 13 some negotiators, but not Bolling, were reported to be converging on a package that would have put a 4 percent surcharge on taxable incomes over $35,000, added a tax on crude oil, repealed income tax deductions for most consumer interest, capped COLAs at 4 percent in 1983, and accepted a number of further social cuts. Hoping to lock Reagan into a deal, Howard Baker all but endorsed the surtax, warning that without quick agreement the Senate would go off on its own.^[32]

The Speaker of the House was not enthusiastic. Saving discretionary programs by cutting social security was not Tip O'Neill's idea of a compromise. Both his staff and Rostenkowski's, however, did like the idea of doing something about social security—perhaps a revenue solution? Reagan, meanwhile, kept up his public campaign for accepting the original presidential budget priorities. On April 16 he told a group of newspaper editors and broadcasters,

The one sure way to reduce projected deficits, bring down interest rates and still encourage growth is to reduce government's share of the gross national product [that is, cut spending]…. We hear so many judgments about compassion—who has it and who hasn't…. Where was the compassion in those bankrupt spending policies that brought the pain of high inflation and interest rates to so many people? Where is the compassion now in raising tax rates again on our people, making it even harder for them to work and compete?^[33]

These are not the words of a leader about to retreat very far; they are the words of a leader trying to give his followers acceptable arguments against the "fairness" issue.

The negotiators were unable to overcome the differences. Bolling said he would have to consult with the House Democratic Steering and Policy Committee before going any further. The president's men began to look for ways to turn any breakdown of negotiations to their political advantage. Reagan told a news conference that he would "go the extra mile" to win an agreement, to which the Speaker scoffed that "President Reagan proved he was willing to walk a mile—for a camera."^[34] These, too, were not the words of a leader planning a retreat.

The president announced that he would be willing to go to the Capitol to meet with the Speaker on Wednesday, April 28. The Democrats could hardly refuse but insisted that the talks essentially were stalemated.^[35]

When the Speaker and the president met, the essential differences between the two proposals involved the three fiscal years from 1983–1985

The two sides roughly agreed on some big, but dubious, numbers: $54 billion from management initiatives, including pay restraint, and $105 billion from lower interest payments. Of the latter, $64 billion would result from borrowing less because of the other deficit reductions. Less credibly, the markets were supposed to be so happy about deficit reduction that expectations would change and rates would come down enough to reduce debt service by $41 billion.^[36]

In the terms that would later become matters of great recrimination, counting the more concrete social security proposals and the dubious numbers as spending reductions, the Democratic package was about three to two in spending cuts to revenue increases; the administration's plan was closer to five to two. If we exclude management initiatives and interest, however, and group defense cuts with tax hikes as changes the

administration did not want, while it wanted to cut social spending, the difference in priorities is even more clear. The Democratic package was about 80 percent tax increases and defense cuts; the administration's proposal was about 60 percent, and the differences would grow in the out-years.

What hope there had been quickly evaporated in a fiery confrontation of strongly opposed principals. The president and the Speaker clashed bitterly over the fairness of the Reagan program. "Your budget was unfair. It had no equity," O'Neill accused. "I've heard all that crap," snapped the president. "You had a depression when I took over."^[37] "Each saw the other as the archetypal representative of the opposing ideology," a participant recalled.

Howard Baker proposed a compromise in which the 1983 tax cut and 1983 COLAs would each be delayed by three months, but that foundered on social security politics. According to the New York Times,

The President wanted the group to know that he had never approved of cuts in the cost-of-living adjustment for Social Security benefits. "He said he had nothing to do with the COLAS," the Speaker said. "You fellows are going to offer the COLA to me. I said, 'I offer you nothing.'" "I told the President in no uncertain terms that they were trying to set us up," Mr. O'Neill said. When Republicans insisted that reductions in the cost-of-living adjustment had not come from them, Mr. O'Neill said, "They're not coming from us—I'll take them off the table."^[38]

O'Neill didn't want the blame for a proposal he didn't even approve. Reagan felt he had already given a lot from his original budget; at the least, the president and his party did not need the blame for the package's most unpopular part. Bolling and the Speaker, meanwhile, did not want to cut more from domestic spending than they had offered. Liberals felt those programs had taken too big a hit in 1981; they wanted program increases in response to the recession. The fireworks between the principals merely widened an already unbridgeable gap.

So the blame shedding began. OMB's summary of the differences, reported in the New York Times, excluded all but the COLA limit aspects of the social security dispute—an obfuscation to which neither side objected!

Trying to show that the Democrats were being unreasonable, in a televised address on April 29 the president reported on the spending side: "Our original cuts total $101 billion … but they were rejected, believe me. Our own representatives from the Congress proposed compromising at $60 billion. Their counterparts from the Democratic side of the aisle proposed $35 [billion]." He, too, didn't mention social security COLAs. He added that "I swallowed hard and volunteered to split the

difference between our $60 and their $35, and settle for $48. And that was rejected. The meeting was over."^[39] Implicitly, although criticizing Democratic unreasonableness, Reagan also acknowledged that his own party had torpedoed his original budget plan. The president's rueful "they were rejected, believe me" reveals that the opposition to his original cuts was overwhelming.

Bolling summed up the Democrats' case succinctly:

He believes his program is working. And he believes that he hasn't hurt anybody. But the fact of the matter is that that is not what's been happening…. His program didn't work and his new budget was not acceptable, not only to many Democrats but also to many Republicans. The revolt against the President was in the Republican Senate.^[40]

Why, then, one might ask, should the Democrats dig Reagan out by sacrificing social programs to the deficit?

Passing a Budget: The Senate

The Reagan budget was dead; the bipartisan budget was stillborn; now it was Domenici's turn. The day after the Reagan-O'Neill meeting, SBC met and began drafting. Senator Moynihan proposed a vote on the president's budget so as to embarrass Reagan before his television address that evening. Domenici prevented that vote, but not until he insisted that "we don't have to be subtle. The President's budget will not pass."^[41]

Although Reagan used his speech to appeal for support, the response, as in September, was minimal. Kent Hance reported that he had received only fifteen calls compared to one thousand after one of Reagan's 1981 appeals. "People want to support the President," said Louisiana's John Breaux, "but the enthusiasm has worn off, except for the hard core."^[42] There was little reason for representatives to fear presidential wrath for interring his budget.

The SBC chairman went to the White House on Monday, May 3, to discuss his plans. Then, while admitting that congressional leaders and President Reagan showed "much concern and consternation" about his plan, Domenici announced his proposal to the press: a three-year tax increase of $125 billion, a one-year social security benefit freeze, and many other spending reductions. The SBC chairman emphasized that "this is not a Republican plan, this is not a White House plan, this is my plan." Domenici was going to force everyone else to react to him; he had taken the position that Reagan had always claimed to (but no longer did) occupy: the man with a plan, challenging others to articulate alternatives. Slade Gorton of Washington and Steven

Symms of Idaho voiced their support, and William Armstrong, leader of SBC's conservatives, announced that the plan's "sense of rough justice" won his support.^[43]

SBC met to begin its drafting on Tuesday, May 4; Hollings moved for a vote on the Reagan budget. Domenici agreed and, sending a message to the president, began the voting with his "no." The senators laughed and cheered the 20 to 0 wipeout.^[44] So much for any Reagan hope that the Gang's breakdown would resurrect the original White House budget.

Hollings then proposed his own alternative, including a one-year social security COLA freeze followed by two years of COLAs limited to 3 percent less than actual inflation. In his draft, Hollings (like Domenici) allowed increases in food stamps, veterans' benefits, and supplemental security income. Unlike Domenici, SBC's ranking Democrat would not have frozen domestic discretionary spending; and Hollings's $36 billion three-year defense slowdown was larger than that in Domenici's plan. Hollings also proposed a $198 billion, three-year tax hike, including a halving of the 1983 tax cut.

By going out front on social security, against the advice of his party leaders, Democrat Hollings let Republicans hope that they might not have to take full blame for pension changes. Furthermore, Hollings's proposal provided an alternative that, from Reagan's perspective, looked far worse than the Domenici plan. Robert Kasten (R-Wis.) proposed only a $73 billion three-year revenue increase, guaranteeing the third-year tax cut, but that proposal was rejected 17 to 4. The Kasten vote made it obvious that the committee meant business on taxes. Domenici's plan began to seem both more necessary and more attractive to the president than it had been a few days earlier.^[45]

That morning Reagan had met with James Baker and Stockman to devise new budget numbers. When SBC recessed late that afternoon, Stockman and Baker met with Domenici. They agreed that the tax hike would be reduced to $95 billion in return for presidential leadership on social security. The freeze was abandoned. Instead, the budget would require social security savings, to be produced by the Greenspan commission, of $6 billion in FY83 and $17 billion in both FY84 and FY85. Republicans hoped to present the cuts, not as balancing the budget on the backs of the elderly, but as securing the pensions by instigating needed reforms. Domenici took the package to a caucus of SBC Republicans and won their support. The president pledged his support in a phone call; and the compromise passed the committee on an 11 to 9, party-line vote.

Reagan strongly endorsed the Senate Budget Committee plan the next

day. The tax hike was less than he had been prepared to accept in the Gang-of-17 negotiations; defense spending would be more; social spending cuts would be substantial. When asked about social security, he suggested that the savings might come from "an entire restructuring of the program," a line that revealed the president's old distrust of the program and, fortunately for him, received little publicity. Unfortunately for Reagan, the proposal's raw numbers were trouble enough. Democrats began blasting the social security provisions even before they emerged from committee on the night of May 5. "This is a time bomb designed to raid and loot the Social Security system," declared Michigan's Senator Riegle, "but they want to wait until after the election."^[46] "The President proposes to mortgage the future of the elderly to keep alive the folly of his Kemp-Roth tax cut," declared Minority Leader Byrd.^[47]

Vulnerable Republicans, including Senators Lowell Weicker, John Chafee, David Durenberger, and John Heinz, all up for reelection in 1982, ran for cover. Out at the grassroots, Republicans already were in a near-panic about the political impact of the recession. Governors Robert Ray of Iowa, William Milliken of Michigan, and Albert Quie of Minnesota had declared that they would not run for reelection in what promised to be a very bad year for their party. Now, the New York Times reported, Republican pollster Robert M. Teeter "said he had been getting calls from worried Republican candidates all day. He said he had been told that Democrats were so overjoyed at the political opportunity they had been handed that 'they can't believe what they're hearing.' He commented sourly, 'Me neither.'"^[48]

Republican House leaders declared against the compromise on May 11. Robert Michel insisted that members who had to run for reelection could not be saddled with the social security cuts; the matter would have to wait for the report of the Greenspan commission. Trent Lott added, "Social Security is out, Period. No plug, no honorable mention."^[49] Back in the Senate that same day, Daniel Moynihan proposed an amendment to the defense authorization bill that would repudiate the social security cuts. Howard Baker won the votes to defeat Moynihan only by promising an amendment that would put the Senate on record as opposing any but "corrective" actions "to save the system."^[50] So died the social security part of the SBC budget. Newsweek (in "The Third Rail of Politics—touch it and you're dead") quoted a White House aide, "All Republicans should be required to get a lobotomy before they can say the words 'social' or 'security' again."^[51]

Senate Republicans dumped the social security provisions on May 18. They also added back $3 billion in domestic spending so as to aid the reelection prospects of nervous Frostbelt Republicans. As adjusted, the

package was fairly similar to that of the Gang of 17. Despite some grumblings, these changes were enough to unite the party. The united Republicans took the resolution to the floor, beat back numerous Democratic amendments, and passed it, 49 to 43, on May 21.^[52]

Passing a Budget: The House

After one nasty screwup, the dominant party in the Senate had passed a budget resolution. The House had no dominant party; its action was therefore almost a parody of everything bad that has ever been said about Congress. Disorganization? Posturing? Legislation by exhaustion? The House provided these—and more. About all that can be said of the House's activities is that they were very (small "d") democratic. Everybody had a say; although agreement may have been achieved only through fatigue and creative accounting (that fooled no one), the result did represent opinion on the House floor.

"There are three ways you can pass a budget," said Representative Timothy E. Wirth of Colorado. "One is to get all the Democrats. A second is to get all the Republicans and the weevils. And a third is to find a compromise right in the middle."^[53] Or maybe there was no way. No one expected to unite all the Democrats. The 1981 Republican/weevil coalition was in shambles because of gypsy moth dismay about priorities and boll weevil distaste for deficits; and the ranks of centrist Republicans and Democrats—Frostbelt moderates, some Sunbelt conservatives and moderate loyalists, maybe a few of the responsible conservatives—were unlikely to yield a majority. Nonetheless, Wirth and his "Gang of Five" partners (Panetta, Mineta, Gephardt, Aspin) went to work with gypsy moths to design a centrist budget. James Jones and Delbert Latta, meanwhile, worked the partisan sides of the budget track.

On Thursday, May 6, ten gypsy moths told James Baker that it would be "politically stupid" and "indefensible" for them to vote for the Senate budget plan. They released their own alternative, which included greater reductions in the defense buildup, higher social spending, and no foolishness on social security. On Friday, Republicans Jim Jeffords (Vt.), Jim Leach (Iowa), and Tom Tauke (Iowa), along with the centrist Democrat Gang of Five, signed a bipartisan budget plan. "I would like to work with my own party," proclaimed Claudine Schneider (R-R.I.). "But we have been pushing and pushing and we haven't got any response. I think we need to work with the Democrats."^[54] This moderate proposal, known as the Aspin budget after its Wisconsin Democrat coauthor, would test the proposition that there was a hidden moderate majority.

On May 13 the House Budget Committee, in a party-line vote (Phil Gramm abstained), adopted a plan that claimed to meet the Senate's

deficit reduction targets but relied on substantially higher tax ($147 billion versus $102.3 billion in the final Senate version) and defense savings ($47 billion versus $22 billion) to achieve that deficit target. This was the Jones budget. Essentially, it matched the Democratic Gang-of-17 proposal but left out social security and cut defense more.^[55]

Robert Michel established a nineteen-member group (including five boll weevils and four gypsy moths) to try to recreate the Republicans' 1981 coalition. "It was like being in a snake pit," reported Silvio Conte, both a party leader and a gypsy moth. "The boll weevils gave some. We gave some."^[56] On May 19 Conte and others joined GOP leaders in announcing support for what would be called the Latta budget, with totals similar to the Senate's plan. But, by further cutting domestic discretionary programs ($41.3 billion versus $27 billion) and through matching the other House plans for larger "management initiative" savings, as "iffy" as could be imagined, Latta projected a lower deficit.

David Obey and the Black Caucus each proposed more liberal budgets; Republicans John Rousselot and William Dannemeyer of California proposed a plan that had massive social spending cuts so as to achieve balance. California Democrat George Miller produced a "pay-as-you-go" plan: spending would be frozen, and then all increases, including those in defense, would be funded by new taxes. This was a neat variation on Miller's theme that the military "spenders" created deficits (see his comments on the 1980 reconciliation).

Having tried to limit choices in 1981, House leaders now maximized them. One Democratic leader recalls, "There was … a good deal of frustration in the House; everybody thought they could come up with something politically and economically acceptable. I figured, let them see how easy it was." In addition to looking at seven comprehensive budgets, they proposed a rule that would allow extensive amendments to the three main proposals. First, the House would vote on the Miller, Obey, Black Caucus, and Rousselot plans, in that order. Then amendments could be offered, applicable to any of the three main alternatives (Aspin, Jones, and Latta). All three would be debated simultaneously. Then Latta, Aspin, and Jones would be voted on in sequence. The last one to get a majority would win. It was, Richard Bolling admitted, a "very complicated" and "unique" rule. But the Republicans found it fair, and there was no rule fight.^[57]

"Does Anyone Have a Budget?" Time asked, and then described how it appeared to outsiders:

Seven competing budgets. Flocks of nuisance amendments proposed for the sole reason of forcing opponents to cast embarrassing "no" votes….

The scene in the House, which begins voting on the budget this week,

was fairly close to legislative anarchy…. House Republican leaders produced a budget that looks very much like the Senate document but, somehow, projects $15 billion less spending. How did they accomplish this feat? An aide to Senate Republican chiefs had a simple answer: "They lie." Retorted an aide to the House GOP leaders, "Our numbers are no phonier than anyone else's."^[58]

On May 24 the Miller, Obey, and Black Caucus plans were defeated; each received almost no Republican support. The next day the Rousselot plan lost by 242 to 182, receiving 47 Democratic votes but losing by 53 Republican defections, almost all Frostbelt moderates. The Rousselot vote may be the best measure of the ideological thrust within the House to balance the budget by drastically cutting spending: the cutters were outnumbered.

During the votes on the three major resolutions, Mary Rose Oakar (D-Ohio) offered a crucial amendment. She proposed to increase medicare and decrease defense spending in all three budget plans. When her amendment was offered to the Latta plan, about 60 conservative Republicans chose it as an opportunity to express unhappiness with that plan and to remind Robert Michel that he could not take them for granted. Accordingly, they voted "present." Their moderate colleagues, however, seeing that Oakar had a chance to win, voted for her amendment and were joined by diehard liberals and moderate loyalists. This victory by the Democratic/Frostbelt coalition left the Latta plan with lower defense numbers (by $4.5 billion in FY83) than conservatives could accept yet with larger social cuts than moderates could stomach. It was widely argued to have ensured defeat of the Latta plan, which lost 235 to 192 as 20 Republicans defected.^[59]

In spite of pleas by Democratic and Republican leaders that the House pass something—anything—all three plans were defeated. The Aspin, supposedly centrist, budget turned out to have no real base, losing 109 to 129 among Democrats and gaining only 29 Republicans. Jones's plan also was beaten decisively, 253 to 171.^[60] Republicans were unanimous against Jones because the rule gave moderates a chance both to oppose Latta and to vote for the Aspin alternative; so the gypsy moths' discontent did not help the Democrats.^[61]

The leaders had one trick left. Following seven budget defeats, the original HBC plan (without the amendments added during floor debate) came up for a vote. "We come to the moment of decision," declared the Speaker. "The hour is late. Most Americans have retired for the evening. Tomorrow morning, when they wake up, I want them to know that Congress did its job and passed a budget."^[62] The members weren't interested in what anybody thought at breakfast, at least not on the Budget

Committee's terms, and voted down the eighth plan 265 to 159. Surveying the wreckage, Les Aspin commented, "Right now, you haven't got the votes out there to pass the Lord's Prayer."^[63]

President Reagan denounced the budget process as "the most irresponsible, Mickey Mouse arrangement that any governmental body ever practiced."^[64] For some reason he had not felt that way when he prevailed under the same rules in 1981; ridicule, moreover, would not produce a budget.

Politicians were beginning to wonder why they should go through so much pain to get down to a $100 billion dollar deficit. But people don't necessarily get to choose their problems. Or, if they have chosen them, it becomes hard to avoid them when there is an audience. The audience remained, not so much the voters as the markets. Something had to be done about interest rates; and so, in the logic of the time, something had to be done about the deficit.^[65] The next event reflected the seemingly contradictory notions that unless something were done about the budget, disaster portended;^[66] because budget resolutions didn't mean much anyway, however, any resolution would do. Basically, the Democratic leadership chose to force adopting a budget even if the Republicans were to win.

"I think the Speaker felt," one leader recalls, "that this was a Republican game, don't muddy it up, and we would straighten it out through the election." To clarify the choice, both parties moved away from the center. "At least we'll go with the true philosophy of our party," said Tip O'Neill. "To pass something," said Delbert Latta for the other party, "we have to go farther to the right."^[67] Democratic leaders estimated that a more liberal proposal might attract only about 180 votes, but they still added a few billion dollars in social spending to the Jones budget.^[68] Bowing to the lesson of the Oakar amendment, Republicans cut medicare by less, but they financed the change by reducing medicaid and nutrition programs.

"Will we do what the medieval bleeders did," Jim Wright responded, "and, if the patient doesn't respond to the first bleeding, bleed him some more?"^[69] Yet while the Republicans were leaning on their members to vote for the Latta proposal, Wright told reporters, "Last week the official party line vote was to vote against Latta. This week, the official party line vote was to vote for Jones. After the Jones vote, we told everyone to vote his conscience."^[70] First the Jones and then the Latta budgets would be considered as amendments to the original Reagan budget. If both failed, Congress would have to vote on the original Reagan budget, a prospect few Republicans wished to contemplate. When Jones failed, therefore, Republicans had an extra incentive to vote for Latta.

Jones lost 202 to 225; 39 Democratic defectors made the difference. Then Latta passed, 221 to 208, supported by 46 Democrats and opposed by 15 Republicans. On the final vote to pass the budget as amended by the Latta substitute, Republicans again won 221 to 207, as symbolic votes against the deficit by "opposers" were offset by new defections among moderate-to-conservative Democrats.^[71]

Happy to end the long fight, the representatives cheered the Latta budget's passage on the House floor. Hawaii Democrat Cecil Heftel explained that the budget passed "not because it was a good budget or fair budget or an accurate budget. But because it was the only budget."^[72]

Off went the plan to a conference dominated by three days of private meetings among Republicans. At the end of these meetings, conferees had pretty much accepted the House plans on revenue (slightly smaller increases) and defense (slightly larger reduction from Reagan's plan). The most objectionable of the Latta plan's entitlement cuts, for example, medicaid and food stamps, were sharply reduced, back to the numbers in the Senate plan. Discretionary spending choices tended toward the House position.

Conferees also moved to reduce the appearance of deficits, changing economic assumptions and accepting all the House's management initiatives. By conjuring up these reduced deficits, it became possible to predict lower interest payments. The Democrats scoffed at the result. Hollings declared, "We know it's out of whole cloth." And Domenici came back, "It has about as much realism as any budget we've produced." Fatigue leads to cynicism.^[73]

Table 7 summarizes the conference report that squeaked through the two houses; now Congress had to make it come true. The congressional task was not as big as the totals suggested. Congress could not legislate the management and interest savings. Federal pay, as in 1981, was only being restrained relative to an unrealistic baseline. The defense and nondefense discretionary savings would begin in the FY83 appropriations, but they also depended on action for FY84 and FY85. With virtually no disagreement, the 1981 experiment in controlling appropriations through cutting discretionary program authorizations had been abandoned in early 1982. Republican leaders made clear they would not again do that to the authorizing committees.^[74] Reconciliation instructions, therefore, covered only the entitlement and revenue changes, a third of the total savings.

A $100 billion tax hike would be difficult enough. Bob Dole and his allies, however, had spent most of the year putting a package together. The budget resolution would provide the argument that brought the president into their camp.

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)

The 1982 tax hike was devised and pushed through by politicians and staff who believed it was good policy and who, in the case of Republican leaders, singled out their own constituents to be the victims.^[75] Until the 1986 tax reform, we could hardly ask for a better demonstration of the limits of interest group power. Business lobbyists had collected a string of victories in the late 1970s, and in 1981 Democrats, led by Jones, had joined Republicans to encourage investment through favorable tax provisions. Suddenly, in 1982, the momentum reversed. The palaces of K Street, where lobbyists and lawyers dwell, glistened no less and the coffers of corporate PACs bulged as tightly; but their influence had waned. Convinced of the need to do something about the deficit, politicians believed that "something" should include new revenues. Businesses themselves were screaming about the deficit and interest rates, so they could not deny the problem. But when revenues were needed, in the words of one tax lobbyist, "The main individual [tax] preferences are health, homes, and retirement. And on the business side there is the investment tax credit and accelerated depreciation…. Where do you go

for the money?" Politicians, particularly Republicans, may not have wanted to raise business taxes, but it would certainly be better than either abandoning the third year of 5-10-10 or going after homeowners. The question changed from How do we encourage productivity? to Whose taxes shall we raise? Then business lobbyists went from occupying the high ground to being up to their necks in alligators.

Corporate tax breaks, as loopholes for undeserving fat cats, always had been subject to criticism; publicity about the auction of 1981, along with some provisions of the 1981 act—its negative rates for some profitable corporations, especially "Safe Harbor Leasing"—only intensified that image. Under "Safe Harbor" provisions, businesses that could not use deductions for investments because of low income or no income against which to offset the expense essentially were selling their tax breaks to profitable corporations. Whatever the argument for subsidizing the nonprofitable corporation, it was hard to explain why the purchasing corporation should be able to rake off a portion of the tax advantage in the process. A business lobbyist described safe harbor leasing as "a PR fiasco." Some Republicans, particularly Barber Conable, thought leasing worked. But on February 19 Senator Dole went so far as to unilaterally announce its demise: "However desirable many tax theorists find the current … leasing rules in the abstract, they are indefensible in a year in which the federal deficit will reach nearly $200 billion…. Corporations entering into leasing deals after today do so at their own risk."^[76] He was partly grandstanding, but the finance chairman knew the fans were on that side.

The January budget had proposed a minimum tax on corporations and, far more potentially controversial, a tax withholding on interest and dividends. While Reagan disbelieved in the corporate tax, his Treasury did not, and the politics clearly favored the tax. Interest and dividend withholding was far more risky. A Carter withholding proposal had been riddled with grapeshot in 1980. Treasury staff saw it as a compliance issue: if everybody who should pay taxes did, rates would not have to be so high. Regan and Reagan agreed.

With tax increases looming, business groups had to choose between two strategies: oppose all change, or try to shift costs to somebody else. Charls Walker, business lobbyist and past chairman of Reagan's tax policy transition team, remarked that "there is the potential for goring all sorts of oxen…. People are scared to death."^[77] He took the second tack, testifying to Ways and Means that the third year of the individual tax cut might be postponed or that tax breaks for oil and natural gas could be reduced.^[78] The Business Roundtable suggested higher excises and user fees. Others, particularly the Chamber of Commerce, opposed all tax increases, reflecting in part its devout supply-sider leaders. Yet the

Chamber's split from the Roundtable also reflected their different constituencies; the Chamber's small(er) business members had different concerns than the Roundtable's CEOs of major corporations.

Every threatened tax break had defenders. Airlines and aircraft makers claimed they depended on Safe Harbor Leasing.^[79] The administration's minimum tax proposal was said to fall most heavily on banking and oil industries. Normally, groups are able to protect themselves by claiming unfairness: "Why me? Why am I worse than anyone else?" In 1982, however, there was an answer: "We have to get somebody, and you've done well lately. It's your turn." The chief counsel and staff director of Senate Finance, Robert Lighthizer, expressed that basic principle: "How can you do anything about a $150 billion deficit if you can't assure that major corporations pay a 15 per cent tax?" He asked, "What can you do if you can't do that? Go out and nail some more students, or make some more cuts in food stamps?"^[80] Staff—on both tax committees and in the Treasury—felt policy was out of control, and they were determined to correct it. "We didn't know what was coming until it was in the report," a business lobbyist ruefully reported.

By filling in the blanks of something like $100 billion of revenue increases over three years, Treasury and Finance staffs were serving their leaders, particularly Bob Dole. If business interests were left off, everything would be contested, and Dole could not allow that.^[81] An administration member of the Gang of 17 recalls that "there was not much difference of opinion. [The troika,] Stockman, and Treasury all were on board because we had come up with $750 billion in revenues [lost in ERTA] when the original target had been more like $600 billion."

The Tax Policy office was very active. "We were providing him [Dole] all sorts of help," a participant said. "It was an ideal situation to us, we could make very good changes in the tax law and he would take the heat."

Determined to proceed with business tax increases, Dole let the administration know that, if it backed down, it might get something it wanted far less. "We're willing to raise revenues, and we believe we can protect the third year" of the individual tax cut, the senator reported telling Reagan. "But if people in the Administration are dealing off different tax provisions that affect business and others, they will put more pressure on the third year."^[82]

In late May Dole presented a list of thirty-four proposals to Finance Committee Republicans and asked which each found unsupportable. Each senator's staff aide then began meeting with Chief Counsel Lighthizer. The aides agreed on about $68.5 billion in tax increases that, at least to them, were noncontroversial. Other provisions, such as the minimum tax, an energy tax, and tax leasing (the latter being as strongly

defended by Minnesota's David Durenberger as it was disliked by Chairman Dole) were considered contentious. As of mid-June, Senate Republicans were still divided over the last $30 billion.^[83]

On June 30, the last day before the start of the second phase of Reagan's three-year tax cut, Senate Finance Republicans tentatively approved a package that met their budget target.^[84] During markup, however, four of them Jumped ship on interest withholding. Dole hinted that total repeal of tax leasing might be needed to make up the resulting $12 billion revenue loss. After more bargaining, the defectors backed down, and withholding was adopted on a party-line vote. In order to appease banks and other interest or dividend-paying institutions, some smaller tax breaks were added to the package.

Within Senate Finance, Russell Long proposed to defer the third year of the tax cut on higher incomes (raising $37 billion over three years); he lost 7 to 12. On a party-line vote on July 2, the committee adopted a plan that would raise $98.5 billion over three years; $17.5 billion would come from measures to increase taxpayer compliance, such as collecting taxes from restaurant owners on waiters' tip income. Withholding 10 percent of interest and dividend payments was expected to yield $11.6 billion. The twenty-five provisions ranged in comprehensibility from repeal of the modified coinsurance tax loophole (your guess as to what that was is as good as ours; but, anyway, its estimated worth was $5.2 billion) to doubling the excise tax on cigarettes ($4.8 billion).^[85]

The Finance package was brought to the floor as an amendment to a minor House-passed revenue measure (H.R. 4961), so as to circumvent the constitutional requirement that revenue bills originate in the House. It then was considered as Finance's reconciliation bill, including $17 billion in spending savings. Senator Bradley proposed a Democratic alternative that would limit the third-year tax cut for persons earning above $46,400 per year and repeal it (ostensibly, delay it until the budget was balanced) for persons with incomes greater than $78,700. "It's the last stand on the third year," Dole predicted; and indeed, on a nearly party-line vote, Bradley was defeated.

Dole beat off, or compromised on, a series of smaller challenges. Kasten and Hollings tried to delete the withholding provision, but Dole won (48 to 49) after exempting lower incomes, with help from liberals Ted Kennedy, Alan Cranston, and Chris Dodd. A Democratic proposal to limit medicare cuts was headed off by a smaller adjustment, proposed by David Durenberger. After several attempts by tobacco state senators to defeat or reduce the cigarette tax increase, the Senate agreed to make the increase expire after three years. Once again games were based on the three-year budget horizon! At 4:30 a.m., July 23, the Finance Committee

reconciliation tax bill, H. R. 4961, passed 50 to 47 on a nearly party-line vote.

Back in the House, Rostenkowski came out of the Gang of 17 with a rough sense of revenue-raising targets. Ways and Means staff worked with Rostenkowski and Conable to put together a package, which Rosty then brought to a caucus of committee Democrats. But the discussion did not go well:

At our meeting some members said, "Why are we taking the lead, Danny?" And some disagreed on the details, going after oil particularly. So the meeting broke up and only three members, Rosty, Shannon and Brodhead, were really for it. Brodhead thought it was the best reform package in years. Eighteen were against…. The meeting broke up with a consensus there would be no bill. And a few of us sat down … and agreed to get some bill about anything to the Senate, to let them do it and then we'll do our part in conference.

Seeing that the Senate would be able to piggyback on H. R. 4961, Ways and Means' staff consulted with Dole's people during his markup. Then, on July 28, the committee voted to go straight to conference on the Senate's amendments to the originally rather innocuous H. R. 4961. Agreeing that it was the only way to get a bill and hoping (wrongly) they would have some influence in the conference, Conable and three other Republicans joined the committee majority. That afternoon on the House floor, Rostenkowski admitted "deep personal misgivings" about going to conference without House consideration of the issues. Nevertheless, he argued that "any attempt to craft a tax-increase bill in the House would lead to political chaos, severely reducing the chances of its passage." Conservative John Rousselot challenged the Ways and Means maneuver; but his motion to table lost 229 to 169. With the support of forty-five Republicans, mostly "responsible conservatives," the House agreed to send H. R. 4961 to conference.

Rousselot predicted that the president would be lucky to get one hundred Republicans to support the tax increase when it reached the House floor. The Democrats liked the idea of making the president fight for a tax increase, especially since they did not trust his support. They were glad to see Reagan pushed out front by his own troops. "I want there to be presidential leadership, and sheer pain, as there was sheer pleasure last year," said Richard Gephardt.^[86]

Reagan's allies were badly divided; even his long-time aides, Lyn Nofziger and Martin Anderson, publicly opposed the tax increase and had to be reined in by White House staff. After Senate action, however, Reagan heartily supported the TEFRA tax increase. He did so in part

because many components were described to him as mere matters of ensuring tax code compliance or correcting mistakes in the tax code.^[87] More important, however, Reagan thought he had gotten a very good deal. As he continually declared in appealing for Republican support for the tax hike, for every dollar in new revenues, the budget plan provided three dollars in outlay savings.

Table 9 shows where Reagan got that idea: revenues were, in fact, only 26 percent of the total package. Stockman pointed that out to Reagan as part of the argument for TEFRA. It also shows what was wrong with Reagan's idea: the 1982 reconciliation would be three to one revenues ; even counting all the spending savings, Congress could itself deliver, including defense, a balance more like 1 to 1. Most outlay savings were items Congress could not, and had not promised to, deliver: for example, lower interest payments.

In essence, the funny numbers, meant to impress voters and maybe markets, fooled the president. They also fooled Donald Regan and Ed Meese.^[88] When eventually someone (Stockman blames Kemp) told Reagan that Congress did not give him any three-for-one, the president felt betrayed. Believing the administration had been "snookered," "screwed," "hornswoggled" on TEFRA, Reagan, Regan, and Meese became very suspicious of other compromises.

To Stockman, Baker, Darman, and congressional leaders, this sense of betrayal was ludicrous; no one ever said Congress would pass three-for-one. The resolution was clear enough about that. But when Stockman perceived, during the fight to pass TEFRA, that Reagan might have missed the point, there wasn't much the budget director could do. If he tried to clear up the confusion, Reagan might have changed his mind on TEFRA itself. Instead, Stockman let it slide and hoped for the best. He could not have anticipated the endless recriminations that would follow, outlasting him in the administration. In a letter to Reagan on January 16, 1984, for example, Senator Dole had to write:

The most frequently voiced objections to packaging new spending cuts and revenue increases together is that Congress would enact the new taxes but renege on the spending cuts. These critics cite as evidence the alleged failure of Congress in 1982 to deliver any of the promised three dollars in spending cuts for each dollar of tax increase. I respectfully submit, Mr. President, that you were not "taken in" by this budget plan.

Nevertheless the president decided he had been taken in, a perception that would explain the later Gramm-Rudman Act. Actually Reagan was not all wrong: while the deal never was three-for-one, he did not get all the social cuts he might reasonably have expected. On the other hand, Reagan and Weinberger tried to renege on the defense cuts!

In August 1982, however, Reagan still believed. In Billings, Montana, on August 11, the president opened his campaign for the new package of tax hikes. "The bottom line is this," he told his audience, "would you rather reduce deficits and interest rates by raising revenue from those who are not now paying their fair share? Or would you rather accept larger budget deficits, higher interest rates, and higher unemployment?" The president had convinced himself that the Senate plan was reform of unfair "loopholes." "In order to get $280 billion in reduced outlays over the next three years," he declared, "we had to agree to the added revenues of $99 billion. The ratio of reduced revenues to outlays is three to one."^[89]

The Republican National Committee taped two spots with the president asking voters to urge their representatives to support the plan. The spots carefully avoided describing the package as a tax increase, but the message to wavering Republicans—that the president wholeheartedly favored the package—had to be clear. On Monday night, August 15, Reagan would urge support for the plan on national television.

As Reagan campaigned for TEFRA, there was one minor complication: the bill did not exist. Conferees still had to settle many issues, and the administration lost on virtually all of them.

It was a very strange conference, beginning with an about-face by the administration on the tax side. "We went up to a meeting with Dole, Darman, Regan, Baker, Chapoton and so on," a House source recalled. "We thought it would be a pep-talk meeting, and found they wanted changes in the out-year (depreciation) and other business-type things." A coalition of business groups had finally managed, as a lobbyist put it, "to draft an alternative that was revenue neutral…. Dole wouldn't introduce our plan, and Jim Baker didn't approve it until a few days before the conference." At the last moment, Treasury supported these "more satisfactory schedules for business," as the lobbyists put it.

It was too late; TEFRA's business cuts were loosened only slightly. It was great stuff for Democrats: political jujitsu in which the Republicans became victims of their own momentum. "We kept receding to the Senate positions," a Democrat said, "which they kept denouncing in the Senate." The bargaining situation—Reagan out front, the only formal proposal from the Senate, the administration needing Democratic votes—gave Rostenkowski the advantage.

If the administration did badly on taxes, it did worse on spending. Ways and Means had taken a vote on spending provisions on July 15 but had bypassed the floor with its approval to go straight to conference. The conferees protected AFDC and restored some medicaid cut in 1981. On AFDC, a key staffer estimated, "We were up $400 million; they were down $1.8 billion." After they "hung on to the nth degree," Ways and

Means held the cuts to "maybe $100 million." They cut a similarly good deal on unemployment compensation. Savings were produced by coupling an extension of benefits to a small increase in the employer portion of the tax.

Conferees cut medicare even more than, but not in the same way as, the administration desired. The administration wanted to cut medicare costs by reducing benefits and raising patient costs, which, by market logic, would reduce "unnecessary consumption" of medical services. Congress agreed that medicare costs were soaring out of control, largely because under the third-party payment system neither providers nor consumers had to worry about costs. The committees also wanted to do something about the problem before the medicare trust fund went broke, expected around 1990. Reconciliation made for a great cover. Ways and Means and Finance, however, hit the providers, not the patients; instead of allowing prices to hurt customers, the conferees moved to regulate prices.

The conference agreement set temporary limits on physicians' fees and hospital prices. Then it ordered HHS to develop a procedure for "prospective" payments to hospitals and nursing homes by which costs for patients would be anticipated (based, in the end, on the diagnosis) and payments would be held down to a set amount for each diagnosis.^[90] TEFRA's cost restraints hit medical providers so hard that, when HHS completed its study, the new prospective payment system, though quite complex and regulatory, looked better to the hospitals than the alternative. Therefore, when the new system was enacted as part of the 1983 social security rescue package, hospitals did not resist strongly. Ironically, Ronald Reagan, who opposed medicare from its inception, was dragged into endorsing greater government regulation of the medical profession in the course of his own campaign against the welfare state.

On almost all categories of spending, results were closer to the House than the Senate numbers for an important reason. Republicans could hold only half their own troops in the House for a tax hike and knew it; therefore, there was no hope of a GOP/boll weevil coalition. Only the Speaker could deliver the necessary votes. If spending had not been packaged with revenue increases, Senate leaders might have fought harder (we cannot know; Dole certainly lacked enthusiasm for AFDC cuts). As it stood, however, they couldn't even protest much. "If I had screamed too hard on the [spending] compromises," a TEFRA advocate explained, "that would have given Gingrich and Kemp and the other guys the smoking gun to get rid of TEFRA. They could tell Reagan he was [getting shafted]." TEFRA was big, bigger than it seemed; it made no sense to complain about "$5 to $7 billion out of three years" when the tax might be "$300 billion over six." Executive branch aides and the

senators kept quiet so as to keep Reagan on board, while conceding to the Democrats to keep them on board. This time, packaging favored the Democrats.

Fearful of deficits and browbeaten by a heavy dose of jawboning from the White House, even most business groups went along. Although their proposals were rejected at the end, the Roundtable helped rally business interests behind Reagan who was, after all, "their" president. Donald Regan declared that business had to understand that new revenues must come from corporations and the wealthy: "Because of last year's tax and budget cuts, a mistaken impression is abroad that this administration favors only the rich. Business must understand we have to correct this mistaken impression."^[91]

Liberals did not quite believe their good fortune. "Liberals should be behind this bill one-hundredfold," proclaimed the national director of the Americans for Democratic Action. "The bill includes in it reforms we have sought for years." "From a tax standpoint, we closed a lot more loopholes than we opened," said Ways and Means Democrat Fortney (Pete) Stark of California.^[92] The Democrats, too, felt the bill was redistributive, away from the rich and toward the middle class.

On Monday Reagan went on television to explain his support for the tax increase. Once again he presented himself as surrounded by rumors, out to set things straight. The tax increase was not "the largest tax increase in history" as some would claim; but it might be the largest tax reform in history. The tax package had to be passed to "end the bickering here in the capital" and allow the Reagan program and economic recovery to proceed.^[93] Now, he could hope, his third year of tax cuts was safe.

This speech, like the others since September 1981, provoked no upwelling of support. Yet, reading it closely, we suspect the speech served another purpose: its rhetoric continually sought to reassure people that Ronald Reagan hadn't changed, that a few great principles informed his policy, and that the public should pay no attention to confusing reports from Washington that suggested otherwise. Reagan's speeches succeeded in maintaining his bond with supporters in the face of criticism and bad news that had undermined his predecessors.

In response, Democrats declared they had not supported Reagan's extreme tax cuts in 1982 but would now support him in rectifying some of his own worst excesses. Their language was restrained, emphasizing bipartisanship. The most important result of the speeches was not the weak public response; the speeches helped to cement the temporary alliance between House leadership and the president.

H.R. 4961 finally emerged from conference on Tuesday, August 17, after a series of last-minute deals.^[94] In the two days before the vote, both

the president and House leadership worked their troops furiously. In spite of the leaders' efforts, both parties were badly split. It was a big tax increase close to an election. In the five districts where, due to reapportionment, incumbent Democrats were running against incumbent Republicans, all ten candidates opposed the bill. The GOP could not even use its regular whip structure because the whips were split. Kemp, Rousselot, and other strongly antitax Republicans led the opposition. The Chamber of Commerce,^[95] National Federation of Independent Businesses, and Farm Bureau fought against TEFRA; aside from labor, there was no real countervailing force back in the districts.

The key vote came on an attempt to revise the closed rule for considering the conference report. As Trent Lott put it, "If we try opening this package of tax and spending cuts at this point, and then succeed in knocking just one provision out on a point of order or a vote, then we risk losing the whole package for good."^[96] The rule held, 220 to 210, with mainstream and diehard liberal Democrats joining responsible conservatives in a rather unusual alliance. Republican leaders held only 75 of their troops on the rule vote, but, on the final vote on the conference report, 103 Republicans supported the president. As Democratic support for the plan declined between the two votes, the result was a narrow 226 to 207 victory for TEFRA, the Tax Equity and Fiscal Responsibility Act of 1982. After the House vote, Senate action was anticlimactic, although the margin was narrow. With crucial support from nine Democrats led by Ted Kennedy, Robert Dole and Ronald Reagan triumphed, 52 to 47.^[97]

The deficit mattered. Without that threat, such substantial action was unlikely. Morality mattered. How the deficit was reduced was determined by shared notions of equity. Politics mattered; it looked awful, but it worked well.

As the tax-hike debate reached its peak, Wall Street took off on a rousing rally.