In rejecting a bold move to unleash American investment, Ronald Reagan went against the advice of the Treasury, the Office of Management and Budget and his own instincts to accept political advice that he not risk branding himself as the rich man's president.
The markets eagerly had awaited the volcanic impact of a Reagan call to cut the top 70 percent rate on "unearned" income (dividends and interest) down to the 50 percent top on "earned" income (salaries and wages). The announcement at 4 p.m. after the close of business Friday the 13th climaxed a week of backstage debate that ended with the forces of supply-side tax reduction in retreat and confusion.
The movement's political leader, Rep. Jack Kemp (R-N.Y.), wound up opposing his own idea in return for a trade-off that vanished. The result is that Reagan goes to Congress Wednesday with a limited package, out of fear of political dangers to a conservative Republican administration defending wealth.
Therein lies the political-economic vicious circle described in George Gilder's important new book, "Wealth and Poverty," as "the greatest peril of capitalism in our current inflationary period. As the wealthy consume more and invest less, resentment toward them increases and ignorant or demagogic politicians impose yet higher rates to punish them." The circle is closed when the rich escape this punishing higher taxation, going on to even more consumption and still less investment.
To end this debilitating process, two of the Republican Party's most dynamic young figures met after the election: Kemp and David Stockman, tapped as Reagan's OMB director. They agreed nothing could help more than immediately ending the rate differential between "earned" and "unearned" income (a differential ironically imposed at the Nixon administration's urging in 1969).
But how to avoid being savaged by those "ignorant or demagogic politicians" intent on redistributing wealth? It was somewhat vaguely decided to keep the proposal under wraps until the Reagan tax package was submitted. Naturally enough, word quickly seeped out.
But the issue did not come under intense public scrutiny until Feb. 10, when The Washington Post quoted presidential counselor Edwin Meese III on page one saying a proposed drop in "unearned" income tax rates would be contained in a hitherto unannounced second tax bill. That was a tip-off that Meese actually opposed the scheme. While the Treasury suggested a second bill as a dustbin for assorted tax schemes, it wanted "unearned" income rates handled in the first bill.
Reagan instinctively had supported the idea. But that very Feb. 10, a rainbow of Republican economic thought gathered at the White House to discuss taxes. The surprising consensus during five hours of discussions do not eliminate the differential between "earned" and "unearned" income.
Only one savant present, George Shultz, supported the scheme (less than vigorously). Opposed to it was everybody else from Herbert Stein (high priest of the deep root canal school of austerity) to Arthur Laffer (inventor of the Laffer Curve justifying tax reduction). So were Charls Walker, Arthur Burns and, astonishingly, none other than Kemp himself.
Kemp's rationale: it would be better to get the maximum rate on all "earned" income down to 37 percent at the end of three years (the top rate stays at 50 percent in one of the little-noticed defects of Kemp Roth), then push for the quick drop on "unearned" income. Kemp and Laffer left the meeting elated over the prospect of a 37 percent top rate. Reagan had seemed to agree.
But later that afternoon, outside adviser Alan Greenspan entered the game. While advocating the drop in the "unearned" rate, he opposed Kemp's 37 percent "earned" rate as impractical. That was the position also taken by the Treasury and backed by Stockman.
The big political guns at the White House next wheeled into line. Meese and presidential pollster Richard Wirthlin argued that a rich man's tax cut was politically unacceptable. Meese cited supply-siders Kemp and Laffer as backing his position. But the Kemp-Laffer proposal for getting the top rate on "earned" income down to 37 percent died along with the quick drop of "unearned" rates to 50 percent.
All this is seen as tragic by George Gilder and other outsiders who consider the Reagan administration as a last hope for radical change. With even Stockman unable to seriously reduce federal spending, such supply-siders see dramatically increased savings and investment as essential to finance the huge deficit while expanding the economy. Reagan signaled on Black Friday 13th he will not risk class warfare on Capitol Hill in quest of that goal.