7 Questions and Answers Jude Wanniski January 11, 2001

1. SOME DEMOCRATS ARE ARGUING THAT TAX CUTS CAN BE INFLATIONARY. I KNOW YOUR VIEW IS THAT THEY ARE DEFLATIONARY. HOW DOES THIS BODE FOR THE TAX DEBATE NOW TAKING PLACE?

Wait a minute. Tax cuts are only deflationary in the sense that as they increase the demand for liquidity, a failure by the Fed to supply it makes dollars scarce relative to gold (first) and then all other commodities. Tax cuts will not be deflationary if the Fed is following a price rule, which means increased demand will automatically be matched by an increase in liquidity. (The Kennedy tax cuts of 1964 provide such an example.) We can't say tax cuts are deflationary if the real problem is the Fed starving an economy that wants to expand because tax rates have become less onerous. The problem for George W. Bush is that his economists are all Keynesians, a la Larry Lindsey, who would increase consumer spending in order to expand the economy. This plays into the hands of the Democrats, who are already arguing that the Bush tax cuts will go into the pockets of the rich, who will not spend the money, because they already have all they need. They argue instead that tax rates be cut on the middle class, who have purchase needs and will thus spend any extra money they get from tax cuts. Lindsey has painted Bush into a corner. It will make life difficult for him as he tries to push the plan Lindsey has designed for him.

2. WHAT DO YOU THINK ABOUT THE BUSH CABINET CHOICES OVERALL?

It's too soon to make a final conclusion, except on national security, where I think the selections have been excellent. Bush will have a broad range of perspectives, from doves to hawks, with Colin Powell at State the leading diplomatic dove and Don Rumsfeld at Defense, a reasonable hawk. Vice President Dick Cheney is in the middle -- casting the "tie-breaking votes" in the White House, as he did in 1990 when he sided with Powell in recommending AGAINST sending the Gulf troops into Baghdad to dislodge Saddam Hussein. There is not yet a similar balance on domestic policy, with none of the economic posts filled so far reflecting supply-side views on monetary and fiscal policy. I met with Cheney when I was in Washington last week and made this point. There are candidates for top posts in Treasury who would provide such balance, but Paul O'Neill, who will be Treasury Secretary has not yet made his choices known. Former Missouri Senator John Ashcroft is a very good choice for Attorney General and I think he will be confirmed. The liberal interest groups opposing him cannot raise money to sustain themselves unless they pick ideological fights, which is what this is all about.

3. WHAT IS YOUR OPINION OF TRENT LOTT'S POWER-SHARING ARRANGEMENT?

I'm very impressed with the deal Lott has cut with the Democrats. That's because I think there is almost as much weakness on the GOP side as on the Democratic side, and as little wisdom on either side as the other. In the 106th Congress, for example, I think the smarter positions on tax policy were on the Democratic side with Charlie Rangel than with the GOP side, especially on the estate tax. But Republicans were so sure they were going to win in a Bush landslide, they killed the tax cuts, and the economy lost a full year of a lower risk structure to support the New Economy. If I were to list the most anti-growth members of the Senate, a good number would be Old Guard Republicans in power positions.

4. DO YOU THINK THE DEMOCRATS WILL BE ABLE TO TEAR UP ASHCROFT THE SAME WAY THEY DID CHAVEZ? WHAT ARE ASHCROFT'S CHANCES OF ACTUALLY BEING CONFIRMED?

Linda Chavez, a very nice lady, was an ill-considered appointment, unless the Bush team really did want to expectorate in the face of organized labor. After an election showing the electorate is evenly divided between the philosophical stances of the two parties, the Labor slot should have gone to someone who is on good terms with organized labor -- someone labor leaders can get on the phone with when some issue of importance arises. Chavez was not that person. The Attorney General's office does not represent a narrow slice of the population but is the President's lawyer, with both representing the whole country. Ashcroft is hardly a right-wing ideologue, as he is being portrayed by liberals and by left-wing ideologues. He is perfect for the job and also would be a good choice for a Supreme Court seat when one opens up. The confirmation fight over the AG seat will serve for both posts. If he handles himself well and is confirmed with the 50 GOP votes now lined up for him -- plus a good number of Democrats -- I think he won't have to go through a SCOTUS confirmation battle if and when that time comes.

5. WHAT DO YOU THINK GREENSPAN'S RESPONSE TO THE BUSH TAX CUTS WILL BE? NOW THAT HE'S CUTTING RATES DOES THAT MEAN HE'S ON BOARD, OR JUST THE OPPOSITE?

That depends on what kind of package the Republicans come up with. I often wonder if Greenspan has forgotten much of what he knew when he and I were on speaking terms, but I do know for sure he understands that some tax cuts are superior to others. He would always support a cut in the capital gains tax because he knows -- and has said so to congressional committees in the past -- that a capgains tax is the worst, because it is a direct tax on productivity. In other words, a capgains cut, in his mind, will not be inflationary even in a cash-flow Keynesian model, as real wages will rise as workers get a higher share of increased productive output. He probably feels the same way about cutting the top marginal income-tax rates, which are part of the Bush package, and even estate tax relief. But big aggregate numbers -- like the $1.6 trillion Bush proposal over 10 years -- would not impress Greenspan.

6. REPUBLICAN LEADERS NOW ARE CALLING FOR RETROACTIVE TAX-RATE REDUCTIONS TO PROP UP THE ECONOMY (from front page of Wednesday's WSJ). WHAT WILL THE EFFECT OF RETROACTIVE TAX CUTS BE ON THE GOLD PRICE? AT THE MARGIN, WHAT DOES THIS MEAN FOR EQUITIES?

If the tax cuts proposed to be made retroactive are Keynesian -- putting money into people's pockets a la the marriage tax penalty or a higher earned-income tax credit -- the effect on the gold price would be negligible. They would not give rise to an increased demand for liquidity. If the congressional Republicans push for a cut in the capital gains tax -- which I believe they would like to do -- there would be a clear increase in the demand for bank reserves. The same is true for the pension-fund reforms that almost passed in the last Congress with broad bipartisan support. If the Fed does not supply the liquidity, my guess is there would be some downward pressure on gold. Then we get into sector analysis on which equities do better with the tax cuts than with a bit more monetary deflation. We still think the tech stocks would appreciate in a more favorable capgains environment and would get a better kick out of retroactive tax cuts than the old economy companies that have poor debt/equity ratios. Remember, we said several weeks ago we had become persuaded that the New Economy equities would feel less of the deflationary drag of $265 gold now that there has been so much "correction" in their valuations. There would not have been as much correction if last year's tax legislation had made it into law.

7. ANY CHANCE OF A CAPGAINS CUT IN THIS CONGRESS?

Nobody is talking about one at the moment, but I think if Senate Majority Leader Trent Lott and House Majority Leader Dick Armey begin talking about a cut to 15% from 20% to boost the economy, it would catch fire. GWB surely remembers his father campaigned for a 15% rate in 1988, but the Democratic Congress denied him -- one of the reasons the economy went into recession and Bush was defeated by Clinton in 1992. There is always plenty of support for a cut in capgains among House Democrats and Southern Democrats. With a Republican in the White House ready to support such a cut, there's no reason to stop it. Except for Larry Lindsey, who says the idea is not on the President-elect's list of priorities.