The astonishingly large margin of victory for the capital gains cut in the House last week, as 64 Democrats defected to the GOP position, greases the way for a much better bill in the Senate. We'll get at least a permanent, indexed differential at 19.6%, with a chance of getting the rate a bit lower. Our forecast last December of an 18% rate at the final bell doesn't look too bad. Senate Majority Leader George Mitchell says he has the votes to defeat the House version, but of course that is his fig leaf, the only fig leaf left to the party's liberal theologians! By eliminating the 2 ½ year "yo-yo," as Mitchell put it, the Senate would provide an avenue for their own liberal members to get aboard a permanent cut. The fig leaf also extends to House Democrats who voted against the cut, giving them a reason to switch sides on the conference report.
There's still the possibility of sequestration in two weeks, but a lot can happen very fast on Capitol Hill when the opposition gives up, wanting to bury defeat as quickly as possible. Generalship encompasses the skills of strategic retreat, and Senator Mitchell, House Speaker Tom Foley, and House Ways & Means Chairman Dan Rostenkowski now have responsibility to their constituents in Congress to spill as little blood as possible. House Majority Leader Richard Gephardt, the architect of this debacle, can't have much influence on the process.
Senate Finance Chairman Lloyd Bentsen is in a key position to emerge as the party's de facto leader. A longtime supply-side supporter of a capgains differential, Bentsen backed away at the last minute, but only because of the yo-yo provision. And he put into play the idea of reviving the IRA exclusion, which almost surely will provide the Democratic imprimatur on the final package. It was also Bentsen who wheeled out the idea of taxing short-term trades by pension funds, which would offset the alleged revenue losses of capgains in the out years. Taxing capgains on pension assets held less than 30 days at 10%, and 5% on assets held less than 180 days, already has the support of Senate Minority Leader Bob Dole, and fits neatly into Richard Darman's philosophy of discouraging "non-nowism." At rates this low, Alan Reynolds believes the negative effects would be minimal, and considerable revenues would actually be raised. The tactic was originally suggested to us in late November by Morris Mark, one of our Wall Street clients. I suggested it to Darman in early December, at a dinner in Washington, and to Bentsen in an April 20 letter, after discussing capgains with him at a lunch the previous day. (My regrets to our pension fund clients.)
The House vote last week was historic, an important step for the Democratic Party, one that extends far beyond the question of how capital should be taxed. Gephardt essentially saw defeat looming in early August and decided to play double or nothing, with one more big push, one more New Deal battle cry. We are bound to see the payoff in a host of social reforms, in welfare, health care, and education. The old order endeth.
One of the party's more rational liberal theologians called me after the vote, with congratulations, acknowledging the depression he felt in defeat. I offered to buy lunch, but he said he couldn't stand the gloating that would go along with it. He fears the party division will result in more moderates leaving Democratic ranks for the GOP, and the loony fringe will be left in control. I'll be sorry, he predicted, when they seek retribution after the next recession. I said I'll let my children worry about that in the 21st Century.