by Alan Murray
But the pragmatists in the White House—including Baker, then-presidential assistant Darman, Stockman, and Economic Adviser Martin Feldstein—thought talk about the benefits of tax reform sounded like more of the supply-siders “voodoo economics,” to use a phrase coined by George Bush before he became Reagan’s running mate. The real problem, in their view, was the deficit, and tax reform offered no solution to that.
Before the 1983 State of the Union address, Stockman and Darman worked on a scheme that would combine long-term tax reform with a “temporary” short-term tax increase. The tax increase, they thought, could then be sold to the public and to Congress as merely a “bridge” to raise revenue until the new tax plan took effect. In Stockman’s words, it was “a perfectly disingenuous plan” to convince the president to back a tax increase.
But the Stockman-Darman compromise never got off the ground. White House officials disagreed about what tax reform should look like and feared that the idea might not sell well to the public. Out of this confusion came the vague, two-pronged plan that the president pushed in his 1983 State of the Union address. He called for a “standby” tax that would be triggered only if Congress first approved the administration’s budget—an unlikely condition. After that, he said, the administration would “continue to study ways to simplify the tax code and make it more fair for all Americans.” The standby tax was quickly forgotten, and discussions of tax reform did not surface again in the White House until the end of that year.
As the 1984 State of the Union address approached, Baker finally decided that the best strategy was to defuse the tax issue by having the president call for a “study” of reform, without delineating any specifics. This would take the wind out of any Democratic plans to endorse the Bradley-Gephardt bill and avoid the risks of angering specific voters by putting out details of a plan. The promise of a “study” also would help the president duck the question of raising revenue to reduce deficits. The move was political, as most election-year White House decisions are, and it was based largely on a mistaken judgment about the Mondale campaign.
Treasury Secretary Regan, spurred by the handwritten note from the president, had by that time grown fond of reform, seeing it as a way to regain center stage in the Reagan administration. But his entreaties were rebuffed by White House aides. “I insisted that we had to have tax reform, that the system was crazy,” he recalls. “They agreed to let me study it. Like a pat on the head for a little child, they sent me off to go and play.”
On January 25, 1984, the president appeared before a joint session of Congress to deliver his annual State of the Union address. He stood on the speaker’s podium, with Vice President George Bush and House Speaker Thomas P. “Tip” O’Neill seated behind him, the House members and senators spread out in the audience before him. The House chamber was a majestic room, with a stained-glass eagle on the skylight soaring overhead and symbols of each state emblazoned on the ceiling. As he spoke from the high, altarlike podium, the president was flanked by giant portraits of George Washington and the Marquis de Lafayette, a French general and early friend of the Republic. The legislators sat quietly as he spoke the following words:
Let us go forward with an historic reform for fairness, simplicity and incentives for growth. I am asking Secretary Don Regan for a plan for action to simplify the entire tax code, so all taxpayers, big and small, are treated more fairly. And I believe such a plan could result in that “underground economy” being brought into the sunlight of honest tax compliance; and it could make the tax base broader, so personal tax rates could come down, not go up.
It was an impressive performance, and those watching the president might have been convinced by the president’s sincerity, had it not been for the very next line: “I have asked that specific recommendations, consistent with those objectives, be presented to me by December 1984.”
December 1984: To the members of Congress seated in the House chamber, the date conveyed tremendous irony. The presidential election was in November, and the president’s promise seemed no more than a cynical ploy to deflect the issue until the election had passed. Given the date, few of those who heard the speech believed the president was serious; few thought that the same president who had filled the tax code with huge new loopholes in 1981 was now ready to turn around and rid the code of those same preferences.
In a rare display of disrespect, the Democrats in the solemn chamber erupted into derisive laughter. “Did I say something funny?” Reagan asked with a smile.
Tax reform seemed no more than a joke.
Chapter 3
The Horse You Rode in On
November 5, 1984—the day before Ronald Reagan’s reelection—Treasury Secretary Donald T. Regan walked into the conference room that adjoined his office, where a small group of his closest advisers waited for him. A distinguished-looking man, with his silvery hair combed straight back from his forehead, Regan carried himself with a patrician air that belied his blue-collar Boston accent and upbringing. He took a seat, as always, at the head of the conference table, his back to a window that looked out across East Executive Avenue to the South Lawn of the White House. On the wall was a giant portrait of Andrew Mellon, the treasury secretary during three Republican administrations in the 1920s. This was the nerve center of the U.S. Treasury Department: President Reagan had asked the Treasury to come up with a plan for overhauling the nation’s tax laws, and it was here that Regan and his ten advisers were carrying out that task.
Only a few weeks remained before the tax plan would have to be delivered to the White House, and all of the men were beginning to worry that it would not be well received. They had fashioned a proposal more radical than any ever contemplated at such a high level of government. It swept away hundreds of special-interest tax breaks, and was sure to offend countless Republican constituencies. It totally eliminated the investment incentives that were championed by President Reagan in 1981. The plan was a political bombshell, and it was about to explode upon the nation. Regan’s eyes twinkled mischievously as he surveyed the group, and asked: “All of you have your résumés ready, don’t you?”
Few people in Washington had taken President Reagan seriously in January of that year when he called for a historic reform of the federal income tax. Treasury Secretary Regan was one of those few. He saw tax reform as his opportunity to regain prominence in the Reagan administration, and he went at the task with relish. For months, he worked diligently with this small group of men, combing through complex tax law, section by section. He kept the group isolated from the political storms of the election campaign; indeed, he kept them isolated from all the pressures that usually play upon people in power. The meetings were supersecret; the secretary ordered members of the group not to talk about their work to anyone outside of the conference room. Papers presented at the gatherings were passed out just two days before each session, in sealed envelopes marked Eyes Only, with explicit instructions that the contents were to be viewed only by the ten policymakers, and not by their deputies. After each session ended, the papers were collected again. Week after week, the group debated proposals that promised to shake the financial foundations of virtually every American family and business. Week after week, they made multibillion-dollar decisions that struck not only at taxpayers’ pocketbooks, but at the very structure of American society. Their actions would affect the home, the family, the church, everything considered most sacred.
The men sitting around the table were an eclectic group, which included the department’s two top tax experts: Ronald Pearlman, a lawyer who served as assistant secretary for tax policy, and Charles McLure, an economist and Pearlman’s deputy. In addition, there were two other economists who held strong views about the tax system: Manuel Johnson, the young assistant secretary for economic policy, and Beryl Sprinkel, the department’s undersecretary. Roscoe Egger, the commissioner of the Internal Revenue Service, was there as well, along with Deputy Secretary Tim McNamar, a former management consultant from Califo
rnia. At the far end of the table sat Bruce Thompson, in charge of legislative relations; Alfred Kingon, a former Wall Street money manager and magazine editor who was assistant secretary for planning and public relations; Thomas Dawson, a former management consultant who served as Regan’s liaison with the business community; and Chris Hicks, whose job was to coordinate the activities of the sprawling department.
Until this November day, the members of the elite group had enjoyed the luxury of thinking their actions did not amount to more than reshuffling toy dollars in a giant board game, but now, they realized, the game was over. President Reagan’s reelection was a near certainty, and soon they would have to complete their work. Their plan would be made public, carrying the weighty imprimatur of the secretary of the Treasury, and possibly the president of the United States.
“We didn’t kid ourselves,” recalls Thompson, the most politically savvy member of the group. “We knew it would be controversial. But we kept thinking that as long as we get the rates down low enough, people won’t mind.”
As chief executive of Merrill Lynch, Regan had been an avid backer of investment tax breaks. During his first year at the Treasury, he led the battle for the rapid depreciation write-offs in the 1981 tax bill. But in the privacy of his conference room in 1984, the secretary shed his image of a promoter of business incentives and became instead an ardent tax reformer. One after the other, he accepted proposals to do away with long-standing tax preferences. It was a remarkable transformation.
Although a bright man with a quick mind, Regan had no firm economic or political philosophy, outside of a businessman’s basic conservatism. He was not introspective, not given to theorizing, and never worried much about the consistency of his positions. As a result, he was often open to persuasion by others who did have firm and unequivocal beliefs. In his first two years as Treasury secretary, he presided over a staff split oddly between committed supply-siders, who believed that low tax rates made the world go round, and doctrinaire monetarists, who thought the growth of the money supply determined all. Regan’s own pronouncements were at times an awkward reflection of that split; he was unpredictable. Once, when asked whether he agreed with Regan’s statements on the budget deficit, Exxon Chairman Clifton Garvin quipped, “It depends on what hour of the day he said it.”
But the idea of a radical tax plan had an instinctive appeal to Regan. He relished the prospect of unveiling a proposal that slaughtered whole herds of sacred cows. At heart, he was a contrarian. The son of a railroad security guard and a former marine, Regan had worked hard to make himself into a multimillionaire. He had struggled to get where he was, and the experience had made him pugnacious and defiant. He liked to take on the establishment, even though he had labored feverishly to become a member of it. He took an almost-perverse pleasure in a good fight. One aide recalls that Regan’s eyes would light up when he was preparing to testify before a particularly hostile congressional committee; the sparring enlivened him.
A symbol of Regan’s defiance, well-known among his aides but seldom heard outside of Treasury, was an old saying he picked up from John “Buck” Chapoton, Pearlman’s predecessor and the first supervisor of the tax-overhaul project. Chapoton told the story of a foul-mouthed, poker-playing friend of his in Texas, who once blurted out in the middle of a card game, “Fuck you, and the horse you rode in on.” Regan was tickled by the saying, and adopted the last half of the phrase as his own. When an aide made a point he disagreed with, Regan would interject, “And the horse you rode in on,” causing the room to break up in laughter. The phrase became a repeated source of amusement to the tax-writing group and eventually earned itself a place in history. In the large, official portrait of Regan, which hangs in the hall on the third floor of the Treasury and will continue to hang there long after Regan dies and his tax proposal has been forgotten, there is only one book that can be seen clearly on the shelves over his right shoulder; its title, The Horse You Rode in On.
Regan’s feistiness was legendary on Wall Street as well. He shook the financial establishment in the 1970s by supporting an end to fixed commissions for brokers. Merrill Lynch under Regan became one of the first Wall Street firms to go public, and it pursued an almost-reckless acquisition strategy. Once, it even considered acquiring the Chicago White Sox.
With Regan at the helm, the firm also conducted what some Wall Streeters termed a “ruthless” campaign to bring in new clients by hiring away top securities analysts from other firms. And in the late 1970s, Regan’s Merrill Lynch came up with an innovation that changed the nature of the business forever: the cash management account, which allowed clients to write checks against their brokerage accounts. Regan’s revolution at the investment house was so complete that when Citicorp Chairman Walter Wriston was asked at a 1980 bankers’ meeting in Boca Raton what his dream bank might look like, he replied bitterly that it already existed: “Don Regan runs it, and it’s called Merrill Lynch Pierce Fenner & Smith.”
“Do you know why I’m hated?” Regan said once to a Washington Post reporter. “I broke up their cozy little club. Wall Street was a cartel. They proclaimed capitalism—but practiced cartelism.”
Tax reform offered Regan a similar opportunity to rattle the business community. It would put free-market rhetoric to the test by taking away business-tax subsidies and making everyone compete on a level playing field. Regan cherished the thought of how his proposal would stick it to the wealthy special-interest lobbyists that he and his aides referred to as the “Gucci boys.” “He has these populist tendencies, that’s why he took on Wall Street the way he did,” said Manuel Johnson, the assistant secretary. “That’s why he always liked to buck the establishment. Tax reform was a natural for him.”
Regan also had a fabled ego, and he craved the public spotlight. He bridled when other economic policymakers in the Reagan administration, such as Budget Director Dave Stockman or Economic Adviser Martin Feldstein, received more news coverage than he did. “I’m the president’s chief economic spokesman,” he said with almost comic regularity. Despite such protests, he never felt he got the attention he deserved.
A revolutionary tax-reform bill, Regan believed, would surely put him back at the center of things. The more radical the plan, the better. As a result, the secretary never shied away from the tough decisions. He strode into the conference room one day when some particularly touchy issues were under scrutiny and declared with a smile, “This is the day we do away with Santa Claus.” On occasion, he even urged his reform-minded tax experts to take more hardheaded positions than they were inclined to on their own. For instance, when Pearlman proposed putting a limit, or a “cap” on the amount of employer-provided health insurance a person could receive tax-free, Regan’s response was: “Why cap it? Why not tax all health insurance?”
During his first three years as Treasury secretary, Regan had developed a reputation as the president’s yes-man. “He would try to guess where the president was going to come down on an issue,” complained one unadmiring administration official, “and then get there before him.” Although his Wall Street background led him to fear the effects of giant deficits, Regan was nevertheless unstinting in his defense of the president’s huge 1981 tax cuts. When the massive budget deficits surfaced in 1982, he insisted repeatedly in public that deficits did not really matter—a position that was anathema to most serious economists, but one that endeared Regan to the president, who was eager to avoid a tax increase. In White House meetings, Regan was “determined to prevail for the sake of prevailing—even if it meant advocating nonsense,” wrote Stockman. His method of determining his position on any given issue, detractors said, was to lick his finger, hold it up, and sense which way the White House political winds were blowing.
But in that small conference room at the Treasury in 1984, there were no winds from the White House. President Reagan had expressed a general interest in tax reform, but provided virtually no guidance on what shape reform should take. White House Chief of Staff Jame
s Baker wanted nothing to do with Regan’s plan, in large part because he did not want details to leak out and create controversy during the reelection campaign, but also because neither he nor others on the White House staff took the effort too seriously. “I don’t think people over there realized what we were doing,” says Regan, who had grown resentful and jealous of the powerful White House staff during his time in Washington. “They thought yeah, all these guys at Treasury, Christ, they’re dreaming. It’ll never come about.”
As a result, the sixty-five-year-old Treasury secretary was rewriting the nation’s tax laws in a complete political vacuum. Under strict instructions to keep details from leaking out of Treasury, Regan could not even float the proposals with key members of Congress or with people or groups likely to be affected. He had to rely on his own instincts and the advice of ten other men.
Two men, in particular, had the secretary’s ear: Ronald Pearlman and Charles McLure. They invariably dominated the discussions in the conference room, and the tax plan that emerged was, in the final analysis, their tax plan. Pearlman was a short, balding Missouri lawyer with a thorough knowledge of the tax code and a theoretical bent. McLure was a soft-spoken Texas economist who had written numerous books on the economics of taxes. IRS Commissioner Egger occasionally talked about the difficulty of administering certain portions of the tax code, and Manuel Johnson frequently argued with McLure about the economic effects of business tax breaks. But for the most part, the views of the department’s two top tax experts, Pearlman and McLure, went unchallenged. Backed by a talented staff of about eighty lawyers and economists, the two men set the agenda for each meeting and prepared the papers to be discussed. They made proposals to Regan, and with surprisingly few exceptions, those proposals were adopted unchanged.