Summer Clouds
Jude Wanniski
June 26, 1990


BUDGET SUMMITRY: This morning's statement by President Bush citing his willingness to pursue "tax revenue increases" can be viewed as a breaking of his no-tax pledge or a simple restatement of his belief that economic growth alone will produce "tax revenue increases." It may simply be a gesture, to show Bush's flexibility in the face of Democratic inflexibility, as budget summitry has been going nowhere. The stock market liked the looks of it, as the sooner a deal, the sooner a cut in capgains. What still worries me, though, is a scheduled House vote in July's third week on a constitutional balanced budget amendment, which is attracting a screwball coalition of mindless GOP budget-balancers and liberal Democrats who like its provision requiring simple majorities to raise taxes. I'm not concerned it will make its way into the Constitution, but even a close vote could muddy up the budget summit, opening the way for a tax-increase deal. Continued focus on the deficit is steadily pushing the White House and GOP back into the Old Guard mold that is so good at losing elections.

S&L CRACKDOWN: President Bush's Friday speech to federal prosecutors, spurring them on to go after the frauds, cheats and chiselers in the S&L crisis, may be the politically clever thing for him to do, as Democrats and Republicans prepare for a mudslinging contest on who's to blame. But it certainly doesn't do anything to ease the Regulatory Reign of Terror that is pinching off credit lines to small businesses and helping drive down real estate values. Anyone making a loan with federally insured deposits, at a thrift or a bank, has been especially warned against real estate. Just before the Dow lost nearly 60 points in the last hour of trading Friday, the broad tape carried a dismal account of the spreading problem: "Paul Fritts, a senior FDIC official, told the Senate panel the real estate swoon hasn't bottomed out in New England yet and that softness is starting to show up in California. He suggested weak real estate markets will be here for some time to come." The same account closed, at 2:56 p.m., noting Treasury Secretary Brady's report "that healthy depository institutions once expected by regulators to be primary purchasers of thrift assets are more leery about taking on more real estate assets in light of market conditions." Practically everything the Administration is doing lately is making the problem worse.

CAPGAINS: The one thing the Administration could do to bring quick relief to the S&Ls is to get Congress to cut the capgains tax, a fact few in Washington seem to appreciate. In Congressional testimony June 22, Fed Chairman Alan Greenspan blamed the present depression in the real estate market on "past excesses." He could not be more wrong. No matter what the real estate market did in the past, it is easy to show that a 28% capital gains tax and 5% inflation will depress current real estate prices, starting from any price level. You buy a property for $100,000. You expect the price to increase by 7% a year ~ 5% for inflation plus 2% real appreciation. The 2% real appreciation reflects the present economic growth rate, because assets bought for capital gains (real estate, growth stocks, etc.) will, on average, appreciate in proportion to the long-term growth of the economy's real earnings. After ten years, the market price of your property will have almost doubled, to $196,715. Your real profit, reflecting 2% real appreciation, is $21,899, but you pay $27,081 in capital gains tax on the inflated value. This amounts to a partial confiscation of wealth via the government's ability to inflate the currency. A 15% rate on the same $100,000 property would at least leave the investor with a net profit, after paying taxes of $14,507. It would thus promote investment in risk assets, and increase asset values.

THE AMERICAN FLAG: The heaviest burden GOP candidates for the House and Senate will bear this fall will be the idea that Democrats are vulnerable for voting against a constitutional amendment to burn the American flag. It's a losing issue for Republicans because it is anti-democratic. Flag burning is a moderate, non-violent form of political protest. Yes, the first impulse of Americans is to feel negative toward those, including Democrats, who won't protect the flag. The second rational reflection, though, is to feel negative toward snarling, right-wing Republicans who have so little appreciation of democracy that they would deny their fellow citizens this moderate, non-violent form of political protest (inviting them to use bombs to express themselves.) Nelson Mandela was correct in pointing out to President Bush Monday that he cannot renounce violence unless he has adequate non-violent means of political expression. Remember: "Taxation without representation is tyranny," and "Give me liberty or give me death." A big part of the problem is that House Minority Whip Newt Gingrich, who is out selling this losing flag issue to innocent GOP candidates, still thinks George Bush won in 1988 with issues like Willie Horton and the pledge of allegiance, not economic growth.

CANADA: At some point a referendum of the people of Quebec will decide oft going it alone or staying in the federation without "distinct society" status. If the many distinct societies of Europe can move toward political integration, there's no practical reason why Canada has to blow apart. A major source of irritation in Quebec is the deflationary monetary policy of the Bank of Canada. John Crowe, head of the central bank, has been willing to keep unemployment and personal bankruptcies high with his deflation policy, in the name of fighting inflation. Mulroney and Finance Minister Michael Wilson have supported Crowe. The French have no tradition of using deflation as a policy tool. It is part of British tradition, though, following the Napoleonic War and World War I. Quebec would clearly be better off without this economic mismanagement, as would all of Canada. I've recommended to the Mulroney government in Ottawa, in order to remove this unnecessary irritation to Quebecers, that Crowe be persuaded to resign, and be replaced with someone from the French community. It is hard to hold together federations of disparate cultures, whether in Canada or the USSR, when the money is being mismanaged.

JAPAN: The Nikkei Dow took a big hit Monday, tumbling almost 600 points, and it was not hard to find out why. The Kyodo News Service informs us that "A panel of tax advisers to the prime minister outlined basic quidelines for a sweeping review of land taxation as a step toward halting the land price spiral." The panel proposed "a new national tax on corporate land holdings while recommending heavier taxes on idle or less-used land." The proposals grow out of the Structural Impediments Initiative talks (SII), which resumed Monday between U.S. and Japanese officials in Tokyo. The U.S. team argues that it is hard for foreign investment to gain a footing in Japan because land prices are so high. Of course, the mature Japanese companies own much of the commercial real estate, carrying it on their books at cost, while it is capitalized in the value of their shares. (This is a big reason the p-e ratios on the Tokyo stock exchange are so high.) It makes sense for Japan to begin the process of withdrawing subsidies to its rice farmers, allowing the importation of foreign rice. Taxing commercial real estate to bring down its price makes no sense at all. It certainly wouldn't make it any cheaper for a foreign investor to buy heavily taxed land. The sooner U.S. trade negotiators get out of Japan, the more comfortable we will feel with any investments there.