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Eleven Fake Budgets and a Real Tax Hike
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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


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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


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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


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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


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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


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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!


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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


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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


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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


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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.


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Eleven Fake Budgets and a Real Tax Hike
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