A Republican Bear Market Jude Wanniski April 14, 1997

The only thing at hand that might put a floor under the stock market would be a commitment at tomorrow’s one-day Tax Summit of Republican leaders to move a tax bill to the President’s desk immediately following a budget resolution. The 148-point DJIA sell-off Friday reflected the likelihood that the GOP leaders have shot themselves in the foot once again, with House Speaker Newt Gingrich pulling the trigger. As we have previously reported, based on discussions with the best legislative technicians we know, the Gingrich blunder of postponing tax cuts until the budget reconciliation process has gotten past the Medicare cuts will mean no meaningful cut in the capital gains tax. In this morning’s WSJournal, Larry Kudlow spells out the mechanical problem in excruciating detail in “How to Give Newt’s Tax Pledge Some Teeth.” Kudlow has been here before. He was Budget Director David Stockman’s chief economist in 1981, when Stockman sold out to the Hoover Republicans on these same issues -- putting spending cuts ahead of tax cuts and, with the help of the Fed, producing the worst recession since the 1930s. Kudlow now looks at all these grandiose promises of tax cuts “sometime this year” from Newt and his hapless lieutenants in the GOP leadership, and concludes...

“In short, it will never work. And if it does happen, expect tax cuts to get short-changed. Mr. Gingrich and the GOP leadership are much better advised to stick to first principles by putting tax cuts on the same footing as budget savings. For that matter, why not put tax cuts first and then force the spending side to conform to budget estimates? Republicans are gun-shy about Democratic demagoguery on Medicare or “tax cuts for the rich.” But liberals will always do this whenever taxes are cut, be it this summer, this autumn, next year, or 2020. It’s already begun. Following Mr. Gingrich’s tax-cut speeches, Treasury Department official Lawrence Summers hauled out the old static scoring model to argue that capital gains and estate tax cuts “would exceed $300 billion over five years, which would threaten Medicare, education and the provision of basic government services.”

Our January 2 forecast of at least 7400 on the DJIA this year was predicated on sufficient bipartisan harmony to produce a budget deal that would include a 50% exclusion on capital gains. The “irrational exuberance” that Fed Chairman Alan Greenspan saw on Wall Street in early December was then a reflection of the happy talk between the re-elected President and the return of Republican control in the 105th Congress. House Majority Leader Dick Armey said it best when he pointed to a one-year window of opportunity opening in 1997, before partisanship would rear its ugly head in advance of the 1998 elections. Harmony, though, began breaking down as soon as the Inaugural balls were over. The Russell 2000 and NASDAQ hit their exuberant peaks on January 22, the day Newt was socked with a $300,000 penalty attached to his ethics problems. The DJIA kept up its ride for a while, as investors leaving the riskier stocks crowded into a handful of blue chips.

We reject the idea that says the Fed’s quarter-point boost in the funds rate is all that it took to burst a bubble that had been steadily deflating since the end of January. Greenspan has merely contributed to the burdens of a glacial economic expansion that, like all other economic expansions, is built on credit. We dispute those analysts who now argue that Jones should not have been extending credit to Smith, as George Melloan does in his Global View column in the WSJ. Melloan will, of course, insist he said no such thing, but how else do you build an argument for excessive credit expansion at the national level without starting with Jones and Smith at the margin? On the right and on the left, voices are creeping into the discussion about the irrationality of markets, the theme Greenspan kicked off. His irrational policy, which the markets expect will lead to another half-point hike in the months ahead, threatens any future economic expansion, including that which might be induced by the long-awaited tax cuts.

Kudlow is exactly right, I think, when he argues the Republicans should simply go ahead with a tax bill even before budget reconciliation. What he ignores is what the Republicans might include in such a tax bill. If it were confined to a 50% exclusion on capital gains, a modest change in estate taxes, and the President’s college-tax credit, it would fly through both houses and be happily signed at a mammoth Rose Garden ceremony. The problem is that Newt continues to insist that it include a $500 kiddie credit, which he promised the Christian Coalition back in 1994 in the Contract With America, and which the Coalition’s lobbyists, Ralph Reed and Gary Bauer, want him to deliver. Asked on "Evans&Novak" this weekend if there was any chance of dropping the kiddie credit, Armey said there was not. Armey has privately acknowledged that the kiddie credit is a dumb economic idea, patterned after similar schemes designed by European and Canadian socialists, but he is stuck with Newt’s expensive millstone, which drags down the whole enterprise.

Newt is now said to be enjoying a comeback, his Speakership no longer in danger for the moment. But I watched him on "Fox Sunday Morning" with Tony Snow yesterday and found him living in a dreamworld. The man still believes he has a 15% popularity rating because the AFL-CIO ran ads last year denouncing him for shutting down the government, which he did. He pompously declares himself to be a humble man, willing to hear criticism in this best of all possible democratic worlds, but he remains in complete denial over his disastrous leadership of the 104th Congress. Does a cool-headed strategist who wishes to enact a bipartisan budget deal urinate all over the opposing team? I could not believe my ears in hearing Gingrich practically demanding the head of Attorney General Janet Reno, who may be the only person in the government who has a higher approval rating than Bill. Why? Because she may not appoint yet another special prosecutor to investigate charges that the Beijing government secretly sent $5000 to the Clinton campaign to buy the election. Can you even imagine the stacks of money laundered to both GOP and Democratic campaigns from Taiwan? Yet here was Dick Armey on "Evans&Novak" this weekend, making fun of Vice President Gore for having toasted the Chinese leadership in Beijing. Why should the President and Vice President do anything to accommodate the mean-spirited behavior of the House GOP leaders? Gingrich, Armey and House Majority Whip Tom DeLay almost every day are taking cheap shots at anyone who does not kiss their behinds.

Where does that leave us? The only chance to get on a track that could lead to success will come in the next several days, as the GOP leaders huddle to decide on strategy. It will be up to Senate Majority Leader Trent Lott to somehow rescue the tax cuts, which only can be realistically done within the budgetary straitjacket by cutting the kiddie credit to the bone -- or better yet, finding a way to postpone it indefinitely. The Tax Summit tomorrow is really only a series of four- and five-minute speeches about taxation, from 9:00 a.m. to 10:30 a.m., by Lott, Gingrich, Armey, Jack Kemp, and some lesser lights. The commitment that comes out of the summit is all that is important about it. If Kemp can pull it off, he’ll be a hero. If he can’t, we face a long, slow grind right through to the end of the year, with nothing much good happening.