Opening the Tax Battle

As the economy sinks, Reagan and Carter jostle over 1980 's first issue

It is one of the oldest traditions in politics for the governing party to cut taxes in an election year, but this year, the Carter Administration vowed, that would not happen. Absolutely not, declared Jimmy Carter. Absolutely not, vowed Treasury Secretary G. William Miller. Absolutely not, echoed Federal Reserve Chairman Paul Volcker. The great problem was inflation, the Administration said throughout the spring, and that required a balanced budget, and no tax cut. "I will not consider any reduction in taxes," said Carter last March, "until I am convinced that the 1981 budget will be balanced."

By last week, with the recession now crunching up the economy and the election drawing ever nearer, the Administration made it clear that it was changing its mind. Alfred Kahn, the President's chief inflation counselor, was characteristically blunt. Said he: "Nobody doubts that a tax cut is inevitable." He even put a figure on it: $20 billion to $25 billion, perhaps more.

While the Administration moved toward yet another policy shift, however, the Republicans seized the issue that they have been promoting for months. Ronald Reagan, the all but certain Republican nominee for President, called a press conference in Los Angeles and announced that he and the Republican leaders in Congress would fight for a $36 billion tax cut to take effect on Jan. 1. As a result of President Carter's economic policies, said Reagan, "production lines are being idled, factory gates are closing across the land, and housing construction has gone into a tailspin."

The G.O.P. Senators decided that they would try to attach the tax-cutting measure to every major finance bill that came to a vote on Capitol Hill. The very next day, they did just that, proposing an amendment on a bill to raise the federal debt limit. The Democrats had the strength to beat back the tax cutters on a straight party-line vote, 58 to 38, but the prospect of more such votes was an embarrassment. Senate Majority Leader Robert Byrd denounced the Republican maneuvering as a "Tinkertoy economic solution" and "a con game with the American people." To head off more such votes, he called on the Senate Finance Committee to draw up its own tax-cutting measure by Labor Day. But since the Administration is due to produce a revision of the planned budget by July 15, some Democrats were urging that Carter come out with his own tax-cutting plans as early as next week.

So, while everyone suddenly seemed to agree with Kahn's prediction that a tax cut is "inevitable," no one could agree on what size it should be or what form it should take. Reagan's plan called for a straight 10% reduction on individual returns. For a family of four with a median annual income of about $20,000, this would mean a tax saving of $227 next year. Reagan also called for faster tax write-offs for business investments, allowing a company to deduct from its taxes the cost of new buildings over ten years, new equipment over five years, and new light trucks and cars over three years. The Democratic leadership is considering a rebate on next year's scheduled increase of $17 billion in Social Security taxes and speeding up tax write-offs for business.

A number of interested organizations are fighting to see how a tax cut can be apportioned. The U.S. Chamber of Commerce, which praised Reagan's proposal, has already appealed for a $27 billion reduction, including faster depreciation and a two-point drop in corporate taxes. Such measures, said the chamber's chief economist, Richard Rahn, "should greatly increase the supply of savings, and that is a very positive program." By contrast, Robert McIntyre of Ralph Nader's Tax Reform Research Group is wary of faster depreciation and wants payroll taxes cut. Says he: "We think it would be a relatively progressive tax cut. It would go to working people mostly, though it would go to business too."

Any new tax reduction will be welcomed by inflation-weary voters. the average American's taxes have gone from 19.4% of his income in 1975 to 21.9% today, and will reach 22.7% in 1981. Federal taxes next year are due to increase by about $45 billion because of higher Social Security payroll deductions, the new windfall profits tax on oil companies and the so-called bracket creep, whereby inflation pushes taxpayers into higher income and tax categories.

Economists disagree on the wisdom of a tax cut. Some consider it a questionable adventure, since the inflation rate, though down from last winter's 18%, is still racing along at 11%. Many experts actually believe that the worst part of the economic decline, which the tax cutters want to alleviate, may be over. Auto sales and housing construction are beginning to show the first signs of stabilizing. Any tax cut now carries the danger of simply reviving the inflation rate. It would do little immediately to help unemployment, which is now 7.8% and still rising.

Anthony Solomon, president of the New York Federal Reserve, and Frank Morris, his Boston counterpart, are opposed to any tax cuts now. And former Federal Reserve Chairman Arthur Burns urged last week that any tax reductions should be held to a "symbolic" level so that the federal budget could be kept from sinking further into its impending deficit.

Nonetheless, it will probably be early next year before business again picks up even moderately. Says New York Business Consultant Kathryn Eickhoff: "The economy has moved from a state of disaster to just terrible." Warns Otto Eckstein, president of Data Resources: "It would be the extreme of irresponsibility and the worst economic policy since the 1930s Depression to let taxes increase at the rate planned." And alongside the conservative tax cutters stood Liberal Walter W. Heller, President Kennedy's chief economic adviser, who called for a reduction of $30 billion. Said he of the fears of renewed inflation: "That $30 billion isn't going to begin to be inflationary."

But it was the conservatives who saw a strong campaign issue and made the most of it, reports TIME Congressional Correspondent Neil MacNeil. The idea originated with Charls Walker, tax lobbyist for a number of big corporations and now a Reagan adviser. Walker sent a memo to Reagan headquarters last month to urge action, and when Reagan went to Chicago two weeks ago for a meeting with top strategists, he made his pitch in person. "There's no question we need this," said Reagan. "Any negatives?" "No negatives," said Walker. "Let's do it," said Reagan.

Reagan has consistently favored a tax cut not as an antirecessionary measure but as a goal in itself. The intellectual underpinnings for Reagan's current ideas were supplied mostly by Arthur Laffer, an iconoclastic young (40) professor at the University of Southern California whom Reagan began consulting in 1976, when most of the powers in traditional Republican economic thought were allied with Gerald Ford. Laffer is the originator of the Laffer Curve, a diagram that he delights in sketching on napkins at any dinner he happens to attend. It purports to show that past a certain hard-to-determine point, high tax rates depress the economy so much that they actually reduce federal revenues.

Laffer sold his ideas to Jack Kemp, a former pro-football quarterback, now a New York Congressman, and a Reagan idea man, who introduced the Kemp-Roth Bill to cut taxes 30% over three years. It became official policy of the G.O.P. leadership in 1978.

Both Houses of Congress have rejected Kemp-Roth, and the measure still bears an aura of eccentricity. In recent months more traditional Republican economists, like former Treasury Secretary George Shultz, have begun winning a greater influence in the Reagan camp. And last week the congressional leaders persuaded Reagan to limit for now his for mal proposal of Kemp-Roth to the first year's 10% cut. "Don't go for the second and third year," argued New York's Barber Conable, ranking Republican on the House Ways and Means Committee. "The press will aggregate it, come up with a big figure, and make it look awful."

That tactic enabled middle-of-the-road Republicans to join in. Announced New York's Jacob Javits, who had opposed Kemp-Roth: "I can go along." Added Illinois' Chuck Percy, who had taken little part in the negotiations: "We have jointly worked out a tax program." Gloated Conable: "This all happened while Jimmy Carter was in Portugal. It shows how relevant he is."

Despite the embarrassment of being pushed into the position of voting against a tax cut, the Democrats are not without their own resources, of course. Since they control Congress, they can control what legislation comes before it. Said one rather cynical Democratic Congressman: "Carter would be smart to out-promise Reagan. Politically, the popular thing to do is to promise a tax cut and not deliver."

The fear of such antics is one of the forces that kept many Administration officials opposed to a tax cut as long as possible. Specifically, their concern was that once a tax-cutting measure came before an election-year Congress, it would be hard, if not impossible, to keep the reduction within reasonable limits. There are many constituencies, and each one feels the pain of recent economic injuries. One influential Democratic Congressman, Oklahoma's James Jones, foresaw the problem when he said last week: "I'm getting pressure from steel, autos, rubber. There are some very nervous folks out there."

Good politics does not necessarily make good economics. A large tax reduction would be a pleasing sweetmeat to offer a ravenous electorate just before voting day. But the U.S. can only return to economic health once it has beaten down its still dangerous inflation. Any impetuous lurch toward a massive reduction in taxes or other quick fixes to end the recession risk setting off another price explosion. That would be bad economics, and ultimately bad politics.

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