Showdown at Gucci Gulch

by Alan Murray

  For McIntyre, who was trained by consumer advocate Ralph Nader, the publicity was ample return for the hours he spent deciphering corporate reports. He too was a lobbyist of sorts, working for a labor-funded group called Citizens for Tax Justice, which promoted the closing of corporate loopholes. Unlike the lobbyists who represented big business and other wealthy interests, he did not dine at plush, expense-account restaurants, nor did he spend much time buttonholing members of Congress. His $38,000 salary was a mere fraction of the much larger sums earned by his corporate lobbying foes.

  No matter. In the tax debates ahead, Bob McIntyre’s one-man report would turn out to be more influential than all the firepower the corporate lobbyists could muster.

  The goal of tax reform was to eliminate or curtail as many tax expenditures as possible. To be sure, not all tax breaks could be eradicated: Some were politically immovable; others served critical social functions. But the tax code was badly in need of a housecleaning, and tax reform was intended to give it just that. Reform also promised a trade-off: Tax breaks for the few would be replaced with lower tax rates for everyone.

  As appealing as the concept sounded, however, few in Washington thought it could be done. The groups with an interest in the existing tax system were well-organized and ready to defend their breaks at a moment’s notice; the populace who stood to benefit from lower rates was unorganized and diffuse. Furthermore, Congress was a slow and cumbersome institution that usually made only piecemeal, incremental changes. Tax reform proposed something very different: a radical revamping of the entire tax structure. There was a tremendous inertia in Congress that resisted any such sweeping change. As a result, the conventional wisdom in Washington held that tax reform was destined to lose, and the conventional wisdom had plenty of history to back it up.

  Tax breaks, after all, had always been part of the currency of Congress. Politicians liked to give them out; they did not like to take them back. The seventy-three-year history of the income tax had been a story of steady erosion in the tax base, with more and more loopholes being added and few being taken away. Indeed, the very structure of American government, with its checks and balances, argued against the success of such a bold plan. The American revolution had been fought largely over the question of who should have the power to tax: the King’s appointed governors or the popularly elected legislatures. By putting the authority to tax into the hands of the legislature, the Constitution ensured that our tax system would become and remain a political potpourri. A parliamentary government might be able to fashion radical tax-reform legislation in the executive branch and be assured of its success in the loyal parliament, but the American system subjected such bills to the tugs and twists of 535 members of Congress, each with strong political interests to protect.

  Idealists had tried with little success to eliminate loopholes almost from the day the income tax was enacted. One man even died trying: In 1956 Randolph Paul, a former Treasury tax expert, collapsed in the midst of telling a congressional hearing that the Eisenhower administration was using the tax code to stimulate business rather than just to collect revenue.

  President John F. Kennedy also tried to launch an attack on the tax code and appointed Harvard law professor Stanley Surrey, an outspoken critic of tax breaks and incentives, to the Treasury’s top tax post. Congressional opposition to Surrey’s appointment was intense. The oil and gas industry, the mining industry, the savings-and-loan associations, and an army of others who benefited from the nation’s cheesecloth tax system raised a storm of protest. Surrey’s reception before the Senate Finance Committee was particularly hostile, with Chairman Harry Byrd of Virginia indignantly accusing him of harboring a low opinion of the nation’s legislators. “You think that some of these tax laws were sneaked through Congress without the knowledge of a great many congressmen,” Byrd charged. The senator assured Surrey that they were not.

  In the face of such opposition, Kennedy’s reform efforts wilted. His first tax bill, signed in October 1962, was designed to jump-start the economy rather than reform taxes. It included a huge new investment credit that subsidized the purchase of business equipment and became one of the biggest tax expenditures in the code, resulting in billions of dollars of lost revenue to the Treasury each year. The bill also contained a new provision, added by Congress, that created a deduction for lobbying expenses. Kennedy’s second tax bill, introduced in early 1963, attempted to combine sharp cuts in tax rates with an array of Surrey’s loophole-closing measures. Virtually all the loophole-closing provisions were abandoned or gutted, either by the Ways and Means Committee in the House or by the Finance Committee in the Senate.

  The closest Congress ever came to enacting a broad reform of the income tax was in 1969. The measure got its start in early January of that year, thanks to Treasury Secretary Joseph Barr, who held the top Treasury post for only twenty-seven and a half days at the end of the Johnson administration. Shortly before leaving office, Barr testified on Capitol Hill of an impending “taxpayers’ revolt,” spurred on by increased public awareness of tax inequities. To ensure the fulfillment of his prophecy, he unveiled alarming Internal Revenue Service figures showing that 155 people with incomes over $200,000 had managed to pay no income taxes at all in 1967. The list, he said, included twenty-one millionaires.

  That disclosure prompted a torrent of press coverage and a blizzard of indignant mail to members of Congress. The new president, Richard Nixon, was no friend of reform, but he immediately came under heavy pressure to embrace tax overhaul. After a long debate, a bill was crafted that repealed the investment credit, ended or curtailed a number of other tax breaks, and cracked down on tax-exempt foundations.

  But the reforms of the 1969 bill were short-lived; subsequent legislation reopened most of the closed loopholes. In 1971, for instance, Congress voted to reinstate the investment credit and also approved new and more generous business investment write-offs, as well as a new tax break for export companies.

  Congressional resistance to tax reform was symbolized by Senator Russell Long, who chaired the Finance Committee from January 1966 to December 1980. Scion of one of the nation’s most colorful political dynasties, Long saw the tax code as his tool for changing society. He had no interest in reform. A wise student of human behavior, Long realized the losers from tax overhaul would make far more noise than the winners. “When we proceed to shift the taxes around so that one set of taxpayers pays a lot more taxes and somebody else pays a lot less taxes, the people who benefit from it do not remember it very long,” Chairman Long said in 1976. “They tend to feel that it should have been that way all the time, and the people who are paying the additional taxes resent it very bitterly.” On another occasion, the wily Louisiana Democrat gave an even more cynical assessment of reform. “I have always felt,” he said, “that tax reform is a change in the tax law that I favor, or if it is the other man defining tax reform, it is a change in the tax law that he favors.”

  Reform-minded legislators attempted an end run past Long in 1975 and enacted legislation that cut back the oil depletion allowance, one of the largest and least-justified breaks in the tax code. But even then, Long succeeded in undermining the reformers’ victory, restricting the change to the major oil companies and leaving the generous break intact for the prosperous independent producers in his state and elsewhere. Another failed attempt at reform was made in 1976, when the House passed a bill with a tough anti-tax-shelter provision, only to have it dropped by the Senate. (Ironically, the attempt to shut down tax shelters was stopped partly through the efforts of Senator Packwood of Oregon, who ten years later made a similar provision the foundation of his own tax-reform bill.)

  Tax reformers breathed one last gasp in 1977 and 1978, during the presidency of Jimmy Carter. Carter made tax reform a cornerstone of his election campaign, calling the existing tax system “a disgrace to the human race” and “a welfare program for the rich.” In an interview with Fortune magazine, the president said he thought the na
tion was “ready for comprehensive, total tax reform.” While not divulging details, he said his plan would “eliminate hundreds of tax breaks and greatly reduce the tax rate.” After taking office, Carter’s treasury secretary, Michael Blumenthal, began publicly discussing some of the provisions under consideration, and they did indeed sound bold and sweeping. He floated the idea of eliminating the preferential treatment of capital gains, for example.

  The response of interest groups to Carter’s trial balloons was fierce and swift, and the administration’s resolve was indeterminate. In the fall of 1977, Carter aides said they were “reshaping” the tax proposal to reflect changing budgetary, economic and political realities. When the plan was finally unveiled in January 1978, Carter’s grand rhetoric boiled down to a few exceedingly modest reforms, such as cutting back on the “three-martini-lunch” deductions for business meals and entertainment. Even those modest measures were quickly ripped apart by Congress.

  The bill finally enacted in 1978 was a complete renunciation of the Carter proposals and of any notion of tax reform. It included a host of new tax benefits. The Senate proved to be particularly generous, voting to expand many existing tax breaks and adding numerous new provisions targeted to help farmers, teachers, Alaskan natives, railroads, record manufacturers, the Gallo winery of California, and two Arkansas chicken farmers.

  The defeat of President Carter’s tax-reform efforts signaled a new era in tax policy, the triumph of a broad coalition of business lobbyists who came together under the rubric of “capital formation.” These lobbyists argued that the best medicine for the faltering U.S. economy was to create new tax breaks for businesses and investors. They championed a provision in the 1978 law that enhanced the preferential treatment of capital-gains income, bringing the top tax rate on gains income down to 28 percent from the existing rate of 35 percent or more. Reformers complained that the special treatment for capital gains was unfair and fueled the growth of tax shelters, but the capital-formation coalition said the tax break would encourage investment and promote economic growth. The economy was in trouble, they argued, and lower capital-gains taxes were a solution. Tax reform was clearly out; “capital formation” was in. The influence of special interests in Congress had reached new heights.

  The symbol of this new era was an elite group of Washington business lobbyists who in 1978 began meeting each Tuesday morning for breakfast at the Sheraton-Carlton Hotel in downtown Washington. Known among themselves as the “Carlton group,” they were the cream of Washington tax lobbyists—highly paid representatives of the largest corporations and the most influential business organizations in America. They developed into a virtual fourth branch of government, devising new tax schemes that would eventually become the law of the land.

  It was this pinstriped-suited group that gave birth to the biggest business tax break ever adopted—the accelerated cost recovery system, a loophole so large that it allowed many big, profitable corporations to slip through without paying a penny in corporate tax.

  The reputed father of the Carlton group was a man named Charls E. Walker, an expatriate Texan who pronounced “corporate” like “carpet,” and who became the slow-walking, smooth-talking embodiment of the capital-formation crowd. Walker, who was deputy treasury secretary under Nixon, ran a lobbying firm that represented dozens of major industrial clients, from the Aluminum Company of America to the Weyerhaeuser Company. All of them invested heavily in equipment, and all sought ways to reduce the tax burden on their investments. To provide research to back up his efforts, Walker also ran an organization known as the American Council for Capital Formation.

  In Walker’s view, encouraging business investment in equipment was the most important goal of tax policy. He told acquaintances that he viewed capital investment the way Mark Twain viewed good bourbon: “Too much is barely enough.” He felt there should be no tax on corporate investment; indeed, he apparently had no qualms about outright tax subsidies for investment, and that is what his generous tax write-off scheme amounted to for some. His clients were the heart of smokestack America, and their power in the economy was declining rapidly, as foreign manufacturers grew more competitive and as the U.S. economy turned more toward services. His job was to get government to help halt that decline.

  For Walker, promoting investment tax breaks was also good business. As a child in tiny Graham, Texas, he had sometimes slept on the porch when the family was able to rent out his room in their hotel for a night. But as a Washington lobbyist, he learned to live luxuriously. He was, in his own words, “a very diminutive millionaire,” who could garner as much as $7,500 a speech, and who served on four corporate boards. He traveled in a large black limousine and smoked cigars nearly as large, called “Ultimates.”

  In 1980, Walker initially threw his support to fellow Texan John Connally, who was making a futile attempt for the Republican nomination for the presidency. But when Ronald Reagan won the nomination, Walker joined his team. He was asked to become Reagan’s adviser on tax policy, and he jumped at the chance.

  At the time Walker joined the campaign, Reagan’s tax policy was the brainchild of two congressional Republicans who were leaders in the so-called supply-side movement, Representative Jack Kemp of New York and Senator William Roth of Delaware. The Kemp-Roth proposal was a tax cut for individuals known as “10-10-10”—a 10-percent tax reduction across the board in each of the next three years. Walker helped convince candidate Reagan to embrace another set of numbers: 10-5-3. Those figures represented the accelerated write-off scheme fashioned by the Carlton group. The plan would enable businesses to “depreciate,” or write off, the entire cost of a building in only ten years—compared with thirty years under existing law; to write-off investments in equipment and machinery in five years—compared with ten under existing law; and to write off cars and trucks in just three years, compared with three and a half under existing law. It was an extraordinarily rich tax break, worth hundreds of billions of dollars to business.

  Why did Reagan accept such a costly scheme on top of his own tax cuts for individuals? “He didn’t know what he was doing,” Walker later speculated; but Walker certainly knew, and the payoff for his clients was enormous.

  Once elected, the president kept his campaign promise to corporate America. He continued to push for Walker’s 10-5-3 plan, as well as for Kemp-Roth’s 10-10-10. Only once did the administration show signs of wavering on the massive business tax break: In June of 1981, the Treasury Department began to worry that the tax cuts were too big and would exacerbate the budget deficit. In response, the White House considered cutting back the proposed depreciation schedules, but Walker and company showed they could still flex their muscles. In an event later dubbed the “Learjet weekend,” corporate chieftains from across the country raced into Washington to protest any diminution in the 10-5-3 plan. The Treasury quickly backed away from its concerns and even added a few new sweeteners to keep business on board.

  In the end, the 1981 tax bill, called the Economic Recovery Tax Act (ERTA), served as proof of the new power of the advocates of business loopholes. It not only included a revised version of 10-5-3, it also lowered the top tax rate on capital gains yet again to 20 percent from 28 percent. A congressional “bidding war” between Democrats and Republicans to see who could be more generous to whom added even more special giveaways. The Carlton group had triumphed.

  In the 1980s, tax reform seemed even more unlikely than it had in earlier decades. Accompanying the rising influence of business lobbyists was the proliferation of political action committees (PACs), which dispensed campaign contributions. From 1974 to 1984, PAC spending on congressional campaigns increased nearly tenfold. PAC giving to congressional candidates totaled $12.5 million in 1974 and soared to $104 million in 1984. Some of the biggest beneficiaries of this largesse were members of the tax-writing committees. Nearly $3.5 million of PAC money flowed into the coffers of fifty-six tax-committee members in the first half of 1985 alone. With so much money going in
to their campaign chests, members of Congress became more beholden than ever to narrow interests.

  Changes in the way Congress operated also stood in the way of tax reform. A decade and a half before, Congress was controlled by committee chairmen and a few leaders in both parties. Wilbur Mills, for example, held the pen for all legislation that was written by the Ways and Means Committee during his fifteen-year reign as chairman. In the 1980s, however, Congress was more democratic, and members were more independent of their leaders. Congressional subcommittees had proliferated. There were no longer just a few key power centers; power was spread throughout both chambers. The administration could not simply cut a deal in a back room with a handful of important members; it had to negotiate with a Congress full of independent thinkers and minor potentates.

  The yawning budget deficit also appeared to work against reform. Supply-side guru Arthur Laffer, a California professor, had convinced President Reagan and others that the 1981 tax cuts would cause a surge in economic growth strong enough to eliminate the deficit. Instead, the economy slid into recession and the huge tax cuts helped create the biggest peacetime budget deficits the United States had ever known. Republicans had complained about $60 billion deficits in the Carter administration; but under the Reagan administration those deficits soared to more than $200 billion a year, and they showed no sign of coming down. The deficits were clearly the nation’s number-one economic problem, and tax reform, as envisioned by Senator Bradley in 1982, offered nothing to reduce them. It was to be “revenue neutral,” raising neither more nor less revenue than the current tax system. Tax reform seemed to be a sideshow, a distraction from the real problem. Furthermore, the small reform successes of the past had occurred in bills that cut taxes. Barber Conable, a longtime Republican member of the Ways and Means Committee and a keen observer of Congress, predicted reform could only occur when overall taxes were being lowered. “Tax reform must be bought,” he insisted. But with burgeoning budget deficits, the idea of “buying” reform by cutting revenues was unthinkable.