Scoring on a Reverse

By WALTER ISAACSON

With blocking from the democrats, Reagan wins another showdown

"When it came to the test, a bipartisan majority bit the bullet," said an exultant Ronald Reagan a few minutes after the votes were counted. Continuing his remarkable streak of legislative victories, the President had deftly corralled enough Congressmen of both parties into approving a contradictory but much needed correction to his economic policies. In retrospect, the 226-to-207 victory was hardly surprising: the President has made such miracles seem commonplace. What was out of the ordinary was the nature of the triumph. Reagan, who had come to Washington preaching a gos pel of tax cuts, had wrested from an election-edgy Congress a huge tax increase that is expected to raise $98.3 billion over the next three years.

In supporting a tax increase, Reagan caused a deep rift within his Republican ranks and fractured for the moment the conservative coalition that had formed the foundation of his previous successes. Only by appealing to the patriotism and good sense of his liberal critics was he able to carry the day. In so doing, Reagan somewhat lifted from the Democrats the political albatross of being the party of high taxes. His victory, however, showed that Reagan has developed a political skill that is far more important than whatever difficulties he created: the flexibility to modify his ideology and put together new coalitions. "All of us here to day are united by something bigger than political labels," he said last week as House Speaker Tip O'Neill, the florid av atar of old-style liberalism, stood by his side in the Americans." Rose Garden. "We are all Americans."

What caused Reagan to reverse field, with the economy essentially stagnant and nearly 10 million Americans unemployed, was a crippling fear that deficits over the next three years could reach $500 billion if no adjustments were made in his program. In order to keep at bay this looming behemoth and bring interest rates down, Reagan accepted the need to raise new revenues. This pitted him against some of his usually most ardent supporters, like Congressman Jack Kemp of New York, who argue the supply-side theory that only by reducing taxes can the economy expand. The dispute, said Kemp, was "a historic clash of ideas."

Not exactly. But what was historic was the unprecedented Wall Street activity that provided the backdrop to the denouement of the tax battle. For some time interest costs have been easing downward, the prerequisite in most economists' -- and ordinary citizens' -- minds for an economic pirkup. But Wall Street, so often excoriated by Reagan and the Administration for its lack of faith, had paid scant attention until Tuesday, when a leading credit analyst, Henry Kaufman of Salomon Bros., who has been a noted gloomsayer of late, predicted that the trend would probably continue. After being pent up for months, the stock market reacted with a frenzy. The Dow Jones average of 30 industrial stocks jumped 38.8 points that day, the largest single-day gain in history, and the following day 132.7 million shares were traded, setting another record. On Friday, after passage of the tax bill, the Dow shot up almost 31 points. The week's hectic activity, for which the Administration claimed some of the credit, partly reflected a renewed faith in Government policy. Said Wall Street Analyst Hildegard Zagorski: "Passage of the President's plan set the upside juices flowing." Indeed, with a settlement at hand in the Lebanon crisis (see WORLD), Reagan could look back on what Spokesman Larry Speakes called "probably the most rewarding week we've had."

The Great Communicator, stressing bipartisanship and fairness, took his case for the tax bill to the American people last Monday night. "Believe me," he began ingratiatingly, "if some of you are confused, I can understand why." Then he got down to brass tacks: "The single most important question facing us tonight is do we reduce deficits and interest rates by raising revenue from those who are not now paying their fair share?" Reagan admitted that the tax bill was a compromise that he had to "swallow hard" to accept. But he vigorously denied that the measure, which would collect $18.8 billion for fiscal 1983 and $98.3 billion over three years, was the largest tax increase in American history, as critics charged. (Indeed, that distinction could belong to the 1977 Social Security tax increase, the provisions of which are now expected to raise $112 billion during 1983-85.) "Possibly it could be called the greatest tax reform in history," he said.

Almost half of the new revenue in the measure, Reagan noted, will come from "closing off special-interest loopholes." This includes restricting the provision in the 1981 tax bill that permits companies to sell unused tax credits and deductions to other companies through what is known as "safe harbor leasing," and revising depreciation schedules so that companies can no longer write off investments in a way that allows them to recover more than they spent.

Another 32% of the revenue will come from enforcing stricter compliance with current tax laws. The most controversial provisions would require restaurants to keep account of waiters' tips (this was substituted in order to save full deductions for business meals, the so-called three-martini lunch) and institutions to withhold 10% of most interest and dividend income for the IRS. Some of this income now goes unreported. "Simple fairness says that we should collect from those who are freeloading," Reagan argued.

New taxes, the President stressed, would account for only 19% of the added revenues. Excises would be hiked on cigarettes, telephone service and airline tickets. Said Reagan: "Well, for people who smoke a pack a day that tax will mean an increase of only $2.40 a month. The telephone tax increase is only 540 a month for the average household." He argued that the new taxes were necessary to win bipartisan support for $30 billion of cuts in Medicare and other domestic programs that Congress also passed last week.

Reagan's televised appeal did not unleash the usual torrent of support. Afterward, Democrat Buddy Roemer of Louisiana got 100 letters against the bill and only two in favor. The two were signed by the President and Vice President. But the TV speech and the letters from the President were important to the Democrats. They provided protection from being blamed for the tax hike during the upcoming campaign.

"This is one occasion when the President's position is right," said Congressman Thomas Foley of Washington in the Democratic Party's televised response to the speech. "He said that we need this revenue measure, and we do." While reluctant to support Reagan, most Democrats agreed, either privately or publicly, that the increases were necessary to keep deficits from ballooning totally out of control. And the Republican bill incorporated many of the tax reforms and business-loophole closings that the Democrats have long advocated.

From then on, the effort to pass the bill was genuinely bipartisan, with leaders of both parties embracing in a wary waltz. Speaker O'Neill trooped to the Rose Garden with six other House leaders to give a public benediction. When Reagan warmly shook the hand of the gruff Boston pol, O'Neill broke into a warm smile. "It's a hell of a lot more fun this way," said the Speaker, remembering past political battles. They retired into the Oval Office to share Irish jokes.

In the corridors of Congress, Dan Rostenkowski, the tough-talking Democrat from Chicago who chairs the Ways and Means Committee, was seen plotting strategy with Trent Lott, the button-down archconservative Republican whip from

Mississippi. "The coordinated effort was the strangest political phenomenon that this House has seen in a long time," said Republican Barber Conable of New York.

The agreement between the party leaders, however, by no means guaranteed that the bill would make it. The Democrats were determined not to help pass Reagan's bill unless a clear majority of Republicans voted for it. For their part, the White House operatives feared until the end that the Democratic leadership might back out of the bargain. A top Reagan aide admitted that if he had been calling the shots for the Democrats, he would have doublecrossed the President. Said he: "From a purely political point of view, the Democrats should have killed this bill. It could have crippled this President."

Reagan threw all of his energy and prestige into the nitty-gritty fight. Aides said that he dug in his heels after he heard reports that his right-wing allies were doubting both his commitment to conservatism and his understanding of the tax bill. When he saw Kemp on TV arguing against the measure, the President asked his staff: "Why don't we meet with these guys again?" So 28 diehard conservatives were brought to the State Dining Room the night before the vote. John Hiler, 29, a first-term Congressman from Indiana, suggested that a no vote would not be disloyal because it was a matter of principle. Reagan reminded Hiler that he had been "out on the mashed-potato circuit talking about a conservative philosophy when it hurt to be a conservative. Now it's easy to be one." Then the President put the issue in more starkly political terms. Said he: "What are you going to do to my effectiveness if you defeat this bill? How can I campaign that I want more Republicans in Congress if they won't support me?"

Lyn Nofziger, Reagan's longtime political troubleshooter, who had opposed the tax hikes before being won over by Reagan, coordinated the White House's lobbying blitz. More than 35 business and trade groups joined the effort. The President spoke with some balky lawmakers three or four times. Expecting his fourth phone call, Republican Gerald Solomon of New York left a message that he was sick and hid out in the House cloakroom. He voted no.

Political favors were dispensed freely.

Republican Norman Lent of New York was promised that the A-10 Thunderbolt II attack plane, made on Long Island, would not be phased out as planned if he voted for the tax bill. Lent "agonized," then supported the President. Said one White House aide: "This has been the biggest shopping spree we've gone through."

Rostenkowski and O'Neill lobbied just as hard on their side of the aisle. When Rostenkowski realized that certain Democrats were purposely avoiding the floor during the debate so as not to have their arms twisted, he demanded a quorum call to force members to show up in the chamber. "I want to get them over here where I can get my hands on them," he said.

Rostenkowski's most spectacular move was a deal he cut with Don Bailey, a Democrat from the steelworking region of southwestern Pennsylvania. The way the tax bill was written, some depressed industries that installed new equipment before the end of 1982 could sell their deductions under the safe harbor leasing provisions. For the steel industry, however, the deadline had to be extended for there to be any benefits. Bailey told Rostenkowski: "These things have to be changed." But Bailey did not make his request until 10:30 Tuesday night, 90 minutes before the conference committee report on the bill had to be filed. So Rostenkowski got on the phone to members of the committee, asking for their approval and telling them of the 20 votes in the steel caucus that might hang in the balance. Conable, the ranking Republican on the House Ways and Means Committee, strenuously objected, but Rostenkowski had a majority and decided to make the change anyway. Bailey promised that he would lobby to line up support for the bill and vote in favor if his ballot was needed for passage. (It was not.)

Opposition Leaders Newt Gingrich of Georgia and John Rousselot of California, both Republicans, also had an impressive lobbying force behind them. Among the heavyweights: the American Farm Bureau Federation, the National Federation of Independent Business and the staff of the 250,000-member U.S. Chamber of Commerce. As the debate wound down, Gingrich and Rousselot counted only 139 votes for the bill. But despite their well-organized efforts, presidential persuasiveness turned out to be more powerful. When the tally was over, 103 Republicans and 123 Democrats voted for the tax increase, eight more than a majority. Opposing the bill were 89 Republicans and 118 Democrats.

Reagan watched the vote in a room next to the Oval Office with a handful of close aides. When the measure passed, the group broke into applause and all eyes turned to Reagan. Said the President: "O.K., that's enough daytime television. Let's get back to work."

Later Thursday evening, the bill moved into the Senate, where the White House felt confident of its chances. Again, it was backed by a collection of strange bedfellows. "How does it feel to be rescued by Teddy Kennedy?" a colleague teased Senator Robert Dole, the Kansas Republican who fashioned the original bill. Actually, the wholehearted support of Senator Kennedy and other liberals was no laughing matter, since it threatened to alienate potential conservative backers. Majority Leader Howard Baker quietly sent a message to Democratic leaders asking them to restrain any public proclamations from colleagues. As it turned out, eleven Republicans decided to abandon ship, but enough Democrats voted for it to push the bill over the top, 52 to 47.

Reagan insisted all along that his support of a tax increase did "not represent any reversal of policy or philosophy." In fact, however, the tax bill is a notable mid-course adjustment in Reagan's economic approach. The budget and tax bills that he signed last August were the essence of Reaganomics: a program that over three years would cut spending by $119.6 billion and reduce taxes by $266 billion. But these elements, when added to a budget that was already out of balance, led to projections of record deficits exceeding $150 billion a year. Most economists feel this tide of red ink is largely to blame for the lingering high interest rates. One reason is that financing the federal debt threatens to soak up much of the available investment capital. Another is that the fiscal irresponsibility suggests that the notable progress made in cutting inflation is only temporary. The high interest rates have in turn blocked the hope of an economic recovery by dampening investment and demand. A vicious cycle has set in: the continuing recession increases Government outlays for welfare and unemployment benefits, lowers the Government's tax receipts and raises the cost of financing the trillion-dollar federal debt.

While there are signs that the recession may have hit bottom, the long-awaited recovery remains as elusive as ever. Despite a July pickup in multiple-family dwellings, single-family housing starts are still at abysmally low levels. In devastated Detroit, it is estimated that domestic car sales for 1982 could be the lowest in 21 years. The payoff of Reaganomics, which is eventually supposed to be robust growth and balanced budgets, has so far been just the opposite: record deficits and the deepest recession since the Great Depression.

Until his recent initiative, Reagan had always firmly rejected the idea of raising taxes as a way to lower deficits and bring down interest rates. In his State of the Union message last January, he said, "Higher taxes would not mean lower deficits ... Raising taxes will slow economic growth, reduce production and destroy future jobs." He promised: "I will seek no tax increases this year."

Reagan's once fervent opposition to higher taxes as a method of raising revenue stemmed in part from his adoption of the supply-side theory that has been propounded to him by Kemp and others, including University of Southern California

Professor Arthur Laffer and Economic Consultant Jude Wanniski. Supply-siders argue that when taxes are too high, a reduction of rates will produce more, rather than less, revenue by stimulating the supply of goods and services that producers will have an incentive to create. As Reagan expressed it in the 1980 campaign: "If we make a deep cut in everyone's tax rates, we'll have lower prices, an increase in production and a lot more peace of mind."

No economic philosophy is ever translated directly into practice, and the supply-side program was entangled with other policies and conflicting conditions. Perhaps most important, it was accompanied by the Federal Reserve Board's policy (supported by the Administration) of keeping a tight rein on the money supply in an effort to control inflation, in recent years the nation's most corrosive economic problem. Says Wanniski: "Reagan attempted to blend a supply-side fiscal policy with a demand-side monetary policy.

There was an internal contradiction." Gary Wenglowski, the chief economist of Wall Street's Goldman, Sachs & Co., compares the combination of tax stimuli and tight monetary policy to "trying to keep an automobile's speed moderate by pushing both the accelerator and the brake at the same time."

Reagan's decision to seek tax increases as a way of cutting down the deficit is seen by both believers and critics as a willingness to back away from supply-side dogma. Says Democratic Congressman John Conyers of Michigan: "It's the clearest refutation of supply-side economics that we'll ever get." To adherents, this forsaking of supply-side theology is a premature and unwarranted betrayal. "This is not the same man we elected," says Laffer. "This tax package is obnoxious." The villain, says Laffer, is David Stockman, the lapsed supply-sider who as Reagan's Budget Director has emphasized the need to raise revenues. "He's incompetent. My daughter understands what Stockman cannot comprehend." Replies a senior member of Reagan's economic team: "I don't think that supply-side theory says you should not raise revenue. It says that you should not penalize investment or production, and I don't think this bill does that."

Some liberal economists hope that Reagan's support of a tax increase will end the supply-side fantasy for good. "Waiting for supply-side economics to work is like leaving landing lights on for Amelia Earhart," says Walter Heller, chairman of the Council of Economic Advisers under Lyndon Johnson. "The supply-side tax cut scared business, instead of reassuring business, with a massive deficit that kept interest rates high."

As Reagan departed last Friday for a two-week vacation in California, he knew he would not have long to savor his tax-bill triumph. The budget process for fiscal 1984 will start soon after he returns to Washington. "There will be savings again next year," promises Treasury Secretary Donald Regan. "There will be another $60 billion or so." The cuts that were politically easy--discretionary spending on programs like CETA, for example--have already been made. Somehow, far greater savings must be found if the Administration is ever to come close to controlling the deficit. Can Social Security be touched? Answers Secretary Regan: "Some cuts will be in Social Security."

The real test of whether Reagan can maneuver politically, forge true bipartisan agreements and be flexible in his thinking will come when he takes on the areas of the budget that he has heretofore left sacrosanct. The $98.3 billion in increased revenue, even when added to the $30 billion in spending cuts Congress passed last week, was only the first step in a difficult journey.

--By Walter Isaacson.

Reported by Douglas Brew, Neil MacNeil and Evan Thomas/ Washington

With reporting by Douglas Brew, Neil MacNeil, Evan Thomas

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