Power Game

by Hedrick Smith

  Literally at year’s end, Reagan got to tax reform, a few weeks after his summit meeting with Mikhail Gorbachev. Just as bad luck with terrorist incidents had hurt Reagan earlier, now good luck—Gorbachev’s drive for a summit—helped him late in the year. Because of Reagan’s slow start in 1985, there was not time for the tax-reform bill to pass both houses that year, as Reagan had wanted. But the bill finally came to the fore, promoted by Jim Baker and Richard Darman, the Treasury Department’s master strategists, as well as by House Democratic leaders: Speaker O’Neill and Ways and Means Committee Chairman Dan Rostenkowski. O’Neill and Rostenkowski favored the tax bill because it hit business and lowered rates for most middle-income taxpayers; their agenda protected Reagan’s.

  In most respects, 1985 had been a badly broken field for the president. He and his team were largely to blame. They had not played the agenda game well. Nonetheless, through it all, Reagan had personally pursued two priorities, both embraced belatedly: the summit with Gorbachev and the tax-reform bill. And in the end, he got to them both. The summit is less surprising because presidents can manage their agenda with foreigners better than with Congress, and Reagan had softened his conditions for a summit—dropping earlier demands for advance promise of agreements. But the tax bill’s survival was testimony not only to the support of Democratic leaders but also to Reagan’s tenacity. Reagan stubbornly clings to pet goals long after other politicians give up—a personal quality often underestimated by his critics, but essential to presidential success in the agenda game.

  Fallacies of the Rosy Scenario

  Reagan’s 1985 game plan was bedeviled not only by misplayed political tactics and second-term overconfidence. Reagan’s problems were also a matter of substance. His policies had generally lost credibility inside the beltway. In the 1984 campaign, the country bought Reagan’s pitch for “more of the same,” but the Washington political community was disbelieving. In 1981, other politicians, grasping for something new, had been willing to gamble on big Reagan tax cuts and a defense buildup; but by 1985 the political community had largely lost faith in Reaganomics. Big deficits had become an obsession. Senate Republicans, Reagan’s most important allies, were frustrated with what they derided as Reagan’s stand-pat, head-in-the-sand opposition to reducing deficits with a sizable tax increase, as well as his unwillingness to take the political risk of initiating changes in Social Security COLAs—even with his popularity at a peak and his last election behind him.

  In sum, Reagan’s game plan went astray in 1985 because it had gone astray—behind the scenes—in its initial conception, and that was starkly visible by 1985. The Reagan economic plan had not worked out as advertised because of massive mistakes made in 1981. Ironically, at the time in 1981 when Reagan and his budget genius, David Stockman, were most successful politically, the basic architecture of their economic plan was unsound. Stockman knew it then, but Reagan shied away from the bad news. The façade of Stockman’s public certainty helped Reagan’s agenda succeed in 1981. But Stockman had grave doubts, sensing even as he was selling the package to Congress that it was built on disastrously unsound economics. Privately, Stockman came to scoff at supply-side economics.

  At the high-water mark in mid-1981, President Reagan told the nation that his massive tax cut would produce a new burst of economic growth and generate new tax revenues to help bring the budget into balance. On August 13, 1981, Reagan declared buoyantly: “Our tax proposals are based on the belief that a cut in tax rates would not mean a comparable cut in tax revenues, that the stimulant to the economy would be such that the government might find itself getting additional revenues as it did last year in the cut of the capital gains tax.”

  By 1985, most members of Congress regarded that as a colossal blunder; David Stockman had reached that conclusion back in 1981 when he created the “Rosy Scenario”—the nickname that economists and White House aides, with a jaunty combination of cynicism and self-mockery, had given their economic forecasts for Reagan’s program. Stockman later admitted that the Rosy Scenario was so far off that if it had been used to project Jimmy Carter’s budget, Carter would have had a $365 billion budget surplus over five years.58 Reagan’s promises of a balanced budget by 1984 were hollow because they were based on faulty economics.

  For behind the unity and confident prescience of the administration, there had been massive wishful thinking in early 1981 and factions of economists who could not agree. So Stockman, assigned the task of drafting Reagan’s program, plucked the assumptions from each faction most favorable to Reagan’s desires and projected a far bigger economic boom and vastly larger tax revenues than actually occurred or could reasonably have been expected. He has since said so himself.

  People outside the Reagan family had foreseen the danger. Economists such as Henry Kaufman of Salomon Brothers and Herbert Stein, formerly Nixon’s chief economist and then at American Enterprise Institute in Washington, had warned that the Reagan economic numbers were too glossy. Echoes of George Bush’s charge of voodoo economics and Howard Baker’s wisecrack that Reaganomics was a “riverboat gamble.” In fact, Stockman privately confessed to writer William Greider his fear that the Reagan edifice was built on sand.59 The problem was not Reagan’s general direction, but his vast overpromising, for Reagan was either not understanding or ignoring economic reality while Stockman and others were discovering gaping holes in the Reagan formula.

  The problem lay not in the detailed cuts debated by Congress, but in the assumptions made before Congress ever got its hand on Reagan’s program. For a president’s estimates of balancing the budget or controlling deficits and how much of a tax cut or a defense buildup the nation can afford rest fundamentally on forecasts of how the economy will perform. Those forecasts often affect many more billions of dollars—plus or minus—than congressional votes or presidential actions.

  There were three massive miscalculations in the 1981 budget planning that threw Reagan’s economic game plan so far off track by 1985. The most fundamental error was that of supply-side economists: Stockman, Paul Craig Roberts, and Martin Anderson predicted that with Reagan’s tax cut, the economy would grow at a rate of five percent per year—above and beyond inflation—from 1982 to 1986. Others, such as Dick Wirthlin, Jim Baker, and Murray Weidenbaum, chairman of Reagan’s Council of Economic Advisers, warned Reagan that this was “promising too much.” But Reagan blessed the supply-siders, and so Stockman used their rosy numbers. Stockman also expected a bull market on Wall Street after the Reagan economic program was unveiled.

  In fact, the economy turned into a recession; in 1982, it showed not 5 percent real growth but a 1.5 percent decline, after discounting inflation. Supply-siders such as Jack Kemp blamed the tight money policies of Federal Reserve Chairman Paul Volcker. But Volcker was pursuing the Reagan line, the very anti-inflationary policies that Reagan had advocated in 1980.

  The 1982 downturn meant many billions more spent on unemployment compensation and other antirecessionary programs plus $85 billion less in tax revenues than Reagan’s program predicted—a whopping addition to the deficit in one year. Even after the economy recovered, real economic growth under Reagan was less than half what had been forecast and slower than in the Carter years—3.0 percent per year for Carter’s four years, compared to 2.4 percent per year for Reagan’s first four years.60

  When I asked Stockman five years later how he and the others could have expected an immediate jump to 5 percent growth, he replied: “That was crazy. I admit that was an error.”61

  The second big error of Reagan’s economists was disastrously overestimating inflation and the windfall in tax revenues it would bring. Tax revenues are based on the gross national product (GNP)—the money value of national output; “money GNP” rises both from real growth and from inflation. Inflation forecasts are crucial to figuring out how big this number will be and to reckoning tax revenues as a share of it. Murray Weidenbaum, Reagan’s top economist, figured inflation would come down slowly from 10 percen
t under Carter to, say, 7.7 percent in 1982 and to 5 percent in 1985. Actually, it fell to 4.4 percent in 1982 and lower after that. Lower inflation meant the government lost a mountain of tax money that Reagan had counted on—“nearly $200 billion in phantom revenues” over five years, Stockman told me.62

  Again, warnings were raised inside the White House—from Dick Darman, among others—that the numbers going into the Reagan plan were cockeyed. But Reagan and his top aides preferred Stockman’s good-news estimates. Several officials, including Stockman, told me that the president’s knowledge of economics was so shaky and so limited by the relatively simple one-year budgeting in California that Reagan had trouble handling Stockman’s five-year federal budget projections. Stockman also said that Reagan did not grasp the huge difference between reckoning multiple-year budgets in “constant dollars” (factoring out inflation) and “current dollars” (including inflation). Finally, he said, Reagan had trouble understanding that Stockman’s projections already included the best recovery Reagan could dream of; Reagan kept expecting more good news on top of the Rosy Scenario.

  A third major reason the Reagan program was way out of whack was the haste with which Reagan’s rapid defense buildup was projected, without Stockman or any other top White House official truly grasping it. Stockman told me, “Cap Weinberger and I did it [the long-term Pentagon budget] on a hand calculator one night in half an hour, and we made a big mistake.”63 The real architects were some defense hawks in the Madison Group, a tightly knit group of sharp, experienced, well-organized conservative congressional staff aides with links to senators Jesse Helms of North Carolina, John Tower of Texas, and Orrin Hatch of Utah. Some became the most canny and successful bureacuratic operators in the Reagan administration: John Lehman, secretary of the Navy; Richard Perle, the most influential Pentagon figure on arms control as assistant secretary’ of Defense for International Security Policy; and William Schneider, Jr., undersecretary of State for Security Assistance, Science and Technology.

  At the outset Weinberger and Stockman had to rely heavily on their advice, for neither was expert in defense. At the decisive meeting on the Pentagon budget at seven P.M., Friday, January 30, 1981, Schneider was with Weinberger, Stockman, and Deputy Defense Secretary Frank Carlucci. Schneider, then a top deputy to Stockman and a former staff aide on the House Defense Appropriations Subcommittee, had been put in place by conservatives to see that the defense buildup got railroaded through the bureaucracy. In the defense chapter of the right-wing Heritage Foundation’s Agenda for Progress, Schneider had provided a blueprint for the incoming Reagan team—an immediate jump in defense spending of $337 billion.64 If accepted, this would shoot the Pentagon budget up to a new plateau, on top of which future increases would be added, for years to come. That plateau, that base level was crucial to long-term budget calculations.

  When Reagan called in his 1980 campaign for five-percent real growth in defense spending over several years, Carter’s defense budget level was $142 billion a year. But by the time Reagan took office, Carter’s defense budget level had jumped to $176 billion in 1981; it was set for $200.3 billion in 1982 and projected to grow five percent a year on top of that into the mid-1980s. This was more than Reagan had promised. Piling Schneider’s $33.7 billion on top of Carter’s 1981 figure would shoot the Pentagon budget sky-high.

  Career professionals at the Pentagon and OMB expected Weinberger to add something like $4 billion to $10 billion to Carter’s departing budgets. But Weinberger went much bigger; he was under pressure from conservatives who feared he would not be hawkish enough, among them Senator John Tower, new chairman of the Armed Services Committee. Weinberger got Stockman’s agreement to an immediate whopping $32.6 billion—essentially Schneider’s figure. Weinberger told me that the Pentagon had specific spending items all laid out before his meeting with Stockman, but other officials insisted that very little had been done inside the Pentagon and that the Joint Chiefs of Staff were given the first two weeks in February to come up with requests to fill out the $32.6 billion.

  “Weinberger’s next action was to say, ‘Okay, Army, Navy, Air Force, you go fill in the blanks. Fill it up. Tell me what programs you should have,’ ” according to Richard A. Stubbing, deputy chief of OMB’s national security division. “There was no strategy, no priorities. It [the $32 billion] was just a number. Oddly, it was just about the same number they cut out of the domestic side of the budget. In one wink, Stockman gave away all he’d saved. We were stunned. As we heard it, the military services were stunned, too. Weinberger claims that he controlled the process, but no one did. There was almost no review. The services simply went to the shelf and took off everything that had been on their wish lists, even low-priority items. The staff in the office of the secretary of Defense were saying they were frozen out of the process. Same thing with Defense Systems Analysis. They had no real time to take a look at what the services had concocted. It blew us away. During my twenty years that request was the biggest thing ever put in, in peacetime.”65

  On top of that big bump, Stockman’s long-term planning got a second jolt from the defense budget. Reagan and Weinberger felt compelled to do more than the five-percent annual increase, because Carter had gone for that. “The five percent now had a malodorous character to it,” Schneider recalled. “The attitude was ‘anything but five percent.’ ”66 Weinberger wanted nine percent, according to Schneider; Stockman balked, but accepted seven-percent annual real growth, without grasping the enormity of the numbers. Moreover, Stockman agreed with Weinberger that the administration’s big inflation forecasts would be added onto the seven-percent real growth. With that added, the Reagan defense budget would hit $386 billion in 1986, well over double Carter’s 1981 budget.

  Weinberger denied to me that he and Stockman had haggled over percentages,67 but both Stockman and Schneider remembered discussing percentages.68

  “They [defense budget figures] were not based on an assessment of national-defense needs,” Stockman contended. “They were simply based on a rule of thumb that maybe seven-percent real growth was a good idea given how bad our defense establishment was. But I always assumed that was an interim number and that once we went through a three- or four-month exercise of taking stock of the deficiencies and what we really needed to spend, category by category—strategic, conventional, readiness, and so forth—we would then promulgate a revised five-year plan that would represent a balance between what we could afford and what we felt we needed. But that never happened. Instead what happened was the top line [seven-percent compounded growth], plus the inflation added to it, was parceled out to the military—$1.46 trillion over five years—and they in a matter of sixty days built a whole program down to the last six-hundred-dollar ashtray to spend it. Once that got wired into this massive bureaucracy and its correlates in Congress and the defense community, it was hard to ever do anything about it.”69

  For several years, Stockman, Jim Baker, Meese, Deaver, and growing numbers of Senate Republicans fought to correct what they saw as the original mistake of building excessive inflation into the Pentagon budget. But Reagan objected, because taking it out made his defense numbers look as low as or lower than Carter’s.

  Listening to Stockman describe this budgetary chicanery, I found him a strange figure. I remember my numbed shock as he was telling me how crazily and wrongfully the whole Reagan economic program had been put together. We were in the kitchen of his expensive home in Potomac, Maryland, then nearly stripped of furniture because he was moving to New York to a million-dollar-a-year job with Salomon Brothers investment house. Stockman was in a blue jogging outfit, smoking nervously, his slender fingers drumming the table as he awaited a call from the publisher of his then-forthcoming book, The Triumph of Politics: Why the Reagan Revolution Failed.

  I was stunned both by what he said and by his cavalier candor about the hypocrisy of the private debate inside the administration and the obvious flimflam of its public façade. Stockman is a true believer, a pol
itical zealot, Jesuitical in his pursuit of whatever is his current truth, even if that means renunciation of what he believed a few months, or weeks, ago. Political loyalties do not bind him long. In his youth, he had gone from Goldwater Republicanism to anti-Vietnam campus radicalism at Michigan State University, then to Harvard Divinity School, and then he had proceeded to the liberal Republicanism of John Anderson, through supply-side fever into the Reagan camp, and now he was thoroughly disillusioned by what he had imagined as the Reagan revolution. He talked about past allies and enemies with caustic candor.

  However helpful I found Stockman’s frankness about “what happened” in putting together Reagan’s economic agenda in 1981, I was deeply disturbed to hear him talk so offhandedly about fiddling with such huge numbers in private while selling the Reagan program in public. He was willing to admit his guilt and yet seemed to believe that his strange confessional would prove his good intentions and ultimately absolve him of responsibility. But the substance of what he said was damning for him as well as for the president.

  Stockman scoffed that the Laffer curve, on which the Reagan-Kemp-Roth tax cut was based, was “miracle economics.” In restrospect, he said the only way the country could afford a ten-percent annual cut in tax rates—without massive deficits—was through tax bracket creep caused by inflation. When inflation fell below five percent, Stockman said, a structural deficit was inevitable. It became permanently imbedded when Reagan agreed in 1981 to index the tax rates for inflation to stop bracket creep. In Stockman’s view, both Reagan’s program and the disastrous estimates of the Rosy Scenario made a mockery of Reagan’s happy talk that lower tax rates would yield higher tax revenues and thus lead toward a balanced budget.

  “On a five-year basis, our giant tax cut and big defense buildup cost nearly $900 billion,” Stockman wrote in early 1986. “Our domestic spending cuts … came to only about half that. So how could you worsen a budget by $900 billion, cut it by $450 billion, and still come out with a balanced budget?”70 Only by the Reagan Rosy Scenario, fat inflation forecasts, and superoptimism about economic growth. “We insisted that we had found the economic Rosetta stone,” Stockman ruefully commented, but “our Rosetta stone was a fake.”71