Prudential Bache hit the Wall Street telephones Monday with a report that the Bush Administration had made a deal with Dan Rostenkowski on the capital gains tax. Several of our clients called us, alarmed by the report, and we surmised the 37-point selloff was in good part the result of the credibility the rumor developed. Financial news wrap-ups pointed to news from China as being responsible for the market slide, and perhaps some of the early morning weakness reflected the weekend developments in Beijing. But the value of U.S. assets tied to developments in China are trivial relative to Hong Kong's, and in any case the worst news had been digested by Wall Street early, and most of the market slide, 33 points, came after 11 a.m.
The Pru Bache report was that Rostenkowski would agree to a one-year cut in the rate to 20%, to release the locked-in capital gains necessary to patch this year's Gramm-Rudman budget reconciliation. The effective date supposedly would be June 20 or thereabouts, when the deal would be announced. The Administration would agree to permit the rate to rebound to the current level next year, but at that point gains would be indexed to some as yet unspecified base year. Pru Bache, we're told, advised that Rostenkowski would deny the deal when asked, but that it had in fact been cut.
It seemed preposterous to me that OMB Director Dick Darman, who is playing the Administration's cards in this game, would settle for such a pitifully weak exchange with all the aces he holds. On the assumption that he wouldn't admit it if he had (as he plays his cards close to the vest in any case), I called GOP leaders in the House and Ways & Means minority Chief of Staff Philip Mosely, all of whom insisted the administration wouldn't dare make such a deal without consulting Congressional Republicans, and that no such deal was made. Richard Rahn of the U.S. Chamber of Commerce says his constituents would skin him alive if he agreed to such a deal.
My belief is that this is a trial balloon from Rostenkowski or his staff, testing the negotiating parameters, knowing a deal will be cut in late summer during budget reconciliation. The Los Angeles Times two weeks ago reported much the same detail as the Pru Bache rumor, tied to Rosty's staff. The story suggested the administration would concede child health care legislation that the liberals want. As far as I can tell, Darman has not even initiated discussions on this issue with the Democratic leadership, nor is it in his interest to raise the subject until the pressure of budget reconciliation builds up in August. Newt Gingrich is determined to have a floor vote on the Bush 15% proposal, Gingrich assuming that it is a winning issue for Republicans, as I believe (and as liberal Democratic Senator Alan Cranston, a supporter of the Bush proposal, believes). It may be that Darman will have to give some fig leaf to Rostenkowski, but it won't be more than that or the GOP will take the issue back to the voters next year.
The administration's enterprise zone bill, now backed by black leadership, has a zero capgains tax that is especially attractive to minorities. The administration position conveyed to the black leadership is that a 15-point differential is about all they can expect. The Pru Bache rumor of a rebound to 28% next year is unrealistic on that score. The message is to be wary of rumors as we approach reconciliation. We're still optimistic that the administration is going to cut a respectable deal on capgains.