The Clinton (Ha, Ha) Tax Plan /Fedwatch: What Next? Jude Wanniski and David Gitlitz July 2, 1997

Liberals are grousing at Clinton for giving in to Republicans on capital gains taxation, but this is a transparent ruse, orchestrated by the spin doctors at Treasury. Of course, everyone who counts knows the Clinton plan is a hoax. With a 30% exclusion, a one-year holding period, and no indexation, it would cut the capgains rate to 27.7% from 28% in the top income class, which is where there is capital to invest, and with the holding period would be worse than nothing. We can easily imagine Treasury Secretary Bob Rubin and his puppeteer, Larry Summers, rolling on the floor in laughter at having sliced the salami so thin, and with mostly applause from conservatives. House Speaker Newt Gingrich wants to make the President as happy as possible, so Clinton will not veto the puny tax bill when it finally lands on his desk. There is a great sense of foreboding among the GOP tax team at the staff level, believing Newt will accept the President’s ridiculous plan as a starting point for negotiations. If the President digs in his heels, we can already imagine the salami slicing turning into a capgains cut so thin as to be meaningless.

The good news came in a press release issued yesterday, which was not picked up by anyone. Jack Kemp warned Gingrich and Senate Majority Leader Trent Lott against taking Clinton’s “11th-hour” proposal seriously, saying they should treat it as “a crude attempt by the class warriors who advise the president to undermine the mandate the American people have given the Republicans in the 105th Congress.” Kemp said Congress should produce the best possible bill without worrying about a presidential veto: “If the president vetoes good legislation designed to produce tax relief for all Americans and solid economic growth, on the grounds that somebody might get rich, let him bear that burden.” He said he agreed entirely with Sen. Kay Bailey Hutchinson of Texas that it was inappropriate for the President to demand entirely new terms after the legislation had already passed both houses of Congress. The most interesting part of the press release noted that Kemp “has asked for a meeting with President Clinton to discuss ways to restore some semblance of bipartisan harmony in dealing with these difficult budget issues.” A Kemp spokesman at Empower America said “Kemp can appreciate the bind in which the President finds himself, ‘heading a party that still prefers welfare to work and cannot rise above class warfare whenever taxes are discussed.’”

We’re told that Erskine Bowles, White House chief-of-staff, has told Kemp he is amenable to such a meeting and would try to set one up. There will be, of course, a debate inside the White House on whether or not the President should meet with Kemp. How Clinton decides may tell us how bipartisan he wants to be. His tax proposal is clearly at the level of fun and games, with Clinton trying to steal Newt’s underwear after talking him out of his outer garments in the 104th Congress. A Kemp meeting with the President would be a test of sorts for his own political ambitions, which is why Vice President Al Gore would probably argue against such a meeting. Kemp, who is probably Clinton’s favorite Republican, having refused to throw Whitewater mudballs at Bill and Hillary even while on the Dole ticket, may get his foot into the Oval Office on that account alone. Republicans who dislike Kemp anyway would be furious at him for intervening. This, though, is the most promising play on the horizon, with Kemp at last getting into the action after eight months on the sidelines. By warning Newt not to cave in to the President, he threatens a public break with the Speaker that has already been brewing.

Jude Wanniski

FEDWATCH: WHAT NEXT? Having fully discounted in the past few weeks for the stand-pat posture endorsed at today’s FOMC meeting, the credit markets now must guess whether at least one more rate hike will be necessary to keep growth in check. While that speculation is the major factor keeping the 30-year bond yield largely stuck in a 6.70-6.75% range, we see the chances of any near-term Fed tightening as increasingly remote. In fact, with gold now trading at 51-month lows just above $331 per ounce, we would not be surprised to find Alan Greenspan later this month talking down expectations of higher short-term rates.

The conventional take on the policy outlook was expressed in yesterday’s New York Times, “Fed Expected to Hold Line on Rates, at Least for Now.” The Times reporter noted varying levels of strength in May new home sales, personal consumption, and personal income, and concluded: “With unemployment at 4.8 percent already well below the level at which inflation has historically tended to pick up during periods of strong growth, analysts said the likelihood was increasing that the Fed would decide to raise rates at one of its next two meetings, in mid-August and late September.” But somehow the Times -- and nearly all other major press accounts -- entirely overlooked the one element of these reports most relevant to monetary policy: prices. While new home sales, encouraged by declining mortgage rates, rose 7.1% in May, the average nationwide price of a new home actually fell by the same margin. Similarly, the Commerce Department’s report of a 0.4% rise in real personal consumption expenditures (PCE) was lifted by a 0.1% decline in the series’ price index. Although unavoidably backward-looking, the PCE deflator has come to be regarded as the federal government’s most reliable price level gauge.

This decline of the PCE deflator is the most recent indication that the $50 per ounce fall in the gold price since late last year is having real-world consequences and at this point reflects something of a deflationary overshoot. Confirmation can be seen in the 7% drop of the Commodity Research Bureau futures price index since late May, as well as the five-month decline of producer prices. Even the Fed’s most committed Phillips curvers would be hard pressed to advocate a tightening in the face of a steadily declining price level. 

Despite his acquiescence in the March rate hike, which may well have been forced upon him by internal political considerations, we have little doubt Greenspan worries about gold’s continued slide below the $350 level, which we surmise is his personal target. He told a group in mid-March that gold is “the only truly monetary metal out there which captures changes in price expectations as well as anything we’ve got.” He will have a chance to expand upon these views at the upcoming Humphrey-Hawkins hearings before House Banking on July 22. Democrat Barney Frank was the only committee member who took the time to analyze the Fed’s March 25 rate hike, with a lengthy floor statement criticizing the Phillips Curve justification for the move. We have been talking to Frank and find he is poised and anxious to question Greenspan at length and prepared to explore the role of gold in the chairman’s policy formulation process. Greenspan may welcome this chance to change the market’s mood regarding the possibility of another tightening. Meanwhile, with events such as tomorrow’s employment report on the docket, bondholders will incur the usual Phillips Curve risks.

David Gitlitz