by Alan Murray
It was an important concession. Some liberal Democrats, following the lead of Senator Mitchell, were claiming that a 27-percent top rate was too low. It meant a family earning $40,000 a year would fall in the same tax bracket as a family earning $4 million. To liberals, that seemed unfair, but Rostenkowski was forced to accept the fact that the low rate was the magic of the Senate plan. Without it, the senators could not be coaxed into abandoning their special-interest tax breaks. He also knew that the rate was not crucial in determining which income groups got the biggest tax cuts—a central question from his point of view. He came to understand that by eliminating loopholes that benefit the wealthy, a tax system with a top rate of 27 percent could be just as progressive, and show the same distribution of the tax burden among income classes, as his own 38-percent plan.
Rostenkowski also saw political advantage in agreeing to the low top rate. His goal in the conference was to put his mark, and the Democrats’ mark, on tax reform. If he accepted the Senate’s rates as the starting point for debate, the senators would come under tremendous pressure to accept his bill’s corporate reforms. In the Boston speech, Rostenkowski insisted, in effect, that the Senate agree to provide at least as much tax relief to the “middle class” as the House bill did. That was a request that Packwood and the other senators were loathe to reject. But to accomplish it, the senators needed revenue to ensure that the final bill was revenue neutral. If tax rates were not going to be raised to find that money, the only other place to turn was the elimination of corporate tax preferences.
In short, Rostenkowski’s speech meant that business tax breaks were on the chopping block—a fact that caused heartburn among the lobbyists on K Street. The conference was going to be their final showdown, their last stand, and many of them were likely to end up losing big. Said Thomas Quinn, a lobbyist for the mutual-fund industry: “Prayer is our number-one strategy. I advise my fellows to go to the church of their choice.”
Rostenkowski’s concession set the direction of the conference. The House chairman had accepted the Senate’s radical low-rate structure for individual taxes; in return, the Senate would have to accept much of the House bill’s corporate loophole closing. The negotiations would be tough. In the process, the top tax rate might edge up a bit, but the final bill—if there was a final bill—would have to be more sweeping than either the House or Senate measures in terms of reform. To please both sides, it would have to combine the reforms made in both houses of Congress. The usual dynamic of the congressional tax-writing process had been turned on its head. No longer did the special interests have the upper hand. There was not enough revenue to permit many compromises that would help the lobbyists’ clients. Indeed, with a commitment on both sides of the Capitol to dramatically lower tax rates, the general interest would have to prevail, if the conferees were to succeed in getting a bill.
The conference convened publicly on Thursday, July 17, in the cavernous House Ways and Means hearing room. House members, resentful of the acclaim that had been given to Senate tax writers, used the opportunity to complain about the Senate bill’s “phantom” 32-percent rate, calling the 27-percent top rate a lie. When Brockway explained that the difference was “in large part a matter of semantics,” Representative Archer of Texas shouted back, “No, it’s not a matter of semantics.” And when Deputy Treasury Secretary Darman said that no taxpayer would have an overall effective tax rate greater than 27 percent under the Senate plan, Archer rose and walked out of the hearing room.
But those opening shots were mostly for public display. After the first two days of meetings, the conferees secluded themselves behind closed doors and did not meet again in public until the final night of the conference, three weeks later. Packwood and Rostenkowski both believed that they had to shield the conference from lobbyists, the press, and the public in order to make progress. “Common Cause simply has everything upside down when they advocate ‘sunshine’ laws,” Packwood explained.
When we’re in the sunshine, as soon as we vote, every trade association in the country gets out their mailgrams and their phone calls in twelve hours, and complains about the members’ votes. But when we’re in the back room, the senators can vote their conscience. They vote for what they think is good for the country. Then they can go out to the lobbyists and say: “God, I fought for you. I did everything I could. But Packwood just wouldn’t give in, you know. It’s so damn horrible.”
At first blush, the task of combining the two bills seemed manageable. Packwood’s plan raised corporate taxes $100 billion over five years; Rostenkowski’s plan raised corporate taxes $140 billion. The Senate conferees thought they would at worst be forced to raise corporate taxes another $20 billion, and then use that money to help middle-class taxpayers. A $20 billion extra hit on business was tolerable, they thought.
Then came the first crisis. On Thursday, July 24, new revenue estimates were unveiled by Brockway and the Joint Tax Committee showing that the Senate bill was not revenue neutral at all. Instead it actually lost $21 billion over five years. The senators had to find ways to make up that money first, before they could even begin serious negotiations with Rostenkowski. In addition, the new estimates showed that the Senate bill raised only $93 billion in new corporate taxes over five years, while the House bill, reestimated using the Senate’s effective dates, raised $178 billion in corporate taxes. Suddenly the gulf between the two chambers had widened to $85 billion!
Revenue estimates were a harsh master throughout the tax-writing process, but in the conference they became exceedingly cruel. Every time a new set of numbers came out of the Joint Tax Committee’s computers, they had more bad news for Packwood and his crew. The $21 billion shortfall was a huge new obstacle for the conferees and a serious threat to the bill’s success.
The setback was no surprise to the Treasury Department. Months earlier, the Treasury had calculated that the Senate bill lost revenue, but it kept those findings secret. Indeed, the Treasury estimates showed an even bigger deficit than the Joint Tax Committee numbers. The department’s calculations found that the bill would add $30 billion to the federal budget deficit over five years. Baker and Darman hid that fact from everyone except Packwood. Their failure to disclose those startling numbers was a serious breach of traditional practice and, arguably, a disservice to the public and the Congress, but Baker and Darman were not willing to do anything that would endanger the chances for reform.
During debates on previous tax bills, the Treasury routinely made its revenue estimates available to the public. Buck Chapoton said that when he was assistant secretary for tax policy during Reagan’s first term, he felt it was his duty to release revenue estimates as soon as they were complete. Under Baker and Darman, the Treasury had become a very different place. The two men were clever political operators, and they manipulated everything to suit their ends. They feared that if they revealed the bill’s huge revenue loss, the Senate might be less inclined to pass it. So they kept the estimates private and never released them to the public or shared them with senators other than Packwood.
The new Joint Tax Committee numbers, however, publicly confirmed the shortfall and could not be ignored. They increased the pressure on the Senate conferees to clamp down on business tax breaks. Corporate lobbyists became more desperate than ever; they were stuck in a vise, and the new revenue estimates were tightening the grip.
When Packwood learned of the new $21 billion shortfall, he immediately called the Treasury for help. The Treasury and the Finance Committee had worked together closely in fashioning the Senate plan, and Packwood came to rely on Treasury as an auxiliary to his own, relatively inexperienced staff. He and Diefenderfer talked with Darman daily, and they welcomed the Treasury official’s many suggestions and judgments.
The Treasury was supposed to make its expertise equally available to both chambers of Congress, but Rostenkowski had no desire to collaborate with the department. His own staff was more skilled than the Finance Committee’s was, and he could
also rely on Brockway and the Joint Committee for technical expertise. During the Ways and Means markup, he had spurned Darman’s advice and had privately called him names like “stone-faced” and other less complimentary terms. Packwood, on the other hand, saw Darman as a clever strategist, and was glad to make him a coconspirator. As a result, the Treasury became a partisan in the tax-reform battle. It was Packwood, Baker, and Darman working together against Rostenkowski.
Since the days of Stanley Surrey, two and a half decades earlier, the Treasury tax office had been a sort of independent defender of the integrity of the tax code. The assistant secretary for tax policy had always seen it as his duty to stand somewhat above politics, promoting “good” tax policy and opposing “bad” tax policy. At times, the tax office was forced to go against its instincts—such as in 1981, when it was compelled to back Ronald Reagan’s campaign promise for a new rapid depreciation write-off scheme; but generally, the office tried to protect the tax code from undue political tinkering.
During the tax-reform debate, however, the role of the Treasury tax office changed dramatically. Baker and Darman were determined to get a tax bill through Congress, and they were not about to let abstract tax-policy concerns get in their way.
Assistant Secretary Pearlman had struggled to maintain the independence of his office, but he left the department at the end of 1985 feeling discouraged and defeated. His successor was a New York lawyer named Roger Mentz, who had a thorough knowledge of the tax system, but who was less insistent on protecting his department’s independence.
Mentz was a tall man with a large jaw, and his appearance prompted House staffers to nickname him “Lurch,” after the giant-sized butler in the television show The Addams Family. He was a proud man, who insisted on calling Packwood and Rostenkowski “Bob” and “Danny” rather than the more respectful appellation of “Mr. Chairman,” which even the proud Darman always used. Mentz became indignant whenever anyone suggested that the influence of his office had declined, but the truth was that Mentz knew where his bread was buttered and acted accordingly. Unlike his predecessor, Pearlman, he owed his job to Baker and Darman, and he was a good team player. After he took over the tax office, Darman seized control of tax policy, and the independent influence of the office waned. In the early days of the Reagan administration, Buck Chapoton was always the top official at tax markups. During 1986, however, it was Deputy Secretary Darman who took the lead in tax negotiations. Mentz spoke for the Treasury on technical matters, but it was Darman who cut important deals in private and who was the administration’s main spokesman at the most critical public meetings. During the Finance Committee’s markup, Mentz sat at a table reserved for Treasury officials while Darman roamed behind the horseshoe podium whispering to senators and their staffs. During the Senate debate, Mentz watched quietly from the visitors’ gallery, while Darman negotiated with senators in a room off the Senate floor.
The Treasury tax office remained the city’s largest reservoir of talented tax lawyers and economists, and that expertise was frequently called upon to resolve tough technical issues. Skilled tax attorneys like Dennis Ross, Richard D’Avino, Victor Thuronyi, and Linda Carlisle, as well as experienced economists like John Wilkins, contributed immeasurably to the tax-reform effort. The tax office also exerted influence through its close contacts with the professionals on the Joint Tax Committee. But when it came to major problems that could threaten the fate of tax reform, Baker and Darman muzzled the staff. The Senate bill included provisions that the Treasury tax experts privately thought were outrageous: the “phantom” rate, for instance, and the minimum tax on a company’s “book” profits. These were proposals that, to tax experts, seemed sheer insanity, but both proposals served political purposes. The phantom rate enabled the senators to claim their top rate was 27 percent even though it was not, and the book-profits provision ensured an end to stories about companies reporting profits to their shareholders but paying no taxes. Baker and Darman refused to allow the Treasury staff to publicly criticize either of the unusual provisions. They did not want their department to do anything that might trip up the progress of the bill. Mentz took the interference philosophically: “That’s just the way it goes. You cannot be an idealist and have tax reform enacted.”
Packwood met with Treasury officials on Friday, July 25, to discuss ways to close the new $21 billion gap. He asked the Treasury to draw up a list of potential revenue-raisers. Mentz and his staff worked until the early hours of Saturday morning, compiling a hodgepodge of ideas to pick up the revenue, worth a total of $39 billion. The senators then spent most of Saturday reviewing the Treasury’s ideas, throwing some out, accepting others. By 3:00 P.M. they had decided on enough to raise $26 billion. That would pay for the revenue shortfall and leave a little money to pay for more benefits to the middle class.
The list was to become the first volley in a long series of offers exchanged between the two sides. The back and forth represented a kind of sparring session that was prelude to the knock-down, drag-out battles that were soon to ensue.
The Treasury proposals were a strange collection, held together only by the faint possibility that they might be politically acceptable. Some of them were Darmanesque tricks: For instance, the senators accepted a cynical proposal that would allow the tax credit for research and development to expire at the end of 1988, one year short of the extension that was included in the Senate bill. Baker, Darman, and the Senate conferees all knew that the popular credit would be extended again before it expired and that the supposed revenue gain was therefore only a charade, but they were perfectly willing to use such tricks if they helped get tax reform enacted.
The Senate’s proposals were sent to the House the following Monday, July 28, where they were received coldly. Rostenkowski was incensed at what he considered Treasury’s meddling and troublemaking. He was so angry, in fact, that during the conference meeting that day, he asked Packwood to tell Baker and Darman to leave—which they did. Then, Rostenkowski and his House colleagues attacked the senators’ Treasury-generated proposals. Russo derided a proposed change in the existing sales-tax deduction tables, which made the savings from repealing the deduction look bigger than before. He called it an insult to his intelligence. Others complained that roughly half of the sixteen proposals went “outside the scope” of the conference. Conferees are only supposed to deal with issues on which the two bills are in disagreement, but the Treasury’s money-raising list contained many proposals that were not in either bill. Such forays outside the scope of the conference were not without precedent, but the House members thought it was far too early in the negotiations to resort to such gimmicks, especially when the House bill itself was chock-full of corporate revenue-raising provisions.
The House conferees did accept a few of the senators’ revenue-raisers. The proposal to end the research-and-development credit a year early, for example, was adopted. But the senators were sent away from the meeting with instructions to try again. “Our basic position is the Senate came up short,” said Representative Donald Pease. “The Senate has to come up with ways to raise the revenue that we find acceptable.”
Packwood regrouped and convinced his senators to devise a second plan, this time raising $32.5 billion over five years. This was a more serious effort, drawing on a number of proposals in the House bill. The senators agreed to some cutbacks in depreciation write-offs—although still not nearly as much as in the tough House bill. They also accepted the House provision limiting the bad-debt-reserve deduction for big banks. In a show of good faith, Packwood also agreed to curtail a tax break dear to the timber interests in his state—the preferential treatment of corporate capital gains. These were important concessions, and the outlook for reaching agreement before the Congress left for its August recess began to improve.
Rostenkowski responded to the proposal with a counterproposal that accepted many of the Senate’s tax changes for individuals. The House conferees agreed, for instance, to eliminate the prefe
rential treatment of capital gains. That was a blow to a coalition of lobbyists working to preserve that break for investors. Likewise, the House negotiators agreed to the Senate’s tough anti-tax-shelter “passive-loss” provision, despite the fact it would severely hurt many of the Democrats’ allies in the real estate business. At the insistence of Russo and Rangel, however, the House conferees refused to accept the Senate proposal to eliminate most of the sales-tax deduction. The New York lobby and Governor Mario Cuomo were still fighting hard to save all state and local deductions. Rostenkowski agreed to try and retain the sales-tax deduction for the time being, although, in private, he made it clear to Packwood that the elimination of the popular preference was still a possibility.
While the House conferees accepted many of the senators’ proposals on the individual side of the tax code, they continued to hang tough on their corporate provisions. They still insisted on curtailing tax breaks for oil and gas, timber, and military contractors—measures dear to the senators. They also wanted to cut back depreciation allowances by $28 billion, down some from the $38.8 billion cutback in the original House proposal, but still far tougher than the Senate’s more modest plan.
When the senators saw the House offer, they were indignant. “It is questionable whether we will have a bill,” said Danforth, who insisted the $142 billion increase in corporate taxes included in the new House plan would cause “great damage to our country.” Wallop agreed: “I don’t consider it a proposal. If ever there was a dead body leaving the morgue, this is it.”