Three Days in Washington
Jude Wanniski
August 7, 1992


With the single purpose of trying to persuade the Bush Administration to index capital gains, via legislation or executive order, I had wall-to-wall meetings from Tuesday afternoon to Thursday afternoon with the following: Budget Director Richard Darman, White House domestic policy chief Clayton Yeutter, White House Counsel Boyden Gray, the Vice President's Chief-of-Staff Bill Kristol, Deputy Treasury Secretary John Robson, Deputy Commerce Secretary Rockwell Schnabel, Fed Chairman Alan Greenspan, Fed Vice Chairman David Mullins, Fed Governors Wayne Angell and Larry Lindsay, Bush Campaign Director Bob Mosbacher, Campaign Research Director Jim Pinkerton, Senator Trent Lott (R-Miss), Senator Connie Mack (R-Fla), Senator John McCain (R-Ariz), Rep. Vin Weber (R-Minn). For the same purpose, I had lunch Wednesday with Brad Johnson, Mario Cuomo's representative in Washington, and lunch Thursday with Robert Shapiro, Governor Bill Clinton's economic spokesman in Washington. (Tuesday, I took a lunch break from capital gains with Manuel Suarez-Mier, Economics Minister at the Mexican Embassy.)

What I found among Republicans was great interest in pursuing the idea and an astonishing statement from Mr. Shapiro that if President Bush found a way to do it, Governor Clinton would instantly endorse the idea, as the Democratic nominee is fully committed to the idea of indexing capital gains. Most importantly, Shapiro understands the move would be politically popular. The congressional Republicans indicated they would attempt to move the White House in this direction in order to focus the issue on the tax bill now before the Senate. The White House remains hesitant because of the firm position of Boyden Gray that the President does not have clear legal authority to index by regulation and that if he did so, the tax bar would advise against liquidating capital now frozen because of the tax -- until the matter was settled in the courts. On this legal issue, I argued that it is easier for me to imagine water flowing uphill than to imagine a taxpayer being damaged by indexation. The legal experts in tax law, including those who are opposed to regulatory indexing, admit as much. Gray acknowledged that he was not familiar with this position as he did not personally do the research analysis when his office came to its conclusion last March, but he agrees it would be very positive for the economy and the President, and assured me he would revisit the issue and personally do the analysis. If he cannot find the hypothetical taxpayer who would be damaged, he said this would in fact change the complexion of the issue entirely. 

Putting the legal fine points aside, there is a great anxiety running through GOP circles about the evident fact that Clinton appears to be getting stronger, not weaker, as had been the supposition. The inverse is true of the economy, which nobody to whom I spoke believes will be anything but dismal in the months ahead. My argument that this single act, by the stroke of a pen, would alter expectations in a mighty and powerful way, hits home. The four Fed governors I met with were in general agreement that the financial markets would greet such a move positively. Vice Chairman Mullins, a protege of Treasury Secretary Brady, volunteered to me that he would pass his endorsement to Brady. The position of the Fed on this matter is important because of the argument that indexing capgains would deny the Treasury tax revenues it would otherwise get by taxing inflated gains, thus disadvantaging bondholders. Bonds would gain in value, though, because the markets understand, as Ted Forstmann has been arguing at the White House and to the Bush Campaign, that taxing inflated gains is taxing capital itself; to halt the taxing of capital could only expand the size of the future economy and increase the income stream to the government. Forstmann yesterday was contacted by a number of the officials to whom I had spoken, asking his opinion, and he argued that the Administration should stop discussing rate reduction entirely -- at least for the moment -- and concentrate its energies on this powerful issue, which has no ideological overtones regarding "fairness." Forstmann also argues that if the President were simply to ask Congress to index, and explain its importance to the American people, it would propel the issue to a positive conclusion. 

The budget implications are also clear, especially if you put aside reduction of the nominal 28% rate. Darman easily accepts the argument that practically the only revenue the government is getting on inflated gains is from those who are being forced to sell. Hundreds of billions of dollars of capital are frozen, in farms, businesses, heirloom stocks. If indexing removes the threat of capital confiscation, on this account alone there would be a flood of tax revenue to Treasury. A senior citizen holding an asset, in order to avoid a tax of $25,000 would happily sell if the tax liability were deflated to $2,500. A mountain of assets would flow through the Treasury tax gate. When Schnabel at Commerce grasped the implications of my arguments for capital formation and small business, he extended my half hour meeting to almost two hours, walked me to the elevator, and vowed to get Commerce Secretary Barbara Franklin and the Department behind the move.

In the course of sticking to my single-minded agenda, I realized that most of the people at these lofty levels of the government do not understand why indexation is more important than rate reduction as long as the dollar is not on a gold standard. One key official had the belief that only rate reduction would invite more entrepreneurs into economic action. I explained that entrepreneurs are not interested in the capital gains tax, as they believe their enterprises will succeed, enriching them for the rest of their lives, and they never have to encounter a capgains tax. It is the market that is concerned about the rate, the mechanism that allocates the nation's capital -- the financial services industry. This giant computer acts on the assumption of failure because most new enterprises fail. I explained that if there are forty 40-to-1 shots, and thirty-nine fail, the one that succeeds will pay 40-to-1. The capital allocation machine will find a way to finance the forty. If the Government inadvertently taxes away the rewards to the lone success and also imposes a tax on the failures, the allocation machine must take note of that and refuse to finance any of these fledgling enterprises. This is what inflation does. An enterprise can now fail, the bankrupt owner selling assets to pay the creditors, but the Government submits a tax bill based on asset inflation. As long as this threat of capital confiscation hangs over the economy, the factors of production that would otherwise be assembled into productive enterprise will be viewed as being unable to generate a sufficient return-on-investment to warrant capital.

A nominal 28% capital gains tax is still too high. But as most enterprises take several years to "win" or "lose," the capital allocation computer must tack on the inflation rate as implied by the interest-rate schedule for government bonds. The nominal rate can quickly approach a 60% or 70% hurdle that will shut off most new capital formation. Lowering short-term rates, which is Treasury Secretary Brady's fascination, will do nothing to kick more capital out of the computer if the long rates remain high. Indexing capital gains instantly lowers the implied 60% or 70% tax to the nominal 28%, and suddenly the allocation computer will re-do its risk analysis and pump out capital to awaiting entrepreneurs.

What are the chances for indexing? A bit better, perhaps 6 in 10, if only because a lot of desperate people have been looking for something to revive the President's fortunes, and they will be breathing down the necks of the President's legal and political experts to find a way to do it. My lunch with Rob Shapiro, though, was most encouraging. Shapiro, research director of the  Progressive Policy Institute in Washington, would be the likely Budget Director in a Clinton Administration. If President Clinton were to turn economic policymaking over to a roomful of Shapiros, his administration would not be all that bad. Unlike Paul Krugman of M.I.T., Shapiro is not an Old Guard Keynesian clone, but rather a young man struggling to find his way out of the demand model. He is definitely not an easy-money, dollar devaluationist and I gather he has Clinton's attention there. It wouldn't surprise me to see Clinton soon defend Greenspan's Fed against the continued onslaughts from Nick Brady, who this week joined Democratic inflationists in Congress in attacking the independence of the Fed. (If the President only knew how many of the people I spoke to these three days are trying to figure out how to get rid of Brady without bloodshed, he would be shocked.)

Given the natural resistance of the Bush Administration to improving itself, I left town not feeling very optimistic on that account. Still, I was happier than when I arrived, but that was because I learned Wednesday that my friend Michael Milken will soon be a free man again. Thank you, Judge Wood.