by Alan Murray
The solutions were worked out during the weekend of April 26 and 27. Brockway and his colleagues retreated into the cramped revenue estimators’ office on the House side of the Capitol and started trying to fit the pieces together. The tax plan was like a huge jigsaw puzzle, and Brockway worked with Randy Weiss and revenue estimators Eric Cook, Steve Lerch, and Bernie Schmitt in an effort to find the missing pieces. Cook was the staff expert on a notion that Brockway himself found extremely attractive. It was a complicated and controversial concept, but Brockway knew that the idea could be the linchpin of the entire enterprise and the keystone of a new Packwood plan.
The idea was to launch a frontal assault on tax shelters by prohibiting the use of “passive” losses to offset other types of taxable income. Passive losses were losses on paper that went to investors who did not actively participate in a business. Such losses often resulted from limited-partnership arrangements, and provided investors in high tax brackets with large write-offs that reduced their taxes. Some of the most popular tax-shelter investments, such as real estate, cattle-feeding, and equipment leasing, produced paper losses two or three times the size of the initial investments.
The proposal would prohibit investors from reducing their taxable income with losses from passive investments. Earned income would then be subject to tax regardless of the extent of such paper losses. The screams from real estate interests to a similar proposal in the House had been so loud that the Ways and Means Committee had for the most part steered clear of it, choosing only to incorporate it in its minimum tax. Earlier attempts by Moynihan and Chafee to enact the idea in the Senate had also failed. But this time, Brockway’s scheme had a chance. It neatly addressed the problem of the moment. Indeed, it seemed the perfect political solution to the puzzle that the 25-percent plan created.
The passive-loss provision accomplished several objectives at once. First, it raised a significant amount of revenue—in combination with a proposal to limit interest deductions, it was worth about $50 billion over five years. That helped solve one of the Finance Committee’s most pressing problems: finding enough revenue to save the industry-specific tax breaks that its members cherished. Second, and more important, the disallowance of passive losses hurt wealthy people almost exclusively. That meant the provision would reduce the amount of tax cut that upper-income people received, despite the drastic reduction in the top tax rate. Keeping down the size of that tax cut for the rich was key to the political success of the tax-reform plan.
Brockway thought he could make everyone happy with his passive-loss proposal. The senators would not have to turn to some highly unpopular revenue source, such as excise-tax increases or complete repeal of the state and local tax deduction, to fund their tax-rate cuts. Instead, they could say—truthfully—that they were getting the money from rich people by killing “unfair” tax shelters. They also would be able to say—truthfully—that thanks to the provision they could chop the top individual tax rate nearly in half without giving a windfall to the wealthy.
When Brockway broached the subject with Packwood, he was careful to warn the chairman of the political risks. “Look,” Brockway said, “you can do this, but I can tell you it’s going to be controversial. A lot of people are going to scream.” Packwood was willing to take the chance. “If you give me rates in the twenties,” he replied, “no problem.”
To help further reduce the benefit to the wealthy, Packwood urged Brockway to adopt another proposal, which was more along the lines of a tax-writing trick. First used in the Kemp plan, the provision made the top individual tax rate seem lower than it really was by “phasing out” tax benefits for high-income individuals. Under existing law, all taxpayers, no matter how much money they made, enjoyed the benefits of the lower tax rates on the first income they earned. In addition, all taxpayers got the benefit of the personal exemption. The Packwood proposal was to gradually eliminate those benefits for people whose incomes exceeded a certain amount. This would be accomplished by imposing a surtax of about 5 percent on incomes within a certain range, probably extending from about $75,000 to $200,000 a year. For taxpayers in that income range, there would be a “phantom” top marginal tax rate—the rate on each additional dollar a taxpayer earned—which would be considerably higher than the stated top rate. The scheme produced a perverse result: Families with moderately high incomes would have to pay higher marginal tax rates than would those with very high incomes. The device was a Darmanesque sleight of hand; in fact, it was similar to gimmicks advocated by Darman in his efforts to get a 30-percent top rate during the development of the president’s plan.
Brockway and Weiss thought the idea was wacky, but they were under orders, and they complied. The main attraction of tax reform to the Senate was its low top rate, and the lower that rate was in appearance—if not in fact—the better chance the entire package had of winning approval.
Slowly, Brockway put together a plan that fit Packwood’s demands. It was an intricate proposal, and in many ways, a house of cards. If the senators insisted on changing any major part of it, the whole thing might collapse. In order to drive the top rate into the twenties, as a clear majority of the committee preferred, the package had to contain a strong passive-loss rule, the tricky “phase-out” provisions, and also the repeal of the preferential treatment of capital gains, which was the favorite tax break of a broad coalition of businesses and investors. If any of those three tax benefits proved too resilient and was retained, the distribution of tax cuts would tip toward the wealthy and the plan would become politically unpalatable. Conversely, if the top rate was nudged up higher to increase the bite on the wealthy, many members would balk at taking such controversial steps as repealing the capital-gains benefit, which under existing law taxed long-term gains at 20 percent. It was an extremely fragile plan.
On Monday, April 28, Senator Dole, unaware of any of the plotting at the Joint Tax Committee, spoke the words that were on the minds of anyone who had watched the fiasco at the Finance Committee. Tax overhaul, he said, “is hanging by a thread.” He added, “If we can’t get a good bill, I would suggest we wait until next year.”
But Packwood, secure in the belief that he had an emerging core group and a plan they might accept, refused to concede defeat. “All I can do here is plug away day by day,” he said, and he continued to prepare behind the scenes for what he knew was a critical meeting the next day.
On Tuesday, April 29, the members marched into the exec room expecting the worst. What they found, instead, was a complete, and for some, pleasant surprise. “We came over to hear the eulogy on tax reform,” said Senator David Pryor, “and we found some life in the old corpse.”
Packwood handed out two more plans, one with a 26-percent and another with a 27-percent top rate, the variations Brockway and his staff had devised over the weekend. This time, Packwood did not shrink from taking a healthy chunk of the credit for Brockway’s work. The plans went a long way toward meeting the objections of the members, and they did so without raising corporate taxes too high. The distribution of tax cuts was also politically acceptable: The middle-income categories did far better than the high-income groups did.
Both plans also retained some of the most cherished middle-class tax breaks that the 25-percent plan had eliminated, including write-offs for mortgage-interest payments, charitable contributions, and state and local income and property taxes. The 27-percent plan also kept deductions for state and local sales taxes. However, both plans repealed the extremely popular deduction for contributions to individual retirement accounts, which the tax-writing committees had expanded significantly five years earlier.
Inside the exec room, Bradley took the lead in explaining the delicate interrelationships that held the plans together. He pointed out how important it was to get the rate low and get rid of both the capital-gains and passive-loss benefits. He explained how much of a tax cut each income group would get and why. He concluded that the new plans were superior to the first one, and also bett
er than existing law.
Bentsen, the most experienced businessman of the group, immediately caught the far-reaching import of the passive-loss provision. It was an extremely crude and blunt instrument of reform, and it would be painful to many investors and businessmen. Bentsen was filled with questions and concerns: Which losses would be disallowed, he wondered. Were any real, economic losses on the chopping block? How could eliminating the writeoff for those be justified? What about a more gradual phase-in to prevent the severe dislocations that such a monumental change would cause? Despite his many concerns, Bentsen indicated he would probably be willing to go along, particularly if the top rate were no higher than 26 percent. He knew that an all-out attack on tax shelters would be a politically popular component of reform.
Other members were not as quick to decipher the impact of the new plans. The meeting was spent by most members simply trying to understand what was in the plans and what was not. Chafee inquired about the status of the mortgage-interest deduction: It was retained. Moynihan wanted to know about the minimum tax: A tough one was still included. Danforth wanted to know the status of pension-law changes: The committee’s earlier decisions made in open session still held.
Nevertheless, the senators were clearly intrigued by the proposal. “How do we now proceed?” Danforth inquired.
Packwood noted that corporate taxes would still have to be raised by a substantial amount, although not as much as in the president’s bill or the House bill. He brought out the first of many lists of revenue-raisers that, he said, could easily do the job. If the committee would agree to the changes on the individual tax items, Packwood said, he would start work on the corporate side. Although it would not be easy, he thought he could fashion a plan that would please a majority of the panel.
The attitude of the members was markedly changed by the meeting. Thanks to Brockway, Packwood had in his hands a workable alternative to his failed first attempt. His members considered the new plan “reform,” and they knew they could sell it to their constituents that way. They began to believe for the first time that there would be a bill. The mood had shifted, and a momentum, similar to that Rostenkowski had created in the Ways and Means Committee when he turned around the bank vote, was taking hold.
Signs of this new awakening were immediately apparent. Dole emerged from the exec room to amend his earlier assessment that the bill was “hanging by a thread.” This time, he concluded, it was “hanging by a rope.” Bentsen also was more upbeat: “It is back on track.” David Boren of Oklahoma, the tax-reform opponent, lamented: “Just when I thought I got this bill in bad trouble, he pulls something out of his hat.”
Packwood was effervescent with optimism and said he planned to work through the weekend. “If it looks like we’re this hot, let’s keep going,” he said. “You seize the moment when it’s there.”
The next morning, Wednesday, April 30, Packwood began a ritual that he repeated each weekday until the bill was completed. He met at 7:30 A.M. with his own staff and Brockway and Weiss. Then, at eight-thirty, he met with his core group of senators. At about ten o’clock, the rest of the committee convened in the exec room for private consultations that mostly involved slogging through lists of provisions that would raise enough revenue to pay for the dramatically lower rates.
The most important meeting that Wednesday, however, was an afternoon gathering in the Capitol offices of Majority Leader Dole.
The majority leader’s offices are in the oldest part of the Capitol, midway between the Senate chamber and the Rotunda, and they are steeped in the history of the Republic. When the Capitol was still under construction, the rooms served as the meeting place of the House of Representatives. Later they were the robing chambers for the Supreme Court. The ceiling of Dole’s own office contains one of the first fresco works in America, a miniature of Michelangelo’s “Creation of Adam” done by the man who touched up the Sistine Chapel for the pope. During the War of 1812, the Senate stored books from the Library of Congress in this room, and when British soldiers stormed the Capitol in 1814, they used the books to start a blaze that eventually burned down most of the city. On a little table in Dole’s office is an engraving depicting British soldiers gleefully tossing books into the marble fireplace that still stands nearby.
For the most part, Dole had been cool to the whole idea of tax reform. He had even suggested to White House officials that they drop the initiative, and instead claim victory due to the rate cuts in the 1981 bill and the “reforms” contained in the tax bills he helped shepherd through Congress in 1982 and 1984. He was frequently absent from the Finance Committee meetings because of his own hectic schedule, but when he did arrive during the earlier markup process, his vote was frequently cast in opposition to reform.
After seeing the 26- and 27-percent plans, however, Dole began to change his tune. He was intrigued and impressed. During a private briefing on the intricacies of the proposals, he repeatedly brushed aside reservations expressed by his aide. “This thing,” he said, “is going to pass.” He told Packwood the same thing during a meeting on the balcony outside his office, which commanded a breathtaking view down the Mall to the Washington Monument and the Lincoln Memorial. Dole’s opinion carried a lot of weight. His support for the tax-reform effort would be crucial not only for its success in the Finance Committee, but also for its reception on the Senate floor.
When Dole convened the meeting of the Republican members of the Finance Committee that Wednesday afternoon, his views of the radical new plan were not widely known. Baker and Darman, who were also invited to the meeting, came with a feeling of trepidation. They feared that Dole had called the meeting to bury tax reform, not to praise it.
That worry was soon dispelled. The participants sat in a conference room around an inlaid table. Baker and other supporters of the radical plan gave pep talks. “We talked a lot about lower rates and how this could be something that people could get excited about,” Baker recalls. The Treasury secretary also used the same distinctly negative motivation that had propelled tax reform all along: He reminded the Republican senators that it was particularly important that they not be seen as killing tax reform.
Dole sat at the head of the table and for the first time began to send out clear signs of support for the bill. The majority leader usually talked in brief quips, and it was sometimes difficult to tell exactly where he stood on any issue, but this time his witticisms suggested he would support the effort. “Well, there are eleven of us,” he noted at one point. “We can just vote it out.”
The senators still voiced concerns. They were particularly troubled by two components of the Packwood plan: repeal of the capital-gains preference and the elimination of the IRA deduction. Those were two tax breaks that the president himself had expanded in his own version of tax reform; the Republican senators asked Baker if the White House was now willing to see both eliminated. They did not want to cross the popular president. In 1985 the president had abruptly backed out of a deal with the Senate Budget Committee to support a tax on Social Security benefits as a way to reduce deficits. The members did not want to have the rug yanked out from under them on tax reform in the same way.
In response, Baker gave a glowing dissertation on the concept of reform and on the attractiveness of low rates, but he could not answer the question. It was clear once again that the Treasury secretary was walking a narrow line. He wanted to encourage the senators, but could not speak for the president. He knew that the new White House team was unpredictable and could well decide to withhold the president’s support, as they had in the House. The best Baker could do was to assure the Senators he would urge Reagan to support their bill.
The meeting helped convince the Republicans that it was time to support tax reform. With Dole on board, Packwood felt confident he could complete his bill. Two days later, he announced that he was “reasonably certain” that he had enough votes to pass it in committee.
Baker and Darman were scheduled to leave on Thursday, M
ay 1, for an economic summit in Tokyo. After the Dole meeting, however, Baker saw that a critical point was at hand. “Should I delay until Friday? Should I delay until Saturday?” Baker kept asking Packwood. No, Packwood finally concluded, go to Tokyo, but leave Darman behind. Although a controversial figure during the Ways and Means markup the year before, Darman had become a valued adviser to Packwood and the Finance Committee’s “core group.” The clever Treasury official was skilled in picking his way through the tax minefield, and Packwood publicly referred to him as a “gem.” Starting on Thursday morning, Darman began to attend both the seven-thirty and the eight-thirty private meetings, and he became an integral part of every large and small meeting that Packwood conducted in the interest of tax reform.
At about this time, Kemp attended a Packwood fundraiser and showered praise on the Finance Committee chairman. He compared Packwood’s gutsy effort to cut tax rates to General MacArthur’s Inchon landing in Korea. Soon thereafter, syndicated columnists Evans and Novak, whose column was a font of supply-side propaganda, used the Inchon-landing analogy to bolster the tax-reform effort. The new plaudits from supply-siders indicated that the two warring factions of the Republican party were converging in their opinion of Packwood’s bill. Dole praised it from the traditional moderate point of view, and Kemp from the supply-side right. To any Republican, the signal was clear: This was legislation that deserved support.
On Friday, May 2, a lengthy explanation of the passive-loss provision appeared in The Wall Street Journal. The 980-word story was so long that it was continued deep inside the paper. The article concluded: