In late 1978, a small group of elite tax lobbyists began what were to become weekly Tuesday morning breakfast sessions in the Sheraton Carlton Hotel on 16th Street.
Such meetings have become a commonplace in Washington as business groups, with growing sophistication, have formed alliances and coalitions in preparation for legislative battles.
Similar groups defeated labor law reform legislation and won approval of a measure weakening the powers of the Federal Trade Commission, and an ad hoc coalition has been organized around the reauthorization of the Clean Air Act.
In this case, however, there were some differences. Among them:
* The tax coalition, which would come to be known as the Carlton group, first wrote the basic structure of the business tax cut known as 10-5-3, a system giving companies much faster depreciation write-offs on new investments that went into effect Jan. 1, 1981. The coalition rounded up enough co-sponsors in the House to give the measure majority support and then persuaded the Reagan administration to adopt the measure as its own. But this was no ordinary bill: it would end up costing the Treasury $536 billion through 1990, according to estimates by the Joint Committee on Taxation.
* Not only would the measure represent the largest business tax cut in history, but also it would set new standards for any group seeking to lessen its tax burden: for most new capital investments, the tax break would more than equal the tax liabilities on profits from the investment, creating a situation in which corporations have a stronger incentive to invest than if there were no corporate income tax at all. This effectively created an indirect federal subsidy--or negative income tax--on corporate profits from new investments.
* In gaining the backing of the Reagan administration, the Carlton group had certain advantages. The lobbyist considered the "father" of the Carlton group, Charls E. Walker, was also chairman of President Reagan's tax policy task force. Other members of the task force who also were member of the Carlton group were Ernest S. Christian Jr., who wrote the first three versions of 10-5-3 and whose clients include the American Retail Federation; Richard Rahn, formerly chief economist for Walker's American Council for Capital Formation and now for the U.S. Chamber of Commerce, and Mark Bloomfield, who has Rahn's former job at the American Council.
* At one point in the legislative consideration of the tax bill, the administration and the business alliance briefly split. The administration momentarily decided the measure was too expensive and would severely hamper its ability to balance the budget. But when the administration proposed specific reductions, the business community flexed its muscles in what would become known as the "Lear Jet weekend." Over that June 7-8 weekend, when chief executive officers from across the country flew into Washington to voice their protests, the Treasury Department not only backed off most of the reductions, but also actually added provisions raising the cost of the measure by $41 billion over the next decade.
* One of the key concessions by the Reagan administration to keep the business community fully behind the Reagan tax bill on that June weekend was the addition of a section that would become one of the most controversial tax concepts in recent memory. A superficially innocuous change in the rules governing leasing procedures, the new provision allowed corporations to buy and sell their tax deductions and credits. This provision would end up deeply embarrassing a number of congressional Republicans, who saw this as indirect welfare for business--"corporate tax stamps," in the words of one economist.
* There is a serious and substantive debate over the whole question of the corporate income tax. A number of conservative and liberal thinkers believe the tax, combined with levies on dividends, amounts to a form of double taxation. But the measure written by the Carlton group and amended by the administration created an entirely new twist to the argument. For a broad range of corporations, the combination of existing deductions and credits, the new depreciation schedule in 10-5-3 and the leasing (tax sale) provisions mean that they will actually make money out of the tax system, not pay into it. For these companies, the tax system amounts to a subsidy and functions to give them a competitive edge in the marketplace. As a consequence, rational lobbying strategy would call for these companies to pull out the stops and fight any effort to eliminate the corporate income tax.
* The administration's initial intent was to win approval of a "clean" tax bill containing only the Kemp-Roth individual rate cuts (30 percent spread over three years) and the 10-5-3 business cuts. Part of the tacit agreement with the key business lobbyists was that in return for the very generous 10-5-3 bill, the business community would back the "clean" bill. In effect, under the deal business would have to postpone pressure for a number of more specific breaks. In fact, however, key members of the Carlton group ended up as full participants in what became known as the bidding war between the administration and House Democrats.
This bidding war resulted in the addition of a host of new breaks benefiting the oil industry, financial institutions, truck company owners and the heirs of very large estates. Among the most prominent lobbyists for some of these additions were members of the Carlton group, including Charls Walker. Walker's clients, for example, included a number of multinational corporations seeking an exemption on foreign earned income, a provision that was added in the middle of the bidding war at a cost through 1986 of $2.7 billion.
The process of the creation of 10-5-3, which really amounts to a simplfied and sharply accelerated system for corporations to depreciate the cost of new investments, was not a secret cabal. Members of the Carlton group generally talk openly about what took place, and the general outline is as follows:
During the passage of almost every tax bill over the past two decades, the business community had been bitterly split. This phenomenon continued through the 1978 tax bill, despite the fact that the congressional mood had swung from tax reform to strong support of business interests.
As one key lobbyist who successfully fought for the halving of capital gains rates from 46 to 28 percent in 1978 said: "Small business had been fighting for other things, but we whipped them."
In the aftermath of the 1978 bill, the two architects of the cut for capital gains, Reps. James Jones (D-Okla.) and the late William Steiger (R-Wis.), both members of the Ways and Means Committee, began to meet with key representatives of business and gave them a mandate: agree on a new tax bill and we will sponsor it. After Steiger's death, he would be replaced by Barber B. Conable (R-N.Y.) as the leading congressional proponent on the GOP side.
The mandate was irresistible. An industry group that had been meeting under the direction of Cliff Massa IV, vice president for taxation at the National Association of Manufacturers, was converted into what would become the Carlton group.
The members would include the following: Massa, of NAM; Rahn, of the American Council and later of the chamber; Christian, of the American Retail Federation, and whose firm, Patton, Boggs and Blow, has at least 140 clients ranging from Armco Inc. to Westinghouse Electric; Phillips S. Peter, of General Electric; John Post, executive director of the Business Roundtable, an organization representing most of the nation's largest corporations; various representatives of Walker's lobbying arm, Charls E. Walker Associates, whose 65 clients range from the Aluminium Co. of America to Weyerhaeuser Co.; John M. Albertine, director of the American Business Conference, an organization of mid-sized, high growth companies; William K. Condrell, a partner in the firm of Steptoe and Johnson and representative of the Committee for Effective Capital Recovery; and both James D. McKevitt and John J. Motley of the National Federation of Independent Business.
"Those of us who represent the business community thought about what we might do about capital cost recovery," Rahn said. The group considered a number of options, including indexing depreciation, shifting to a system based on the replacement cost of investments instead of the purchase price, immediate expensing (writing off) of the entire investment in the first year, corporate rate reductions, and some form of reduction or elimination of taxation of both dividends and corporate profits.
"There finally developed a sort of consensus that the thing that made a combination of the best economic and political sense was 10-5-3," Rahn said.
Under 10-5-3 as introduced by the administration, the system by which corporations depreciate investments would have been reduced to basically three categories. Instead of the old system of 132 categories based on the "useful life" of an investment, all automobiles, light duty trucks and research and development equipment would be written off over three years, all other equipment over five years, and certain public utility, owner occupied factories, stores and warehouses over 10 years.
Shortening the depreciation period is of great tax advantage to the investor because the money is available much more quickly. The value of a dollar today is more than its value next year. Some factories, for example, would have seen their depreciation "life" shortened from 60 years to 10 years and some types of equipment from 36 years to 5 years.
The 10-5-3 bill raises a host of critical public policy and economic questions:
* Will it, as some contend, exacerbate, rather than lessen, existing distortions in investment patterns because the tax advantages for some industries will be far larger than for others? A May, 1981, study by the Joint Committee on Taxation, for example, showed that the share of the tax break going to the petroleum and refining industry will be 320 percent larger than its share of total national investment in 1982; while for the airline industry, the share of the tax break will be only 40 percent of its contribution to total national investment, and for the telecommunications industry the share amounts to only 20 percent.
* On a larger scale, should the federal government remain dependent on the corporate income tax as a major source of revenue? Because of past business tax cuts, the proportion of the federal tax burden paid by corporations has been steadily falling, from about 22 percent of the total in 1960 to about 12 percent in 1980. The 10-5-3 bill does not directly address this question, but it does function to speed the process: by 1986, the corporate income tax is expected to provide 7.7 percent of federal revenues.
* What is the appropriate size of the tax cut? This was determined, to a large extent, by the Carlton group and later lobbying pressure. The administration did slightly modify the proposal when it was first introduced as H.R. 2400 in 1981, and later tried to back off from some of the cost in June. The early June cutbacks were, however, restored in less than six days, after the Lear Jet weekend.
Now, however, the administration and Congress are in the midst of a debate on whether or not to raise taxes this year, the first time in recent memory that taxes would be raised in a period of recession. One of the main reasons for the pressure for a tax increase is the deficit, which, in turn, has grown because of the size of the 1981 tax cut.
* Perhaps most important, is 10-5-3 the best vehicle to spur investment and to improve the nation's productivity? Because of the overwhelming and unflinching business support for 10-5-3, other proposals were never given serious political consideration. A system designed by two Harvard economists, Dale Jorgenson and Alan Auerbach, which placed all depreciation benefits in the first year to prevent the distorting effects of inflation never got off the ground in the congressional debate, as the one driving force became a competition between Democrats and Republicans to outbid each other for business backing.
Democrats on the Ways and Means Committee ultimately decided to match the administration dollar for dollar with a combination of corporate rate cuts and a system of depreciation called expensing: 100 percent of the cost of an investment could be written off in the first year, although the investment tax credit would be eliminated. Expensing had long been the goal of the business community, and it even received the backing of the Institute for Research on the Economics of Taxation, the consulting firm formally run by Norman Ture, Treasury undersecretary for taxation and a leading proponent of supply side economics. But, in the politics of the debate, a shift of support to expensing would have become a defeat for the Reagan administration, and the business community remained firm behind 10-5-3.
The final test of the bill will be economic results. To date, the measure has not produced the wave of business investment predicted by the administration. Instead, a survey by the Commerce Department showed that business this year expects total investment to decline by 0.5 percent and last year, with the tax cut fully effective from Jan. 1, 1981, investment increased by only 0.3 percent.