The Politicians Try Tax Reform
The secretary of the Treasury assembled a team of specialists to work out a policy from which to start, a trial balloon to cause reactions that would produce information about budgetary and political feasibility: Is there enough latitude in preferences to allow for lower rates, and, if there is, might there be sufficient support?
Despite the president's decision to postpone the Treasury report until after the 1984 elections, politicians with similar programs were motivated to act. On April 12, Senator Bradley and Representative Gephardt announced a petition drive to mount public support for their fair tax. A few days later, the new Populist Conservative Tax Coalition, chaired by
Richard Viguerie (a political operator who sparked use of mass mailing and computerized telephone techniques) announced a drive to garner a million signatures for a 10 percent flat tax.[14] The symbols used—"fair" and "populist conservative"—showed possible signs of political coalition. If fair is populist and populist is conservative, maybe the two sides can get together. But not at 10 percent!
On April 26 Representative Jack Kemp and Senator Robert Kasten introduced their "fast tax." Like Bradley-Gephardt, Kemp-Kasten would have eliminated deduction of state and local taxes, repealed the investment tax credit, raised personal exemptions, and continued the housing deduction. Kemp-Kasten was flatter—24 percent as opposed to 14, 26, and 30 percent—and provided larger preferences for investment.[15]
During the year other proposals emerged. They ranged from a consumption (cash flow) tax, to across-the-board reductions in tax preferences (base-broadening), to a flat tax—essentially, the Hall-Rabushka scheme for a 19 percent flat rate on all business and personal income with a large personal deduction to get poor people off the rolls.[16]
As the presidential campaign warmed up, Senator Bradley tried in vain to convince Walter Mondale that it was essential to increase the perceived fairness of the tax system before trying to raise revenues that would reduce the deficit. Nevertheless, Mondale chose to focus on the deficit, and proposed raising taxes.[17] The Democratic party platform, along with castigating the existing system and criticizing President Reagan for taking from the poor to give to the rich, pledged itself generally to broaden the tax base and shift the tax burden.[18] BY contrast, the Republican platform came out for a "modified flat tax."[19] Following its president, the Republican party pledged that "tax reform must not be a guise for a tax increase."[20]
During summer 1984, top Treasury officials met to review tax reform proposals.[21] In response to assertions that wholesale reform "would never fly on the Hill," Secretary of the Treasury Don Regan replied that "I don't want to hear about the politics of it. If we worry about the politics, we'll never get anything done."[22]
The idea of a flat tax was dropped because the rate would have to be too high. A close adviser to the president recalls that at 19 percent, "it would mean a lot of increases for a lot of people." Instead, the Treasury tax staff, trading tax preferences for lower rates, came up with personal rates of 16, 28, and 37 percent and a corporate rate of 28 percent. Ronald Pearlman, who succeeded John "Buck" Chapoton as assistant secretary for tax policy, felt that the disparity between the top rates for individuals and corporations was so large it would encourage the movement of resources, so he lowered the individual and raised the corporate rate. "If we're so close," Don Regan asked and advised, why "can't we get to 15,
25, and 35 percent?" Now the top personal rate, coincidentally, would be just half of the 70 percent rate in force when the Reagan administration took office. Lowering the individual rates meant raising the corporate rate to 33 percent, still substantially below the 46 percent rate when Reagan became president.[23] Following a series of hearings in which House Ways and Means member Charles Rangel (D-N.Y.) provided vivid examples of how large a proportion of income was taken from the working poor, the Treasury plan was modified to keep many of this group from being taxed at all.[24]
The 262-page Treasury report on "Tax Reforms for Fairness, Simplicity, and Economic Growth" that appeared after the November 1984 election pulled few punches: business taxation was "deeply flawed"; its subsidies to favored industries "distorted choices"; tax shelters for the wealthy "undermine confidence in the tax system." What more could tax preferences, with their accompanying high rates, be accused of than discouraging "saving, investment, invention and innovation"?[25]
The price for reducing corporate and personal tax rates was high: eliminating the low rate for capital gains (which, however, would be indexed) and wiping out the investment tax credit, accelerated cost recovery system, deductions for state and local income and sales taxes, and for parts of fringe benefits. In sum, personal taxes would be cut by $148 billion while business taxes would rise by $165 billion.[26]
If one picked a bunch of tax economists and lawyers at random, gave them the constraint of revenue neutrality, and told them to come up with a large-scale reform, Treasury 1, as it was called, would be it. Treasury 1 bespoke a commitment to free-market economics, supporting enterprise as a general concept rather than for particular industries.
But not without a struggle. The assistant secretary of the Treasury for economic affairs argued strongly in favor of retaining tax incentives for capital investment. Secretary of the Treasury Regan ruled against him.[27] Indeed, after much debate and not a little soul searching, his other assistants persuaded Regan to go for evenhandedness by having capital gains taxed at the same (now higher) rate as ordinary income. Reagan was told that indexing the original investment against inflation would better protect the investor who saw his stake reduced in value by years of inflation.[28]
Treasury 1 raised howls from the business community and cries of glee from Democrats. After debate within the White House, the president chose to treat the plan as Treasury's, not his, but a good start. On December 7 (perhaps the losers saw it as another Pearl Harbor) President Reagan praised the Treasury plan as among "the best proposals for changing the tax system that have ever occurred in my lifetime." And, in his State of the Union message on February 6, President Reagan
sought to get Congress on the move by issuing a call for "historical reform."[29]
Words of caution were heard. Don Regan, who had become chief of staff, said Treasury 1 was written on a word processor and could be changed. Republican members of the House Ways and Means Committee urged the president not to allow tax reform to divert attention from the deficit. Undersecretary of the Treasury Richard Darman agreed.[30] Still, the president, waxing eloquent in his State of the Union speech, had spoken of "restoring fairness to families" by increasing the personal exemption and exempting the poor. Why, Congress could "pass, this year, a bill … making this economy the engine of our dreams, and America the investment capital of the world."[31]
There were the usual charges of presidential misunderstanding, only this time from the other side. Despite Reagan's reassurance that capital formation would be protected, Jack Albertine, president of the American Business Council, complained that the man in the White House did not seem to realize that increased taxation of capital gains was part of the Treasury plan.[32] A group of ninety-seven House members wrote to the president protesting against the higher rate for capital gains.[33] Lobbyists for the Independent Sector, representing nonprofit groups, and charitable agencies spread concern about the effects of lower rates on donations. As the chorus of protests swelled, White House efforts to distance the administration from commitments to specific provisions created doubts of its commitment to reform.
Politicians and public officials were full of folk wisdom about why nothing much would be done. California Democrat Fortney H. (Pete) Stark, chair of the House Ways and Means Subcommittee on Select Revenue Measures, observed that "leveling the playing field"—a congressional term for reducing tax breaks, so that individuals and industries were treated alike—meant that "the guys who are going to go down are going to fight like hell." His prediction in November 1984 was that "Congress in the middle of something like that never does anything courageous." Stark was seconded by Representative Gephardt, who observed, "My experience in politics leads me to believe that people who are about to lose something tend to be more effective than people who are about to experience a continuation of the status quo even though they don't like it." As the committee's chief counsel, John J. Salmon put it, "There are only big cats and dogs left and they bite."[34]
No one could be more experienced than Wilbur Mills, chairman of Ways and Means from 1958 to 1974. He summed up the difficulty: "There's no constituency for tax reform. People who've got deductions don't want to give them up, and, while most people might be better off, it's hard to convince the public." Indeed, it is, if only because various
segments of the general public want different things. Various polls taken in 1982, for instance, revealed strong support for both a flat tax of 14 percent for everyone, with no preferences, and a progressive income tax. Public opinion analyst William Schneider concluded that, although the public was dissatisfied with the tax system, the people were also reluctant to depart from it.[35] In a more refined analysis of opinion, on particular provisions studied over many years, John Witte (author of the best study of the political aspects of the income tax) concluded that dissatisfaction with the system as a whole is overcome by a lack of support for alternatives. Item by item, Witte finds, contrary to his initial expectations, that the internal revenue code is exquisitely sensitive to whatever public preferences exist.[36]
In mid-1985, starting with the view that paying taxes is hardly a popular activity, Everett Carl Ladd (executive director of the Roper Center for Public Opinion Research) nevertheless found no "populist groundswell" for reform. In a Los Angeles Times poll in January 1985, 59 percent agreed that the present system was unfair, but the same proportion believed they had personally paid the right amount of tax; from that Ladd concluded that "there certainly isn't what I would call significant resistance to the present tax structure."[37]
In the face of "instant obituaries" for tax reform in Business Week and other publications, Ronald Reagan began to reassert that he was serious. He and his people were "totally dedicated" to tax reform, the president told a reporter at his press conference. Worried that the reform would be used to raise taxes to reduce the deficit, Reagan said also that "we're not sending them [the spending budget and Treasury 1] up there [to Congress] as a package that somehow people can begin trading between one and the other."[38] If tax reform turned out to be a tax increase, he might well lose on both counts as his supporters deserted him on the increase and his opponents raised the ante for taxing high incomes. Accommodation would become impossible.
For months Senator Bradley, whose own proposal resembled Treasury 1, had said he would wait for the State of the Union message before lending his own weight to the enterprise; he wanted to see how strongly the president came out for reform. Praising the speech as a major step, Bradley raised the level of commitment: "He's [Reagan's] got to go directly to the people if he's going to counter the special interests."[39] House Ways and Means Committee Chairman Dan Rostenkowski also told everyone in sight that the president's "got to take the heat with the rest of us. A list of lofty principles is not enough."[40] Rostenkowski's ally on Ways and Means, Don Pease (D-Ohio), made the quid pro quo clear: "We won't get any place unless President Reagan is willing to invest a lot of his personal time, energy and political capital in trying to get it
through. If we don't get a signal he's trying to do that, I think the committee will not go through the motions."[41] Democrats and other politicians wanted the "great communicator" to rally the public against the lobbyists.
In spite of what the New York Times called "an extraordinary personal effort" by Reagan[42] to generate that support in speeches and in meetings, he failed. The very fact that he kept trying despite lukewarm response, however, meant that it was worthwhile for others to keep trying. Had President Reagan just sat there waiting for others to take the lead, tax reform would have languished.
New Senate Finance Chairman Robert Packwood was no fan of reform: "I do like to use the tax code for incentives," he told anybody who would listen. "I sort of like the tax code the way it is."[43] But other potent people saw promise. Packwood's new chief of staff to the Finance Committee, William M. Diefenderfer III, saw a chance to broaden the appeal of the Republican party. Diefenderfer characterized himself as one of the "many [who] feel we need a major occurrence [like tax reform] to have the average guy say, 'yes, indeed, the Republican Party is my party.'"[44] Similarly, Dan Rostenkowski, the strongest supporter of tax reform among House Democrats, argued strenuously with skeptical colleagues stressing that "our first order of business is to reduce rates for the people. That's a good Democratic position for us to be in…. I'm sure Ronald Reagan is going to try to steal that thunder."[45]