by Alan Murray
The journey has been long and many said we’d never make it to the end, but as usual the pessimists left one thing out of their calculations—the American people. They haven’t made this the freest country and mightiest economic force on this planet by shrinking from challenges. They never gave up, and after almost three years of commitment and hard work, one headline in The Washington Post told the whole story: THE IMPOSSIBLE BECAME THE INEVITABLE and the dream of America’s fair share tax plan became a reality.
How did it happen? What created this legislative miracle that defied all the lessons of political science, logic, and history? How could Congress—an essentially conservative institution that most experts thought could only enact major changes at a slow, incremental pace—accomplish such a large, complex, and far-reaching tax overhaul? Why were lawmakers, more beholden than ever before to campaign contributors, willing to vote against such a multitude of special interests? What motivated the bill’s unlikely heroes to work together, buck the conventional wisdom, and achieve one of the most impressive legislative victories of recent times?
As the previous chapters have shown, the answer is not a simple one. In part, the deterioriation of the tax code had gone so far that something had to be done. The American people were disgusted with the system, and that disgust represented a latent political force waiting to be tapped. Tax revolts, such as the Proposition Thirteen campaign in the 1970s to slash California property taxes, attempted to draw from this reservoir of disenchantment. President Reagan’s tax cuts in 1981 also were intended to ease the problem, although the bevy of new tax breaks in that year’s bill worked instead to fuel public disillusionment. By the mid-1980s, the loophole-ridden tax system cried out for a fix.
To be sure, public support for the reform proposals debated within the administration and in Congress was never particularly strong. The president’s occasional efforts to rouse audiences to the cause almost always fell flat. Opinion polls showed that the public was outraged with the existing system, but had little trust in the government’s ability to fashion something better. There was a deep public cynicism, fed by the government’s long history of bungled or misguided attempts to fulfill the promise of reform. People doubted that their elected leaders could really achieve such a bold break with the past, and that doubt dampened their interest in the Washington debate.
Smart politicians knew that beneath the apparent public indifference, however, boiled a potential gusher of discontent that could prove to be a fearsome force. Few members of Congress cherished the thought of ending up on the wrong side of the popular president’s battle against the special interests. They may not have wanted reform, but they were not about to be seen standing in its way either. As a result, tax reform acquired an extraordinary momentum once it got rolling. “It breathes its own air,” said an amazed Illinois Senator Alan Dixon as the bill made its way through the Senate.
Reform was also achieved because it combined goals that were important to both political parties. Ending loopholes for the privileged had long been the desire of some Democrats. But the 1980s also saw the emergence of a new wing of the Republican party that was crucial to tax reform’s success—the supply-siders, whose influence grew dramatically after President Reagan’s election and who were passionately committed to lowering tax rates. These activist-conservatives had no deep interest in closing loopholes, but if that was the only way to pay for lower rates, they were willing to go along. By combining with the older Democratic reformers, they created an impressive bipartisan coalition.
To be sure, the opponents of reform in both parties initially outnumbered the proponents. Traditional Republican legislators were hesitant to back an effort that would offend so many of their business constituents; many Democrats, as well, had special interests to protect. Some liberal Democrats also disliked the sharp cut in the top individual tax rate, which seemed to help only high-income Americans.
Nevertheless, a pro-reform coalition emerged that was at once strange and impressive. It linked Ronald Reagan, the most conservative president in modern history, with George McGovern, the Democrat’s most liberal candidate in decades. It paired Kemp, the conservative darling of the supply-side movement and a driving force behind the 1981 tax bill, with Bradley, a liberal Democrat and a fervent opponent of the 1981 bill. It even united General Motors’s chairman, Roger Smith, with his company’s long-standing nemesis, consumer activist Ralph Nader.
The most important player in tax reform was Ronald Reagan himself. The president seldom took an active role in the two-year tax debate; when the Finance Committee held its critical vote to approve the bill, for example, he was seven thousand miles away at the summit of industrialized nations in Tokyo. Nevertheless, the conservative president’s support for an effort once considered the bastion of liberals carried tremendous symbolic significance. Without his backing, tax reform could never have happened. With it, it became a powerful political juggernaut. Reagan wanted to go down in history as the president who cut the top tax rate at least in half, from 70 percent to 35 percent or lower. If abandoning business tax breaks and raising corporate taxes was the price he had to pay to achieve that goal, so be it. Reagan had been reelected in 1984 in a forty-nine-state landslide and, at that point, was one of the most popular presidents of this century. When he put his full weight and power behind an idea that tapped such a fundamental frustration of the American people, others in Washington could hardly ignore it.
The other major players had their own odd assortment of reasons for backing reform. Don Regan became a reformer in part because he sensed the president’s passion for lower rates and was eager to win a prominent place for himself on the president’s agenda. James Baker became a reformer because he was a loyal soldier and because his success as Treasury Secretary depended on his ability to achieve the president’s top domestic policy goal. Dan Rostenkowski became a reformer because the president’s endorsement of reform represented a challenge and a threat to both him and his party: The Republican president was trying to steal the Democratic mantle of “tax fairness,” and Rostenkowski vowed not to let that happen. Bob Packwood became a reformer out of desperation: With Reagan and Rostenkowski moving together, he had no choice but to produce a bill or be branded a sellout to special interests; he was sucked into the great maw of reform.
One of the most intriguing questions raised by the two-year tax debate in Congress was why the many powerful interest groups lined up in opposition to reform never joined forces to defeat it. The total firepower of these special interests was potentially fatal to any piece of legislation, yet they never managed to form an effective “killer” coalition. Darman marveled at their fractiousness. “I couldn’t help thinking that if I were a lobbyist, I would stand in the hallway with a big sign saying: EVERYONE INTERESTED IN KILLING THIS BILL, PLEASE MEET IN THE NEXT CORRIDOR,” he Said at one point during the debate. “There would have been an enormous rush, and they would have seen the power of their collective action.”
The lobbyists never did that. In part, they, like the politicians they worked with, were afraid to be pinned as opponents of reform. Indeed, most of the groups opposing reform insisted in public that they were for it—they just wanted to make certain it did not hurt them. “They were brought down by the narrowness of their vision,” Darman said. “Precisely because they defined themselves as representatives of single special interests, they failed to notice their collective power.”
The lobbyists’ failure also reflected the difficulty interest groups face in combating “populist” legislation. Even though they had made enormous campaign contributions and had much-vaunted access to important legislators, the anti-reform lobbyists remained outsiders throughout the tax-reform debate. They could find few allies in the highest councils of power. At each step President Reagan threatened to label lobbyists’ friends in Congress as toadies to the special interests and enemies of rate cuts for the people, and that was a threat that could not be taken lightly.
Of course, special-interest politi
cs remained strong throughout the tax-reform debate. Some lobbyists, whose clients had only a handful of tax breaks to protect, promoted reform from the beginning, and helped to pass the legislation. Others battled vigorously to retain as many of their tax benefits as possible. Although they failed to halt the bill, anti-reform lobbyists won significant battles: A coalition of labor groups and insurance companies staved off the effort to tax fringe benefits; life insurers succeeded in preserving the tax-favored status of their most lucrative product, cash-value insurance; oil and gas interests kept their pain to a minimum; and hundreds of individual companies won special transition rules.
The special-interest victories, however, were far outweighed by the special-interest defeats. The bill closed loopholes worth roughly $300 billion over five years and replaced them with lower tax rates. It also raised corporate taxes by $120 billion over five years, the largest corporate tax increase in history. Congress was acting in response to larger, broader forces, which, in the end, prevailed.
Tax reform was a uniquely American idea—that somehow the nation could start over and rebuild its entire tax system. “No other country would try anything like this, to go back to the beginning, to be born again,” said Aaron Wildavsky, a political scientist at the University of California at Berkeley. “It was quite a radical proposal.”
Yet even before President Reagan signed the historic measure, pundits began raising serious questions about its economic and political value. In the long run, few experts doubted that lower tax rates would improve the efficiency of the economy and boost the chances for economic growth, but in the short term, many felt the abrupt repeal of investment incentives would cause some serious dislocations. The economy had become addicted to tax stimulants, and a cold-turkey repeal was certain to cause pain: Investment would probably suffer, real estate construction would decline, and charitable giving stood to take a hit. Such radical tax change, whatever its long-term value, would undoubtedly have some unpleasant side effects.
Likewise, the political value of the effort also came under doubt. To be sure, tax reform helped the careers of a few legislators like Rostenkowski, Bradley, and Packwood, but it clearly did not create the grand national “realignment” of party loyalties that some members of both parties had hoped for. Indeed, in the congressional election campaigns that were underway when the president signed the bill in 1986, it was difficult to find any candidate—other than Packwood—who spent much time talking about tax reform or who was either helped or hurt by it. One reason for this might have been Rostenkowski’s ability to make the 1986 tax bill as much a Democratic as a Republican document. Since the legislation was bipartisan, neither side could get credit—or blame.
Whatever its economic and political consequences, tax reform was, without doubt, a landmark piece of social legislation. It took more than four million impoverished working people off the income tax rolls. It also launched a no-holds-barred attack on tax shelters, a growing blight on the American economic landscape. In addition, it ended the ability of large and profitable corporations to escape paying taxes, which, whatever its economic merits or demerits, had become a galling spectacle to the American public. Most important, reform narrowed the enormous inequities that permeated the existing tax system. Although it made no fundamental changes in the distribution of the tax burden among income groups, it did make it more likely that individuals and corporations with similar incomes would pay similar taxes. In that way, it made the tax system more fair.
The legislation also offered the hope of beginning to mend people’s faith in government. Over the previous two decades, Americans had lost their confidence in their country’s capacity to accomplish great things. The triumph of tax reform was a sign that the tide might be turning. As President Reagan said: “America didn’t become great being pessimistic and cynical. America is built on a can-do spirit that sees every obstacle as a challenge, every problem as an opportunity.” Tax reform was that challenge and opportunity.
In terms of its substance, the tax bill was an awkward, hodgepodge attempt at reform, not at all like the pure proposals that so frequently came out of academia or Washington think tanks. It attacked tax breaks with an uneven hand—severely paring preferences for real estate developers, for instance, while preserving most of the generous loopholes enjoyed by the oil industry. It had elements of deceit—the advertised top rate of 28 percent belied hidden surtaxes that raised the top marginal tax rate to 33 percent, and in some cases even higher. It certainly was not simple; but then, it probably never could be. Former IRS Commissioner Sheldon Cohen explained it this way:
People think taxation is a terribly mundane subject. But what makes it fascinating is that taxation, in reality, is life. If you know the position a person takes on taxes, you can tell their whole philosophy. The tax code, once you get to know it, embodies all the essence of life: greed, politics, power, goodness, charity. Everything’s in there. That’s why it’s so hard to get a simplified tax code. Life just isn’t simple.
Despite its warts and wrinkles, the bill succeeded at the fundamental purpose of reform. To those who had grown accustomed to abusing the tax system and its many chinks and loopholes, it dealt a heavy blow, but to those who paid their taxes each year without taking advantage of the long lists of deductions, exclusions, and credits, the tax plan offered a hefty bonus. It was a heroic effort to address a profound and pervasive social and cultural problem that had been ignored for too long. For all its faults, the Tax Reform Act of 1986 was the rough-hewn triumph of the American democratic system.
Rostenkowski frequently joked during 1985 and 1986 that when the tax bill was completed, he planned to hang a sign on his door that read: GONE FISHIN’. But everyone in Washington knew that the battle was by no means over. Congress had passed a major tax bill roughly every year and a half since the income tax was enacted, and there was no reason to expect that to change. Older legislators remembered that Congress had made a less ambitious attempt at reforming the tax code in 1969, only to find much of its work reversed in the next few years. The investment tax credit, in particular, had been through several deaths and reincarnations. Even before the 1986 tax law was signed, defeated lobbyists were already preparing to launch a campaign to restore their favorite tax breaks as part of the “technical corrections” bill of 1987. Charls Walker noted philosophically that tax sentiment is “cyclical,” and he expressed little doubt that the push for investment tax breaks would soon be resumed.
Regardless of the tax changes to come, tax writers realized that it would be a long time before they were back in this sort of spotlight. “We’ll never be center stage like we were with tax reform,” Rostenkowski said.
The elections in November 1986 brought about some important political changes that raised more questions about the future of reform. The Democrats took majority control of the Senate, forcing Packwood out of his chairmanship of the Finance Committee. The new chairman for the 100th Congress, which convened in January 1987, was Democratic Senator Lloyd Bentsen of Texas, one of the most reluctant reformers on the Finance Committee. Bentsen promised to emphasize trade legislation over taxes, but the lobbyists still had hope. After steering the Senate to triumph on the landmark tax-reform bill and easily winning reelection, Packwood was relegated to head the minority portion of the committee.
Every Finance Committee member who sought reelection in 1986 won, but only one of the three Ways and Means members who wanted to move up to the Senate was elected: Wyche Fowler of Georgia. Henson Moore of Louisiana and James Jones of Oklahoma were defeated in their bids.
Rostenkowski remained in the chair at the Ways and Means Committee, but he served in the 100th Congress under a new speaker, Jim Wright of Texas, who was at times a Rostenkowski rival. Before the tax-reform debate, Rostenkowski had created friction with Wright by expressing interest in usurping Wright’s claim to the speakership. Later, Wright angered the Ways and Means chairman by publicly opposing tax reform. After being selected as their speaker by th
e House Democrats, Wright signaled an attack at the heart of the new law: He proposed freezing the top individual tax rate at the 38.5-percent level the legislation had set as an interim rate for 1987. Though the proposal was roundly criticized, more run-ins between the two leaders seemed inevitable.
Russell Long retired to become a Washington lawyer and elder statesman, but he did not leave Congress without first making his mark on the new tax law. He got the better of Rostenkowski by securing for a Louisiana-based utility company the same kind of favored treatment in the minimum tax that Rostenkowski won for an Illinois utility. The Ways and Means chairman tried to camouflage the recipient of his break by describing the size of the utility’s power generator rather than using its name. What Long knew—and what Rostenkowski found out—was that the Louisiana utility had the same size machine and was also eligible for the break. By waiting patiently in the wings until it was too late to turn back, Long secured a $140 million benefit for Middle South Utilities.
In a more far-reaching development, a Russell Long provision in the bill was belatedly discovered to, effectively, all but repeal the estate tax. The senator was trying to bolster tax benefits for employee stock-ownership plans, a cause he had long championed. Instead, he created a $20 billion loophole that would allow wealthy people to convert their bequests into stock, sell them to an employee stock-ownership plan, and in the process, escape estate taxation. Senator Bentsen, in his new role as Finance Committee chairman, promised to close the loophole as soon as he was able.
Only two weeks after the signing of the reform bill, President Reagan became embroiled in the biggest crisis of his two terms in office. Newspaper reports revealed that the administration had shipped arms to the revolutionaries in Iran, bitter enemies of the American people since their seizure of American hostages during the Carter administration. Moreover, some of the proceeds of the secret sale were reportedly diverted to help fund the contras’ fight against the Nicaraguan government. The public perception of the president plummeted in opinion polls, and new revelations threatened to prolong the crisis, leaving the White House sinking in a quagmire of scandal and doubt.