Damage Assessment
Jude Wanniski
October 25, 1990

 

At midday Thursday, there is still a small but significant possibility the Budget Deal will be rejected by the House. Democratic backbenchers are not much happier voting for the package than they were the last time around, and Newt Gingrich's GOP opponents of the Deal are holding firm. If it is, which would be wonderful, Congress would simply pass another continuing resolution and get out of town.

The biggest problem with the Deal is less economic than political. The Bush White House has so thoroughly bungled politically that unless there is a sharp change in GOP fortunes in the next ten days, the new Congress will be more Democrat than the present one. Republican candidates are not losing ground rapidly because GOP voters suddenly want to vote Democrat, but because they are so disgusted they may not vote at all.

If the Budget Deal does make it by week's end to the White House for the President's signature, it will still be important how he explains his willingness to sign it, especially with a majority of his party in both House and Senate holding their noses. Even at this late date, if he provides a garbled "the Democrats made me do it" message, along with a ringing appeal to renew his growth initiatives in January including an indexed capgains cut he could reduce the damage of recent weeks somewhat. He simply has to get the disillusioned people who voted for him in 1988 to turn out November 6 for GOP candidates. Unfortunately, he will be counseled not to mention capital gains at all because it only adds to the Democrats' success in tagging the GOP the "party of the rich."

As to the Budget Deal itself, it is hard for me to argue that what is in it is disastrous for the economy. It is a depressant, but it will not move the economy much below its present track. Trouble is, that present track is sloping down, and requires the capgains cut Richard Darman so casually discarded. Moving the top rate to 31% is not a major problem, especially as people in the "bubble" income class between $100K and $200K have their rates reduced from 33%. Pushing the wage limit on the Medicare portion of the 1.45% payroll tax to at least $125,000 from $51,300, though, wipes out even some of that gain and inches up the marginal cost of labor. The phasing out of personal exemptions for workers above $100K is another addition to the wedge. The worst part of both these features, pure elements of a welfare state, is that it will be virtually impossible to reverse them in a future Congress.

One ameliorating element in the year ahead can be Federal Reserve policy, but only if Chairman Alan Greenspan keeps his eye on gold and commodity prices. The promise of Darman has been that the Budget Deal would bring easy money at the Fed, one of the elements that has driven the dollar down. If the Fed can now demonstrate that it will not inflate to complete its part of the Deal, the credit markets should applaud by increasing the demand for dollar securities. As the fear of future inflation subsides, the destructive effects on the high capital gains tax are reduced. If we were now on a gold standard, to make the point sharply, the markets would not have to incorporate an effective 75% capital gains rate into expectations of long-term investments. It would immediately drop to the real rate of 28%, just as if the Congress had agreed to full prospective indexing.

As The Wall Street Journal editpage points out this morning, the bill undoubtedly is laden with anti-growth landmines that we will not discover until we step on them. One already identified is a provision that fixes "revenue neutrality" into the law, with Congressional staff and their Keynesian Komputer authorized to determine "neutrality." This is the out-and-out prohibition of the Laffer Curve. The equivalent in the private sector would require that if General Motors wished to cut the price of Chevrolets it would have to raise the price of Buicks. Actually, there is a bit of a Lafferian kink in the Komputer. The reason the capital gains tax was not pushed up to 31%, but was allowed to remain capped at 28%, is that the Keynesian Komputer spit out the news that raising the rate by this amount would lose revenue! This suggests that the Komputer, if asked about a 26% rate, would somehow produce a revenue gain. One wonders if Mr. Darman ever asked the Komputer about the precise point where, in its infinite wisdom, it figures the gain would turn to loss. (One of the reasons Mr. Darman failed so thoroughly, is that while he believes he is the smartest man in town, he agreed last spring to the Congressional demand that the Komputer is smarter than all of us.)

If George Bush is to repair his presidency in 1991, he will certainly have to make some changes on his economic team. It is easy to pick on Darman at the moment, but in a larger sense, the fiasco of the past year must be shared at least equally by the Treasury Secretary. At the Cabinet meeting yesterday, the voices raised against A Deal at Any Price were several -- including Vice President Quayle, Commerce Secretary Mosbacher, HUD's Kemp, CEA Chairman Boskin, et al. Darman got his mentor, Secretary of State Baker, to weigh in on his behalf for A Deal at Any Price, which Baker will come to regret. But Nick Brady said nothing.
In retrospect, it now seems almost inevitable that the Administration would stumble as badly as it has by giving the Budget Director the finance portfolio that properly belongs with the finance minister, Mr. Brady. Just as David Stockman turned from Jekyll to Hyde soon after he began quaffing the OMB's bureaucratic brew, so we saw Dick Darman steadily pulled from a growth agenda to Hooverian bean counting. Secretary Brady's contribution has been to frighten America's creditors into demanding higher interest rates to finance our public debt, relentlessly bashing on the Fed to ease and expressing disinterest in the falling dollar. Brady's team of Mulford, Dallara and Glauber would have been most comfortable in the Carter Administration (Dallara was!). The latest mindblower, we hear, is that World Bank President Barber Conable would like to appoint Harvard's Larry Summers his chief economist, Dr. Summers being the Keynesian Komputer behind Michael Dukakis.

Given this political drift in the Administration, it is very difficult to expect the personnel changes necessary to repair the Bush presidency. It is as if the Reagan Years never happened, and we are back in 1981-82, with the philosophical approach to governance that we could have expected if Bush won the nomination and defeated Carter. The big encouraging difference is the continued emergence of the new Republican Party in the House of Representatives, as exemplified by Gingrich, Vin Weber of Minnesota, and the team that essentially arrived in the late 1970s as followers of Kemp. Old Guard House Minority Leader Bob Michel should be gone soon, perhaps from his leadership post next year.

It will be instructive to observe, in the weeks and months ahead, whether the President moves toward or away from Gingrich and Company. The Old Guard would like to punish him in some way for being the renegade that spoiled Darman's Deal of the Century. Gingrich, though, represents the future of the GOP. If the President is going to get back on track in 1991 and have a second term, he's not going to be able to ignore Gingrich whose team is already sketching out the growth initiatives they want to present when the new Congress convenes in January.