The legislative package that Bob Dole put forward in Chicago today, after months of intense internal debate, earns him an "A" for courage. In the end, I'm afraid it will not do him any good politically. Dole chose the option of a 15% across-the-board income-tax cut, which was pushed by those in the Senate who wanted Dole to pretend he is a supply-side Reaganaut. He rejected the option of a rollback of the 1990 and 1993 tax increases, which Jack Kemp and Steve Forbes had recommended, the option out in front before the weekend began. Still, Kemp and Forbes will go on the "Larry King Live" show tonight to defend the plan they argued against. At least they will not have to defend the plan that Dole seemed to prefer late Friday, as reported in the Saturday Washington Times, which would have cut the baby in half and merged the two options around a 10% across-the-board cut.
The problem with the plan Dole chose is that it is very expensive for what it produces by way of positive economic effects. The price tag it carries, $548 billion over six years, has only one element that has powerful growth effects, a 50% exclusion on capital gains that will cost only $13 billion over six years. Even there, Dole does nothing to index capital gains. The other $535 billion in cuts would not even get the top marginal rate back to where it was when Bush left office, and can scarcely be defended as anything but a dead loss to the Treasury. Remember, Reagan's 30% across-the-board cut confronted a top rate of 70% in 1980. It's now less than 40%, and the rules have been changed to require tax cuts to pay for themselves. Dole, of course, will run into the buzz saw that Newt Gingrich encountered on Medicare and Medicaid. It's hard to imagine him defending the plan against the attacks that will be made by the Clinton campaign and Democrats in general. It would have been easier to argue simply that President Bush made a mistake in 1990 and President Clinton made one in 1993. Then, he would not have had to put on a supply-side hat or pose as the Gipper. He could simply have argued that the tax increases in both instances did not work as planned, because the higher rates imposed on the "rich" did not produce the revenues they were supposed to produce.
The other merit of the Kemp/Forbes rollback option was that it would have "cost" only 40% of the option chosen. This is because the higher brackets, where the roll back occurs, produce much less revenue than the middle and lower brackets. The rollback clearly would have the most positive economic effects. The argument that the rollback would benefit the "rich" could be taken care of by spending some of the "savings" in the rollback option to permit deductibility of payroll taxes and an increase in the personal exemption. This would have enabled Dole to comfortably defend the distributional effects on rich versus poor. In the plan he has chosen, only 1% or so of the benefits go to the bottom 20% of the income classes. We have no idea why Dole feels more comfortable with the approach he has taken, but believe this will not last very long. It is amazing that Dole continues to come down on the wrong side of every issue he encounters. It is especially puzzling that in choosing to suit up as a "supply sider" he would reject the ideas and arguments of the two leading supply-siders in the GOP, Kemp and Forbes. Don Rumsfeld, who had been put in charge of this policy unit, clearly let the issue get away from him.
Indeed, Kemp had inferred in his June 18 Wall Street Journal op-ed that Dole should skip both fiscal options — across-the-board and rollback — on the grounds they would simply delay the restructuring of the entire tax system. During the economic summit two weeks ago that Speaker Newt Gingrich and Senate Majority Leader Trent Lott asked Kemp to arrange, Kemp repeated his June 18 suggestion. The economy should be moved into high gear with two executive orders, one indexing capital gains retroactively, the other stabilizing the gold price within a $30 band. The latter would prevent any unanticipated monetary inflation from accompanying the rapid growth that would follow the retroactive indexation. Although this Kemp "bipartisan" proposal was designed to be foolproof against political attacks — and actually got a behind-the-scenes nod from Ross Perot — it could not get off the ground in the Dole camp. Why? Because it did not seem bold enough.
What next? The Concord Coalition, a mostly Republican bunch in the Hoover tradition, took out a foil-page ad in the Times Sunday to warn against the return of "voodoo economics." Headed by one of Dole's best buddies, former New Hampshire Sen. Warren Rudman, it plays into the hands of the Democrats who are denouncing the irresponsibility of big tax cuts. The ad is actually quite interesting in that it accepts the idea that there are some supply-side growth effects that flow from tax cuts. The Concord folks say this happens only if there is lots of slack in the economy - which they insist is not the case today, as the economy is close to foil employment. They will find it easy to blast away at the Dole plan, but their argument is flawed in that employment is not a good measure of "slack" in today's economy. The economy is not short of labor, but of the capital that makes labor productive.
The Clinton team now will sit back and watch how the Dole program plays. We will know it is getting some traction if Dole begins to close the President's 20-point lead in the matchups. If so, the White House will be able to quickly counter with its own program. Clinton had rejected arguments by his political guru, Dick Morris, that he propose a pre-emptive capital gains tax cut. He still has that in his reserve, which he easily could bring up with an indexing provision to outbid Dole. Remember that Clinton already has publicly acknowledged that he is sorry he raised tax rates so much in 1993. He could take a page from Kemp's playbook and do part of the rollback option as well. That is, the Dole plan would be very easy to counter. For his part, Ross Perot, whose Reform Party convention in Long Beach precedes the GOP convention, can be dismissive of the Dole plan and focus exclusively on writing a new tax system, if he so chooses. Dole has left Perot lots of running room up the middle. I believe he also has thrown away his last chance to get to the White House.
FED WATCH: Gold's rise to $390 for the first time since early June injects a note of caution into an otherwise positive market outlook. We doubt the climb signals concern about the Fed's inflation-fighting resolve; much of the move in gold came while there still was strong speculation of an imminent tightening. Instead, we believe the Fed's operating procedures have been pumping unnecessary reserves into the banking system as it tries to keep the federal funds rate at its 5.25% target. Why unnecessary? Because the Fed's reserve estimation procedures have not caught up with the spread of "sweep" programs that allow banks to economize on required reserves. These programs involve banks shifting reservable Ml deposits into non-reservable M2 accounts during parts of the two-week reserve maintenance period. The Fed estimates that sweeps have reduced required reserves by some $10 billion, or about 16%, in the past year. Yet the open market desk remains in a highly generous posture, fighting to maintain a funds rate which traded about 30 basis points above target last week. At the close of the latest statement week, the Fed had more than $15 billion in repos outstanding, a months-long high. If we are right, the problem will be self-correcting and the gold price should fall back.