Recess on Capgains
Jude Wanniski
August 2, 1989

Congress will take its August recess at the end of the week without a resolution on the capital-gains tax, but it seems clearer than ever that a deal will be struck in Ways & Means when Congress returns. The only question is what President Bush will be willing to settle for, having essentially won the debate. With a few public shoves, I think he could get almost anything he wants when Congress comes back. But the White House may decide to take the month off.

Chairman Dan Rostenkowski has put off a vote, knowing he would be on the losing end of the Jenkins package that would lower the rate to 20% for two years and climb back to 28% with indexing in 1991. Practically everyone now reckons this would win on the House floor, with so many Southern and moderate Democrats itching to support a lower capgains rate. But the White House could win much more, I think, if it pressed the issue with the public.

Richard Darman's strategy to date in pulling capgains out of this Democratic Congress has so far been succeeding. But it now looks as if he may get less than he might. House Speaker Tom Foley and Majority Leader Dick Gephardt have elevated the issue as their first genuine "party" issue with the White House, urging fealty among rank-and-file Democrats. But they know they're going to lose at some level and are aiming to give up as little as possible by playing hardball. The question dominating GOP and Democratic circles is how hard the President is prepared to play.

Mr. Bush says he's willing to compromise, as long as he gets a rate differential that encourages investment and job creation. All this means is that he's willing to accept some number higher than his own proposed 15%, but how little will he take in preserving the fiction of friendly bipartisanship?

The deal Rostenkowski is offering, on behalf of the libs, smells to high heaven. He'll give indexing alone, fish wrapped with two abominable legislative issues the liberals want to preserve: the catastrophic illness part of Medicare, which everyone knows will cost a zillion dollars annually in a few years, and Section 89 of the tax code, which forces employers to give comparable health and life insurance benefits to high and low-paid workers (and is inspiring employers to cancel all benefits and buy their own insurance). Rosty should be holding his nose as he does this dirty job for the libs. He certainly knows indexation, by itself, does nothing to help the Gramm-Rudman reconciliation, and probably costs a ton of money. It also benefits most the rich, who have the most capital assets to protect, doing nothing for those who aspire to be rich. I've argued that as a class, black Americans gain most by a cut in capgains, not indexation, but the hidden liberal agenda is to keep black Americans on the Liberal Plantation.

What comes next? The liberals know they'll have to give something on rate cuts. There's talk of a 20% income exclusion after a three-year holding period, which would make the effective rate 22.4%, instead of the 30% exclusion that produces a 19.6% effective rate under Jenkins. Will Bush split this difference and settle for a 25% exclusion after an 18-month holding period, producing an effective rate of 21%? Or is he also playing hardball, aiming at a 40% exclusion and a 16.8% effective rate after a six-month holding period? Will he swallow a temporary, two-year cut or insist that the rate be made permanent?

Nobody, anywhere, knows the answers to these questions, because nobody knows what the world will look like from Washington, D.C., on Labor Day, when the summer recess ends. How hard will proponents of the cut try to sell it at the grass roots? The President should be taking his case to the people. August is the best time to do it, while members of Congress are at home among them. The August recess has always been an unusually good time to communicate with the electorate, relaxed with spare time to listen to news. The liberals used their August two years ago to build the case against Supreme Court nominee Bob Bork, while President Reagan's Chief of Staff Howard Baker sent everyone to the tennis courts. The liberals will be using this month to regroup on capital gains, we can be sure.

It wouldn't take much for the President to get his message out. A speech or two, a radio address from Kennebunkport, something to get his troops working on at the grass roots. We can see RNC Chairman Lee Atwater, who has just announced a new Democratic defection in the House to the GOP, trolling for others, with capgains on his hook. People will pay attention, especially senior citizens who would dearly love to sell assets if the tax rate was reasonable. In his July 28 newsletter, Horace Busby makes this point beautifully:

It is...very much a "woman's issue." The proposed early-stage reductions would have negligible influence on larger investors. The primary beneficiaries, whether intended or not, would be those holding long-term investments in securities or property, permitting them to dispose of such assets without incurring big tax liabilities.

The most numerous holders in this class are women, especially older women. Whether by their own investments long ago or by gift or inheritance from fathers, mothers, husbands or others, they have securities greatly appreciated over decades. Yet they are reluctant to liquidate -- or, in many instances, simply cannot afford to sell because of the taxes which would be owing under existing rates. Thus, for many such women, valuable small holdings will pass into their estates with little of the value realized when most needed. The White House, thus far, has not made this case for its own proposals.

In fact, the White House has thus far not made any case for the capgains cut because it has been Darman's strategy to play this as an "inside" game, which ignores the "outside" public and concentrates on forcing the Democrats to deal for lack of realistic alternatives. White House Chief of Staff John Sununu, the former governor of New Hampshire, believes an outside game would be more effective at this point, especially as the original assumption of bipartisanship has been washed away by the Foley-Gephardt litmus test on capgains. Sununu would have the President warn the voters that any economic weakness or recession that develops in the next year would have been overcome by his capgains proposal. The Democrats are very nervous about this tactic and are already having their allies in the press assert that it is the Fed alone that controls the state of the economy.

Darman has gone along with the Democrats on this, and has already stated publicly that if a recession develops, it will have been chiefly the Fed's fault for overtightening. Inaction on capital gains will not be blamed, he indicated to Evans & Novak on their TV show last week. He still believes patience will bring the Democrats around, telling Rowland Evans: "I'm not convinced that it's going to come to the kind of fight that you're assuming is already there. I will grant that it's been a very unusual performance by the Speaker, and Mr. Gephardt working the committee itself. But I'm hopeful that they will see that they won't benefit from an ugly floor fight, and that it would be in their interest to propose something better than what they've proposed in committee."

When you kibbitz Darman on strategy, you do so with hat in hand. He's the best strategist I've ever known. Still, I've urged him to push the game outside this month, at least to offset the mischief the liberals will be up to. I genuinely believe his strategic successes to date have been driving the stock market up, and the wealth and confidence effects are already benefiting the economy, even prior to the details being nailed down. This could evaporate, though, if the President lets himself be rolled on capgains by his pal Rosty. And if George Bush lets capgains get away from him now, the economy, his administration, and prospects for a second term would unravel rapidly.

My expectation is that knowing what's at stake, the White House will produce an effort to build on the coalition for capgains and that the recess will produce a better bill as a result. We're guessing a permanent 33% exclusion, an 18.75% effective rate, retroactive to July 1, 1989. If so, 3,000 will not contain the Dow. Just guessing.