Clintonomics, on the Line Jude Wanniski May 26, 1993

House Speaker Tom Foley is now insisting that the Clinton economic plan has the votes to pass tomorrow without any GOP support. House Minority Whip Newt Gingrich and other GOP leaders assume the Democratic leadership will "break enough arms" to get the votes, although they still believe Foley is short of the 218 votes he needs. A victory for President Clinton is not what he needs. Indeed, if he went on national television to explain his program to the American people, they would be calling their congressmen to urge them to vote against the ill-conceived plan. The Republicans will vote against the plan en bloc, watching the Democrats across the aisle holding their noses and supporting the President. Yet, if the GOP would come up with an alternative plan that would be attractive to large numbers o£ Democrats, it could salvage the situation even at this last hour.

The only idea around that would accomplish this objective is the plan that Federal Reserve Gov. Wayne Angell has been privately discussing for the last several months: Indexing capital gains, retrospectively and prospectively, in combination with taxation of capital gains at death. The idea is now circulating among GOP senators and Republican leaders in the House who are probing it for weaknesses that we do not think exist. The Republican leadership has to decide, though, whether it wants to bail out the Democrats. If an alternative were built around the Angell idea, it would solve the stickiest problems: Democrats would not have to vote for an energy tax and Republicans would not have to vote for massive spending cuts. By conservative estimates, the Angell plan would produce $100 billion in fresh revenue during a five year period not including any revenues from Laffer Curve effects! That would be gravy, several times $100 billion, as the Angell Plan would send the stock market and the economy on a blistering growth path.

The numbers, again, are these: There are $8 trillion of unrealized capital gains in the system, $7 trillion inflated and $1 trillion real. Angell's idea is that if the tax liabilities on $7 trillion in inflated gains were wiped off the balance sheets of U.S. households, the value of the assets would soar, and the liquified capital would flow to its highest and best uses instead of being locked away to avoid taxation. Meanwhile, there is the $1 trillion in real gains, which now remains outside Treasury's grasp because it can be passed on at death to heirs who receive the asset at current market value, not purchase price. Under the Angell Plan the heirs would receive the asset at the original purchase price, which means they would have to pay capital gains tax on the asset, but not until they sell the asset! That is, family farms and small businesses could be passed on from one generation to the next, with capital gains building up, but with no tax until the farm or business was sold. And then, the asset would first have all accumulated inflation stripped from it.

The method is critical to the political attractiveness of the Angell Plan. Otherwise, Sen. Malcolm Wallop (R.-WY) points out, it would be anathema to the masses of ordinary Americans who are trying to hold onto family farms and businesses. Indeed, Angell argues that all the farmland in the United States is now worth less than it was 20, 30 or 40 years ago in real terms, which means only those few farms that enjoy windfall gains — by virtue, say, of being situated next to an Interstate cloverleaf -- would show real taxable gains under the Angell Plan. If the plan were explained on national television, by, say, Senate Minority Leader Bob Dole of Kansas, it seems to me the farmers, shopkeepers, independents and entrepreneurs of America would build fires under their representatives to make it happen.

As the tax on $1 trillion is 28%, the Treasury would instantly have on its books $280 billion of tax liabilities that would eventually have to be paid --as they could no longer be escaped by intergenerational transfer. Angell estimates that $100 billion would be added to Treasury revenues in the first five years, a number said to be conservative by Gary Robbins, president of Fiscal Policy Associates of Arlington, Va. Robbins, who had worked in the Treasury tax department in the Reagan years, actually did the calculations behind the Angell Plan last year for the U.S. Chamber of Commerce. Lawrence Hunter, who was chief economist for the Chamber at that time and is now chief minority counsel for the Joint Economic Committee of Congress, is urging GOP members to take the idea seriously. He thinks the reason the idea has had so much trouble getting off the ground is that people instantly get turned off by the idea of "taxing capital gains at death," not realizing the problem is dealt with by combining it with indexation, which removes 87% of the problem, and with the feature that permits the liability to accrue until the gain is actually realized, which takes care of the other 13%. The other problem is that Angell will only discuss it with members of Congress if he is asked by them, as he believes it improper for a governor of the Fed to initiate policy discussions with elected officials.

The only other "problem" is that the Joint Committee on Taxation might refuse to concede that the Angell Plan will produce any revenues. That is, they will "score" the plan as a revenue loser, even though the President's own economists would agree it would gain not only via the unlocking effects, but also via Laffer Curve efficiency effects. The Joint Committee got itself into this box in 1989, when it foiled Budget Director Richard Darman's capgains strategy by using a scoring method designed to kill it. My argument to the Republicans is that it is not critical that the Angell Plan pass, only that it be presented as an alternative. If the Democrats want to get the President out of the mess he is in, they will find a way to get the Joint Committee to use a realistic scoring method. The Angell Plan, after all, is fully in accord with the President's principles and campaign promises. He is on record, in print, opposing the taxing of inflated gains. He is also on record as being favorably disposed to taxing real gains at death.

If the plan is shot down by the Democrats, the Republicans at least would have demonstrated to the American people that they have not become willful obstructionists. In good faith, they will have presented an honest-to-goodness proposal that meets all the guidelines, one that produces economic growth instead of economic decline. My guess is that if it were to surface with Senator Dole's blessing, it would be irresistible. The fact that Angell, a fellow Kansan, is a Dole protege, does not hurt at all. As Darman understood in early '89, capital gains is the only fulcrum that could surmount the impasse set up by Gramm-Rudman without political pain. If the Joint Committee on Taxation had been reasonable at the time, the history of the last four years would have been remarkably different. If it suddenly became reasonable now, the history of the next four years would take a turn for the better.

The current alternative by Sen. David Boren (D.-OK) and Sen. John Danforth (R.-MO) is really not that much better than the President's plan, except that it would index capital gains prospectively --a change that would have a fraction of the benefits of the Angell Plan. Insofar as prospective indexation is scored as a $12 billion revenue loser, it then must be offset by tax increases and spending cuts elsewhere, which winds up making the alternative as unpalatable as the President's, except to different people.

What happens in these next few days will ripple through the rest of the economy, through the markets especially. Fed Chairman Alan Greenspan has to be worried that the gold speculators are now again testing the resolve of the Fed to keep them in check. We know the FOMC gave Greenspan authority to raise fed funds at his discretion, to make it tough for those speculating against his resolve. We do not know what the upside limit of his authority is. Can he take fed funds to 4% if necessary? Perhaps, but I doubt it. A negative outcome to the deliberations in Congress this week and next would weaken the demand for dollars and make it harder for Greenspan to satisfy the nation's creditors, by raising short rates to drain reserves. A positive outcome would make it easier for him to do so, which would imply a sharply declining gold price and a resumption in the bond rally. Angell clearly understands what is at stake, as witness his unusual interview in this week's Barron's, in Randy Forsyth's "Current Yield" column, explaining in greater depth the reasoning behind his FOMC dissent in March.

We have our ear to the ground, as usual. If we hear anything, you can be sure we will be hot on the FAX. Clintonomics is on the line, and so are we all.