The volatility in the financial markets is naturally more intense as the bipartisan budget negotiators not only approach a moment of truth, but do so in secret. We reject almost completely the conventional hypothesis that unexpectedly low corporate earnings are behind the sell-off on Wall Street. Earnings are retrospective, telling us only a little about the future income stream of the nation's capital stock. The convulsions in the DJIA, especially the savaging of the technology stocks this week, reflect the high stakes in what has become the "Super Summit" of the top, top leaders in Congress and the Bush Administration.
Because the summiteers are making decisions that will impact the value of the nation's capital stock in a serious way, it was especially important for the markets to learn that the smaller summit would exclude Minority Whip Newt Gingrich, Senators Phil Gramm and Bob Packwood, and Rep. Bill Frenzel, the ranking Republican on Ways and Means. These were the four growth-oriented Republicans at the broader summit. In getting down to brass tax, the GOP team is left with OMB's Richard Darman and Treasury's Nick Brady, Senate Minority Leader Bob Dole and House Minority Leader Bob Michel. Brady, Dole and Michel are all Old Guard budget balancers. Surrounded by supply-siders, Darman would be at his growth-oriented best. In this group, though, his own budget-balancing impulses are probably at a peak.
The Super Summiteers are now exchanging tax and spending proposals in super secrecy. If they can agree to a $50 billion package of half-and-half spending cuts and revenue increases, it would be most amazing, but not as amazing if Gingrich, Gramm, Packwood and Frenzel were in the room. Because of the gridlock over capital gains, the biggest threat is if the President were to be persuaded that a deal without capgains is necessary to get the Fed to lower interest rates. Nick Brady is making this wholly incorrect argument most forcefully. We can imagine Dole and Michel nodding in agreement. For Darman, though, to cave in on capital gains when his entire strategy of budget summitry was aimed at getting this trophy for the President, a deal without it would be egg on his face, but who knows, he might go for it. It's harder to imagine White House chief of staff John Sununu going along with that route. He'd definitely push sequestration and a national political campaign on the growth/capgains issue. The President, who is spending an hour a day observing the gridlock at this Super Summit, is said to be getting increasingly irritated at the lack of movement, and it is showing on the campaign trail, where he is becoming more partisan in his gripes about the Democrats.
A deal without capital gains, simply to avoid the sequestration that Brady predicts would be a disaster on Wall Street, would, indeed, be a disaster on Wall Street. We would expect the economy to sink into recession, nudged along by state and local tax increases. But such a deal would be extremely difficult to get through Congress. The backbench House Republicans who are fearful of such a deal are today circulating a resolution vowing to oppose any summit deal without capital gains. Brady, perhaps even Darman, may believe the White House could round up enough House Republicans for such a deal to satisfy the demands of Senate Majority Leader George Mitchell, who does not want to expose Democratic incumbents to partisan blasts of being for higher taxes and lower growth. The GOP backbenchers, though, say they would make so much noise that Republican challengers to House and Senate Democrats would fire up the anti-tax, pro-growth issue on the campaign trail this fall and cause the Democratic rank-and-file to crack.
The strategy I have proposed so far has no takers, but it is the only thing I could see saving the summit at the last minute. It would involve the President accepting the Mitchell demand of a 33% top income tax rate in exchange for a 15% capital gains rate, with income threshold adjustments to offset the higher rate. In a letter to Darman Monday, I pointed out that if the Democrats had been willing to accept such a deal in 1986, as part of the tax reform, we would have jumped for it. But, I observed:
The objection of all conservatives is a legacy of the bad old days, when they saw themselves on the losing end of the salami-slicing process. They assume if you go to 33%, at whatever threshold, it will not be long before it goes to 38% and 50%. I've been pointing out that the salami-slicing has favored our side these last ten years. We got capgains all the way down to 20%, then had to let it climb to 28%-33% in order to get the income rates down to that level. In announcing a deal, all the President has to do is affirm his commitment to get capgains down to 10% and the top rate to no higher than 25%. We can do it in the '92 campaign! But we've got to get the capgains rate down now, or this economy will continue to sink in its quicksand. Having the Democrats identified with a higher income tax rate is far preferable to having the President identified with a stock-transfer tax or a BTU tax or taxing high-income Social Security recipients. A deal centered on the bubble, Frenzel agrees, enables the President to get much more of what he wants.
If this proposal stays inert, as I expect it will, the odds heavily favor a breakdown at the Summit in the next several days. All the supply-siders I know in Washington are rooting for such a breakdown, believing the President will not only have shown a willingness to go the last mile to avoid sequestration, but also has positioned himself to lead an aggressive, partisan campaign for economic growth in the congressional elections. The economic issue would, they think, once again cement together the broad GOP coalition, lifting it above the divisive social issues that have had the party spinning its wheels. If this is in fact the positive political outcome of the election season, against a backdrop of sequestration, the President could cash in his chips during a special session in November and we'd all forget the anguish of the last several weeks.