Showdown at Gucci Gulch

by Alan Murray

  The effect [of the passive-loss rule] would be to nearly wipe out tax shelters that are a major force in financing commercial real estate construction, oil and gas drilling and certain agricultural activities, such as cattle feeding.

  By coincidence, the story ended just above an advertisement that caught the attention of the Finance Committee. It read:

  FEEDING CATTLE COULD REDUCE YOUR TAX BITE

  Alta Verde Industries, a longtime South Texas custom feed lot is now placing cattle on feed for sale in early 1987. The ratio of 1986 expense to equity required is approximately three to one. If this interests you as an individual or closely-held corporation, check with your accountant, tax attorney or professional financial advisor and write or call for more information with no obligations.

  The juxtaposition of the article and the advertisement so tickled the committee members that photocopies of the two were passed out during their exec-room session that day. The joking reflected a new esprit de corps that was developing among the members as the legislation began to pick up steam. Cloistered in the exec room, isolated from the hordes of lobbyists in the hallway, members of Packwood’s core group began to develop a real interest in reform. Out in the hallway, many lobbyists were still betting the effort was dead, but inside, it was alive and well and gathering strength by the hour.

  In a ploy to keep the effort from stalling, Packwood announced to the hallway loiterers—reporters as well as lobbyists—that there would be no sessions over the weekend. The hallway erupted with applause and cheers. In fact, first thing Saturday morning, the Finance Committee chairman secretly convened his core group for the most serious bargaining session of the entire process. It was a beautiful morning—the kind, Packwood would say later, that members would rather have spent pruning rose bushes or playing golf. Instead, Packwood, Brockway, Darman, Diefenderfer and the core group sat down in the Dirksen Senate Office Building, its hallways now deserted, and began to fill in the details of the most sweeping tax-reform bill in American history.

  Danforth, Chafee, Mitchell, and Moynihan all arrived before 10:00 A.M.; Bradley came later in the day. The New Jersey Democrat was giving a speech in Kentucky that morning and turned down an invitation to the Kentucky Derby in order to return to the tax-writing session. Dole and Wallop did not attend, but were represented by staff.

  Packwood began the day by proclaiming that the group had to find $35 billion worth of revenue-raisers over five years. That would be no easy task. Treasury officials offered up a “hit list,” but nearly every item on the list struck interests dear to at least one member of the Finance Committee. Reform was not going to be painless, but the eight senators represented there were increasingly determined to produce a bill.

  The first tax breaks to go were those favored only by committee members not in the core group. Those who had not embraced Packwood’s plans were made to suffer for their reluctance. A provision providing special treatment for inventories was eliminated by the core group, despite its support by Charles Grassley of Iowa. A scheme providing tax-free bonds to finance municipal bus service, favored by John Heinz of Pennsylvania, was also excised. Oil refineries were taken out of the lucrative five-year depreciation category—a blow to David Boren of Oklahoma.

  Even senators in the core group gave up some cherished tax breaks to make the plan work. Packwood himself sacrificed the preferential treatment of individual capital gains, an important break for the timber industry. Moynihan acquiesced to the repeal of the sales-tax deduction. Each of the core-group members anted up something to the cause of lower rates. As they made these tough decisions, they also developed an inside joke that helped justify their positions: When they chose to remove a tax break dear to any specific industry, the senator who should have been fighting tooth and nail to prevent the change would ask for “a note from the chairman.” That meant that the lawmaker could tell the lobbyists in the hall that he had put up a valiant fight for the break, but that the chairman had taken it away anyway. The lobbyists could then blame the chairman.

  Although they had to give up some of their favorite tax preferences, core-group members suffered far less than others. They were rewarded for their loyalty to the chairman. They each got to keep a few items that were dear to them. “If we were going to be the people supporting this bill, we were going to look after our particular interests,” Moynihan said at the time.

  Packwood agreed to repeal a withholding tax on foreign investors to please Wallop. (The Wyoming senator thought the tax depressed land values by discouraging foreign buyers.) “I gave it to him because he was a good soldier,” Packwood explained. Danforth was allowed to keep the completed-contract method of accounting that was a fiscal boon to the military contractors who were big employers in his home state of Missouri. Even Bradley got a special deal: Limits were removed from the amount of tax-free bonds that could be used to finance the construction of government-owned solid-waste disposal facilities. As in the Ways and Means Committee, support for tax reform in the Finance Committee was, in part, bought with concessions.

  Danforth was one of the wealthiest men in the Senate, and he opposed a new proposal that would increase taxes on income earned on money that grandparents gave to their grandchildren. He was supported in this position by Treasury, particularly by Baker. The Treasury secretary was himself a multimillionaire and did not like the idea of the government taxing away gifts to grandchildren. During meetings at the Treasury, he would erupt in displeasure whenever the “kiddie tax” topic arose. He even called from Tokyo to check on the status of the provision. A Treasury official was once asked why Baker was so adamant on that issue; he responded, “Because he’s rich.” In any case, Danforth and Baker prevailed, and the change was not adopted.

  The group also spent considerable time debating possible ways to soften the controversial passive-loss rule. Rich Belas, Dole’s aide, who had sacrificed a trip to Bermuda to attend the extraordinary weekend session, voiced Dole’s preference for a long phase-in of the tax-shelter-killing provision. He floated the idea of imposing a new surtax on high-income individuals to pay for the more gradual passive-loss disallowance. Mitchell, who as chairman of the Democratic Senatorial Campaign Committee was the chief fundraiser for Democrats in the Senate, knew the passive-loss provision would anger big-money Democratic contributors in the real estate business; he also backed a slow phase-in. In the end, the senators agreed to ease the pain of the passive-loss rule somewhat by phasing it in over four years.

  By the end of the day, the plan was taking shape: The top rate for individuals would be lowered to 27 percent. The special tax break for capital gains would be eliminated, there would be no excise-tax increases, and taxes on corporations would be increased by $100 billion over five years, with the top corporate rate set at 33 percent.

  Before the meeting ended, the members of the group made a pact: They would keep each other informed about their intentions about the bill, and they would work together whenever possible to keep it intact. Moynihan announced that he would offer an amendment to save the sales-tax deduction. Mitchell said he would try to impose a third top rate for wealthy individuals, but would wait to offer the amendment on the Senate floor rather than foul up the committee’s deliberations.

  When the meeting ended late that afternoon, Packwood, Diefenderfer, and Darman retreated into Diefenderfer’s office to watch the running of the Kentucky Derby. Bill Shoemaker won a 17-1 long shot astride a horse named Ferdinand. Darman made a note to himself that the victory was a good omen for the long-shot tax-reform plan.

  The next afternoon, William Wilkins, the Democratic staff director of the Finance Committee, and Karen Stall, Senator Long’s tax aide, went to visit Long at his apartment in the Watergate building. The apartment had once been owned by John Mitchell, the attorney general during the Nixon years, and was the place where Mitchell’s wife, Martha, claimed she was held captive during the Watergate scandal. Its living room had a magnificent view of the Potomac River. The two aides sat do
wn with Long in the living room to review the core group’s decisions of a day earlier.

  Hunched over the coffee table, Wilkins and Stall told Long that they felt it would be politically difficult for him to oppose the bill fashioned by the core group. As a primary architect of the tax code that would be replaced by the radical plan, Long had to be especially careful of being perceived as an opponent. If he fought the plan and won, or worse, if he fought it and lost, he might be cast as the villain, a sellout to special interests.

  Sitting in his cream-colored lounge chair, Long made it clear he did not need a lecture about politics. He understood that a “pure” Bradley-Gephardt-like bill might be the only way out of the corner into which the committee had painted itself. He saw that the politics had shifted in favor of reform. Early in the Senate tax debate, he had begun to prepare for this moment by headlining a newsletter for constituents: LONG SUPPORTS REFORM. He was also a faithful friend and backer of Bob Packwood, the young man he helped train in the ways of tax legislation, and who, in turn, was always careful to keep Long and his interests in mind.

  During the one-and-a-half-hour briefing, Long was most interested in hearing the major details of the plan. He liked the low rates. He liked removing poor people from the tax rolls, for he was always a sort of populist, a lasting legacy from his father. In general, he liked much of what he heard, and more important, he knew it would sell.

  As Wilkins and Stall were leaving, Long asked, “Do you know Lloyd Bentsen’s number at the farm?” He wanted to spread the news.

  At five-fifteen, Monday morning, Senator Pry or, the Finance Committee’s junior Democrat, was awakened by the insistent ringing of a telephone. “Evidently, someone has the wrong number,” he thought, still misty with slumber. “I’m not going to answer that phone.”

  After what seemed like the fortieth ring, Pryor stumbled downstairs to his den and picked it up. “Hello,” he said.

  “Hey man, you weren’t asleep were you?” said the rapid-fire voice on the other end that was immediately recognizable as Russell Long’s.

  “No,” Pryor said, recovering quickly, “I was standing here waiting for you to call.”

  “Well,” Long continued at a breakneck pace, “I wanted to tell you, David, Senator Packwood has a bill that is a good bill, it is a fair bill, and we ought to work with him to get it passed.”

  Other Democrats also got early-morning phone calls. The message for all of them was the same, and the import was clear: Packwood was going to get a bill. The tax-reform train was starting to move, and it was time to jump on board.

  Later that day, the Finance Committee returned to public session on tax reform for the first time in two weeks. It was a brief meeting, but the rhetoric reflected the sea change in outlook. “We have an opportunity that is given to few,” Packwood began. “If we march up that hill and fail, it will not pass our way again for another decade.” His words were echoed by some of the same members who voted against him in the first phase of the markup. Danforth said that allowing rich people to pay no taxes was “just plain wrong.” Chafee added that “it’s insanity the way the current system is working out.” Even the balky Heinz gritted his teeth and said, “I am very close to supporting this legislation.”

  Tuesday, May 6, was to be the final day of the public markup, but a tax bill would not be a tax bill without a last-minute crisis. In this case, the crisis was created by some of the most senior and powerful members of the tax-writing panel. Early that morning, the troublesome politics of oil began, once again, to rear its ugly head.

  A secret meeting was called in the spacious Capitol hideaway of Senator Long, not far from the offices of Majority Leader Dole. The walls of the private hideaway were decorated with Audubon prints, and an imposing armoire made of Honduran mahogany stood to the right of the door. Long sat on a beige daybed in the corner, next to the telephone. Over the years, he had spent so many hours in that spot that the fabric on the sofa arm was worn from chafing. Surrounding Long, in horseshoe fashion, were most of the Finance Committee members who had a stake in the nation’s oil patch, including Senators Dole, Bentsen, Boren, and Pryor.

  In quiet tones, the group discussed their strategy. They were worried that independent oil and gas drillers might be put out of business by the stringent passive-loss provisions. Much of the money raised by independent oil drillers to finance their operations came from “passive” investors. The oilies wanted an exception for these investors, who invested in drilling by acquiring a so-called working interest in a well.

  The meeting was not flashy. There were no rhetorical flourishes. The lawmakers simply had to decide what exception to seek for oil producers and how best to win an eleven-vote majority. The old pros—Long, Dole, and Bentsen—dominated the meeting. They decided to go for a broadly defined provision that would exclude all working-interest investments from the passive-loss rule and would cost the Treasury $1.4 billion over five years. They knew that tampering with passive losses, the linchpin of the package, was risky, but they also understood how important the exception was to the people they represented. Oil politics went beyond the numbers; to these legislators from oil-producing states, it was almost a religious matter. Passions ran high when oil was discussed, and reason was cast to the wind. The assembled senators were ready to fight to kill the bill if they did not get their way.

  Meanwhile, Packwood was on the phone trying to round up support for a rule he hoped would impose discipline during the final hours of the committee’s proceedings. The rule, which neither he nor Rostenkowski had been able to enforce previously, would require that each amendment offered would have to pay for itself. If a senator wanted to restore a certain tax break, he would have to take away another break to pay for it. Packwood believed that he could hold eleven votes, a majority of the panel, if he could enforce that amendment-by-amendment revenue-neutrality rule. “That’s what I really worked on,” he says. “We had almost generic agreement among the core group on almost everything, but it could come undone if we didn’t require revenue neutrality.”

  To entice support for his effort, Packwood even made a few more concessions. To Roth, for instance, he promised to allow generous write-offs for chicken coops, which exist in abundance in Roth’s home state of Delaware. The spadework paid off. When the committee finally convened Tuesday morning, Packwood called for a vote on his proposal to require revenue neutrality for the remainder of the markup. It passed without a single objection. A smile swept across Packwood’s lips.

  The fight was not over, however. In quick succession, Packwood had to beat back two efforts to retain the sales-tax deduction. Two weeks earlier, such amendments would have won easily, but now, the momentum of tax reform had begun to take hold. Both amendments lost by votes of 13-7. Packwood also defeated efforts by Heinz to weaken the corporate minimum tax.

  The toughest vote came on an amendment to eliminate restrictions on deducting business-meal and entertainment expenses. It was the same issue that had come close to sinking Rostenkowski’s plan in the Ways and Means Committee. Only two weeks earlier, William Armstrong of Colorado had been secure in the knowledge that he had the votes to pass his amendment. Whether he still had those votes was unclear. Packwood was not sure he could defeat Armstrong: if he did not, his bill could be in trouble.

  Initially, there were ominous signs. Long supported the amendment, which was paid for by an increase in the corporate rate to 34 percent. He did so in his inimitable, homespun style. “Entertainment,” he said, “is to the selling business as fertilizer is to the farming business.” The stately Bentsen also was a backer. He justified his vote by saying, “I rarely pick up the check, [so] I can be totally objective.” Packwood began to rest easier, however, when Dole spoke up. The majority leader said he believed in the entire package, thought it should be kept intact and would vote with the chairman against the Armstrong amendment. When the roll was called, the Armstrong amendment lost on a tie vote, 9-9. Dole was the deciding vote.

  Th
e members retired into the exec room, out of public view, where they still had a good bit of last-minute tinkering to do. They needed to find some more revenue, and there was still the slippery oil problem to solve. The revenue was found through some painful last-minute changes—they decided, for instance, to repeal the investment tax credit retroactive to the first of the year. They also engaged in some more sleight of hand—somehow the estimators found about $5 billion extra in the passive-loss rule. They found another $1 billion in a provision that no one on the panel had ever heard of. Roger Mentz, the assistant Treasury secretary, suggested extending the application of section 338—a section of the code dealing with premium prices paid for business assets—to raise the money. The senators, having no idea what section 338 was, agreed with a shrug.

  The hassle over working interest was not so sedate. Bradley, Mitchell, and Chafee were violently opposed to the special carve-out for oil companies. They asserted that the hole in the passive-loss rule would serve as a magnet for tax-sheltered investments in the oil and gas industry and would provide an unfair benefit to the oil states. Oil-state senators protested that a working interest was very different than the usual limited-partnership tax shelter. Under a working-interest plan, they argued, investors carried full liability for the project and had to ante up more money if the drilling called for it. The investment was not “passive,” they said.

  Packwood took a risk on the issue. He knew the dispute was a major challenge to the success of his venture, yet he firmly opposed making any exceptions to the tax-shelter-killing provision. To make his point, he stood at the head of the exec-room table throughout the long debate. Darman sided with the oil-state senators, reflecting the preference of Secretary Baker, who was still thousands of miles away in Tokyo. Gradually, it became clear that the oilies had forged some important alliances. The oil interests beat back efforts to compromise their exception in the private meeting. So inflamed were the passions over the issue that Bradley insisted the committee vote again when the senators went back into public session at nearly eleven o’clock that evening.