"The Deal of the Century" Jude Wanniski May 9, 1990

Budget Director Richard Darman's revelation that the 1991 budget deficit might be as high as $165 billion, in large part due to the cascading red ink at the S&Ls, points the Bush Administration toward the mythic "Deal of the Century": A mammoth package of spending cuts, tax hikes and a cut in capital gains tax rates. Because $165 billion is $100 billion higher than the Gramm-Rudman target for 1991, we're talking baloney. There is no way these numbers can be cut or should be cut, and the political process will not permit it to happen. The danger is that we will not get the cut in the capital gains tax, and the high capgains tax is one of the chief reasons the deficit is as high as it is and climbing. Darman insists there will absolutely, positively be no deal without a cut in capgains. We can bank on that. But this simply adds to the likelihood that there will be no deal.

The central problem is Darman himself, who really believes the budget deficit should be dramatically reduced. His Harvard speech May 1 makes it clear that while he understands the negative effects of marginal tax rates on economic growth, he believes the deficit should be confronted directly and forcibly, the same mistake David Stockman made. When the $3 trillion national debt is reduced $150 billion by a 5% inflation, there has to be a $150 billion deficit to keep the government's creditors from becoming illiquid. We had thought Darman understood that this Hooverian thinking is equivalent to the banker insisting you pay off your loan in 5 years instead of 10. But we are afraid that's where he is.

CEA Chairman Michael Boskin understands that it is enough that the deficit falls as a percentage of GNP, which means it is being reduced by growth. But the Calvinism that seems to afflict OMB directors has Darman eager to pull the deficit down faster, which means reducing GNP growth itself. It's not clear that he somehow thinks the loss can be offset by a more expansive Fed policy, although other quasi-supply-siders have that view. (Sadly, in today's Washington Times, Paul Craig Roberts offers the tired Keynesian view that the deep spending cuts being sought should include an agreement by the Fed for easier money.)

Darman could get the deficit down faster with a capgains cut all by itself, but that would be too easy for a century-class dealmaker. I've even argued that the costs of the S&L bailout would shrink dramatically with a 15% capgains. All capital assets would increase sharply in value with that rate announced. All commercial real estate, mortgages and bonds would increase in value if they did not have to someday pass through a 33% tax gate. Because this is the principal stuff of S&L portfolios, the lower rate would lift sinking S&Ls above water.

Another way of looking at it is this: If the Senate Democrats had not blocked a vote on the House-passed capgains tax last October, the taxpayers would have seen the Bailout Meter slow dramatically instead of speed up. Senate Majority Leader George Mitchell and New Jersey's Bill Bradley, who did the blocking, can take personal responsibility for an added $100 billion in taxpayer liabilities, and the meter is still running. (Remember I called Bradley the day the White House was forced to throw in the towel, advising him he could take credit for the 200-point drop in the Dow that followed the noon announcement.)

In a letter to the President I sent April 30, I told him how "my concern about the economy has been heightened by my recent realization that the capgains rate is now effectively the highest it has been in our history. When the rate was 48%, when you were on Ways & Means, the country had not yet experienced the inflation of the '70s. The great majority of American workers, savers and investors were in tax brackets of between 10% and 20%, which meant the capgains exclusion brought them down to between 5% and 10%. And when they realized the sale of an asset, the gains were all real, not simply inflated by the government's devaluation of the dollar. This is an extremely important point you should keep in mind."

The President has every right to say that if he had been allowed a Senate vote on the capgains measure that he campaigned on in 1988, the economy would be growing appreciably faster, the jobless rate would be falling, the value of stocks, bonds and real estate would be higher, the bill for the S&Ls would be lower, and federal revenues would be much higher along with GNP. What's more, every political subdivision in the nation would be experiencing higher revenues!!! The lock-in effect that all economists agree exists at the federal level automatically means there is a lock-in effect everywhere. The Northeast states and California, which contain most of the nation's capital, would be looking at balanced budgets instead of raising taxes to do so. Even school districts would be seeing more revenues as depressed property values bounced back against ad valorems.

Unfortunately, for President Bush to say any of these things would irritate the Democrats no end. It might even embarrass them. They might even boycott his budget summit. They would certainly complain about the President's economics. But it would be hard to find an economist even within the Democratic ranks who could honestly disagree with Bush on these points. There can be honest disagreements on magnitudes, but not on direction.

In fact, the Democrats are so vulnerable to this kind of argument, they would scream bloody murder. But they would have to cave in once the President made his case, for the argument would be taken up by every Republican running for every office in America. The bill that passed the House last September is still alive, blocked in the Senate. The heat the Democrats would feel from the grass roots once the President made an issue of it would force them to act. And if they didn't, the GOP would have a blockbuster issue in the fall elections. Top officials at the RNC tell me no matter how they word the questions, their polling comes back positive on capgains.

As it is, the Congressional Republicans are kidding themselves if they think the Democrats are going to be fooled by the Darman ploy that "everything is on the table." All the jabber about VAT taxes, consumer taxes, pollution taxes, but no income taxes as part of "The Deal" obscures the fact that the Democrats are not going to agree to any Deal that crunches the economy unless the Republicans get the blame for it. Gramm-Rudman targets will have to be scrapped for a year to avoid this.

All we can hope is that all this red ink and budget summitry will put enough pressure on the system to force the capital gains issue into the open. My sense is that it is hanging from the tree like a ripe peach, ready to drop into our laps with just a little shake from the President. If he doesn't, and gets trapped by the Democrats instead, it will go down as the Goof of the Century.