The Republican Convention Jude Wanniski July 3, 1980

Executive Summary: The free-fall of the U.S. economy pressured President Carter into telegraphing his intent to announce a 1981 tax cut after the GOP convention. In so doing, he forced opponents of Kemp-Roth inside the Republican Party to drop their opposition to specific tax cuts and thus unified the GOP. With a party consensus around a supply-side economic program, Reagan avoids an anticipated struggle over the platform and resolves questions about the tenor of his acceptance speech. The incipient Reagan bull market hinges on the market's calculus of his chances of victory in November. Reagan's selection of his running mate will clarify that calculus. George Bush remains the favorite, but Representative Kemp advances rapidly as the supply-side Northeast strategy firms. Richard Lugar is the compromise candidate if the Bush-Kemp contest deadlocks, with Reagan observing the dynamics of the convention as a guide to his selection.

The Republican Convention

The most important unobserved fact about Ronald Reagan is his degree in economics from Eureka College in 1932, when classical economic theory was still in the curriculum. At age 69, he is now the only global political figure with a certified diploma in supply-side theory. That he did not utilize his training at a time when other economists were being transformed by the Keynesian revolution helps explain his attraction to and central role in the current revival of these ideas of his youth. Reagan was 13 when Calvin Coolidge (who he now says is one of the American Presidents he most admires) accepted the Republican presidential nomination on August 14, 1924, at the GOP national convention. One passage of Coolidge's acceptance address was conventional wisdom during Reagan's formative years. Said Coolidge:

Every student knows that excessively high (tax) rates defeat their own purpose. They dry up that source of revenue and leave those paying lower rates to furnish all the taxes. High rates tend to paralyze business. For these reasons I am opposed to excess-profits taxes and high (income) surtaxes. When the Revenue bill of 1921 was passed, abolishing excess-profits (taxes) and greatly reducing high surtaxes, it was immediately followed by a revival in business and an increase in the number of large incomes so that the government received nearly $100,000,000 more in taxes from those having incomes of over $100,000 than under the higher rates of the previous year. But rates were still too high and all kinds of business began to pause... a new tax bill was passed this spring carrying still further reduction, and under its apparent influence this seems to be the beginnings of another increase of prosperity. Good business is worth more to the small income taxpayer than a considerable percentage of tax reduction.

In the first several months of 1980, Reagan surely was fortified by the imprint of his early education. The inflation rate moved to 18 percent, and in the Keynesian model the very last thing the economy needed was a reduction in taxes, which would put more money into consumers' pockets that would bid up prices. Yet Reagan steadfastly maintained an enthusiastic commitment on the stump to the Kemp-Roth 30 percent tax cut as the centerpiece of his economic program. His adversaries in the Republican primaries took every opportunity to shatter his commitment to the idea, George Bush going so far as to term the proposal "voodoo economics". As Reagan rolled up primary victories, and as the camp followers of the defeated candidates spilled into his campaign, the pressure on Reagan to dilute his commitment intensified from within, on the grounds that party unity required consensus. And when his nomination took on the aspect of inevitability, the argument took hold within the campaign that the commitment to Kemp-Roth must be softened in preparation for the contest against Jimmy Carter.

By being specific, it was argued, Reagan would become vulnerable to Carter charges of fiscal irresponsibility. By being vague as to the magnitude and timing of tax reduction, it was said that Reagan could slip the inevitable Carter attacks. Behind this rationale, in part, was the remembrance of 1976, when Carter did best when he was vague, weakening as he got specific. In part, there was a concern that the candidate would not be up to a fierce debate over economic theory and might make a major mistake in the closing weeks of the campaign. Better to be safe and embrace the concept of tax cutting instead of being specific.

Through it all, Reagan remained militant. The Keynesians in the campaign proposed that Kemp-Roth not be mentioned specifically in the Republican platform. Or, that the 30 percent tax cut be phased in over three "or more" years, or three "to six" years. Reagan resisted all of these, but without a consensus among his chief advisers and "kitchen cabinet", the debate continued and pointed to a potential brawl in Detroit over the writing of the platform. Charles Walker, former Treasury Undersecretary and top economic adviser to John Connally, had been named Chairman of the Tax Policy Subcommittee of the Campaign Executive Committee. Walker, in a hot spot, groped for a compromise that would avoid a knock-down in Detroit, but his proposals were rejected by Reagan. President Carter and the Carter recession finally gave Walker what he needed.

The long-awaited, purposely-induced Carter recession finally arrived in late April with a break in interest rates as commercial activity plunged and with it the demand for credit. With the unemployment rate moving past 7 percent and heading higher, the Keynesian model began to suggest the need to inject money into the consumer's pocket. The recession, after all, had been induced by the President's determined efforts to combat inflation through fiscal and monetary austerity including: The Volcker bank credit restrictions of October 6; the mammoth direct and indirect tax increases, including the "windfall-profits" tax aimed at draining money out of the energy consumer's pocket; and the indirect tax increase of inflating the consumer into higher tax brackets.

The confluence of Keynesian Phillips Curve doctrine with classical theory pitched the political debate onto new terrain. Now Republicans who had been fretting over Reagan's stubbornness in hewing to Kemp-Roth found themselves perfectly positioned instead of out of phase, and marveled with new respect for Reagan's shrewdness in remaining militant. Democrats were horrified as they made identical observations. Instead of being able to respond to a vague concept of tax reduction, which he could easily do, President Carter would be forced to deal with a specific proposal as the blue-collar unemployment lines lengthened in the Democratic strongholds. In addition, there was Senator Kennedy hammering at him, proposing Keynesian spending increases to keep the Democratic coalition from blowing apart and hanging the recession around Carter's neck. The President's weak response was to telegraph vague promises to propose a tax cut after the GOP convention, one that would take effect sometime in 1981. He thus handed Charls Walker the solution he was looking for.

In mid-June, at a formal meeting of Reagan's executive committee — which he calls his "kitchen cabinet" — Walker proposed a pre-emptive tax-cut strike against Carter. His ingenious proposal delighted all the factions present and won unanimous approval, even though it maintained Reagan's commitment to Kemp-Roth in all details and specifics and even advanced its timetable. The Walker idea was to not wait until Reagan's inauguration to propose the tax legislation, but to immediately propose that the first year of Kemp-Roth be enacted, with the succeeding years enacted next year. A10 percent across-the-board cut in income-tax rates would take effect on January 1, 1981. In addition, Walker proposed that the Capital Cost Recovery Act — the Conable-Jones "10-5-3"proposal — be folded into the bill. The bill would allow companies faster write-offs on the cost of most machinery and other assets to cover depreciation of those assets, buildings in 10 years and other properties in 5 or 3 years. The names Kemp, Roth, Conable and Jones will not be attached to the legislation. Rather it will be characterized as a "Reagan bill" designed to suit the political and economic moment. The factions which had opposed Kemp-Roth and sought compromise could rationalize their support without swallowing hard. Main Street and Wall Street could come together by twinning the income-tax and business-tax cuts. When on June 25 the proposal was announced in joint press conferences in Los Angeles (by Reagan) and on the steps of the U.S. Capitol (by GOP members of the Senate and House) it was obvious that the one stroke unified the entire party. Senators Javits and Danforth, who had fought Kemp-Roth for years, had been given an easy way to come aboard and they did so gratefully. And the Bush representatives on hand for the Capitol press conference said not a word about black magic or voodoo.

There were a few in the Reagan camp, unhappy with the compromise, who spread word on Capitol Hill that it represented a setback for the Kemp-Roth idea, and there was some confusion when the Washington Post and The Wall Street Journal reported it as a setback. But, this maneuver backfired by irritating Reagan, and his chief of staff, Edwin Meese III, issued a vigorous denial. In his press conference in Los Angeles, Reagan was clear on the matter:

Jimmy Carter says we cannot cut taxes until we balance the budget. But, his policy of fighting inflation with higher taxes, mounting unemployment and deepening recession only guarantees there will be no balanced budget at all—next year or ever.

The fact is, the plunge in employment and production is already drying up revenues. And, these two factors are combining to balloon federal costs at dizzying speed. With each additional one percent increase in the unemployment rate, the federal deficit swells by another 25-plus billion dollars.

Clearly, a tax cut to restore investment, production and incentives—tied to a convincing reduction in the rate of increase in federal spending—is the only means to achieve the magnitude of growth in the economy necessary to balance the federal budget.

Moreover, the phased-in tax cut approach I have proposed is just the first installment of an overall program to get the country back on its feet and moving again... a program to steadily reduce today's stifling tax burdens on citizens and businesses, large and small.

This flawless supply-side rhetoric, if anything, reflected Reagan's deepening commitment to the idea. Only a week before, his chief economist, Martin Anderson, handed him a news clipping from the San Juan Star of May 25 that Reagan immediately began citing in his campaign appearances. The article was headlined: "Revenue increase bolsters Romero tax-cut policy" and stated in part:

Gov. (Carlos) Romero (Barcelo), bouyed by reports that income tax collections are running 13.5 percent ahead of the 1979 rate, admits that he is now a confirmed disciple of Arthur B. Laffer, the economist who has gained nationwide prominence by advocating that government revenues can be increased by cutting tax rates.

Romero, in a lengthy interview at La Fortlaleza last week, conceded that there is evidence to support Laffer's theory in the most recent Treasury report.

Ricardo Muniz, assistant secretary of Treasury for internal revenue, said income tax collections as of April 30 were $654.5 million, a 13.5 percent increase over the $576.4 million in the till on that date in 1979. . .

"It is extremely difficult to say it is all due to the tax cuts," the governor said, "but the things Laffer told us would happen are happening. In fact, he guaranteed it would happen."

Romero adopted the Laffer concept early on in his administration, first eliminating the notorious "la vamparita" 5 percent tax that was imposed during the Hernandez Colon administration. That tax, incidentally, was levied on the counsel of James Tobin, a Yale economist who headed a group commissioned by Hernandez Colon in 1974 to analyze the island's economic ailments and prescribe remedies.

Romero then followed with the elimination of the 5 percent surcharge (World War II victory tax) in 1978 and a straight 5 percent reduction in 1979. He has approved another 15 percent slash in three increments of 5 percent this year, 1981 and 1982.

"I'm sold that the (Laffer) theory is correct," the governor said. "He wanted me to take a much bigger step initially but I couldn't. I felt I was charged with the responsibility of balancing the budget and I couldn't gamble on a 15 percent cut in one chunk. I said if it was going to show results with 15 percent it will show results with 5 percent. . ."

Another factor that contributes to higher revenues when tax rates are lowered is what Government Development Bank President Julio Pietrantoni calls the honesty factor. "Taxpayers are honest up to a point," he said. "But once the rates go higher than they feel is fair, they are going to take steps to avoid payment."

Pietrantoni, also a Laffer advocate, said he had been told by Treasury Secretary Julio Cesar Perez that there are 100,000 more taxpayers on the books this year than last.

Since that many jobs were not added to the economy, he noted the explanation must be better enforcement and a decline in the number of taxpayers who have been rebelling against the higher rates.

Romero, the first political leader to put his confidence in the Laffer Curve and act upon its implications, waited three and a half years to certify it. But when it came, the moment was a critical one. Here was palpable, current support for the idea by an elected chief executive, and Reagan, understanding its importance, added it to his repertoire.

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Of the three major matters to be resolved at the Republican convention in determining the GOP commitment to supply-side economics, the Walker compromise took care of two. The economic plank of the platform is established in unifying fashion. There is now scarcely any chance of the kind of regional and ideological divisions that sank the Gold water campaign in 1964 even before it began, at the San Francisco party convention. This achieved, questions about the tenor of Reagan's all-important acceptance speech—which will give the national electorate its first comprehensive exposure to Reagan's vision of his administration—are also resolved in fundamentals. Instead of being forced to waffle, he can now be ambitious, even audacious, speaking to national unification around a program for national economic revival. Having seized the initiative, he can posture as if he were now the incumbent, thereby reducing the temptation to use this platform to engage in negative attacks on Carter. It will be Carter, in New York in August, who will be thrown on the defensive, forced into negative attacks on Reagan and the GOP.

All this is welcome news to financial markets, and even conventional commentaries on market activity are now beginning to ascribe positive surges of the Dow to the increasing influence of supply-side thinking on policymakers (See, for example, the "Abreast of the Market" column in The Wall Street Journal of June 27). The Reagan bull market, though, is still incipient, for the market must be able to calculate his increasing chances of defeating the incumbent. The third matter to be resolved in Detroit that would add darification to this calculus is Reagan's choice of a running mate. Although there are no clues to Reagan's thinking, except those that eliminate candidates like Howard Baker from serious consideration, it is widely perceived that George Bush is the favorite going into Detroit.

The reason, of course, is that Bush, the candidate of the Eastern wing of the party during the primaries, was the runner-up with victories over Reagan in the industrial states of Michigan and Pennsylvania. There is, though, some discounting of the Michigan-Pennsylvania wins on the grounds that Reagan, having run out of funds at that stage of the campaign, did not deploy his successful media campaign in either state. Still, the pressures on Reagan to embrace Bush are considerable, both from Corporate America and from Capitol Hill Republicans. Because of Reagan's age, and hints that he would only serve one term, the contest for the No. 2 spot has taken on the aspects of a succession struggle. At the very least, a Bush vice presidency would put him in a commanding position for 1984. His selection would surely be applauded in the national press, as a sign that Reagan is willing to take a "moderate" on the ticket.

There would be less warmth shown to a Bush selection by financial markets, though, at least until it was seen that Bush had schooled himself in Reaganomics. While he continues to style himself as a "supply-sider", his economic team remains entirely composed of conservative Keynesians, and this would continue to show up in his campaign rhetoric. The ticket would thus be throwing off confusing signals.

It is for this reason that Jack Kemp has come from a longshot possibility to serious contention. Kemp, who will be 45 on July 13, chose not to enter the primary lists against Reagan, but instead joined the campaign team last November, a move that seemed to take him away from consideration on the ticket. Being inside the Reagan camp, though, enabled him to continue pressing for a Northeast strategy even after the departure of John Sears. The campaign might well have drifted toward Sunbelt strategies being urged upon Reagan — a Nixon strategy of the unpoor, unblack, unyoung. As it is, Kemp's inner-city proposal is being absorbed into the GOP platform with Reagan's blessing and will aim at the heart of the Democratic coalition. The proposal, which has been applauded by black and Hispanic leaders and bluecollar labor, aims at restoring decaying cities through incentives instead of infusions of tax resources.

Kemp's elevation into primary contention came on June 14 when Human Events, the weekly newspaper of activist conservatives, endorsed Kemp in a front-page editorial. It put most of the burden of its argument on Kemp's appeal to blue-collar workers, but also observed that "With the economic issue quite likely to be the overriding one, Kemp would seem to be the best possible choice. There is not a single other name in the pool of VP possibilities who would be as persuasive in explaining the Reagan economic program to the American people."

Reagan, who reads Human Events, recited these arguments a few days later when he met with 18 of his regional political directors in Los Angeles, to underscore what he had just heard from them. Reagan had gone around the table, asking each to opine on the running mate that would help them the most in their respective regions. Fourteen named Kemp, two Bush and two named Senator Baker. The sentiment of these grass-roots operatives thus balanced off Bush's strength with organization Republicans, whose confidence in Bush derives in large part from his tenure at the Republican National Committee.

A Kemp selection would, similarly, put him in a commanding position for succession. It is understandable that promising Republicans who are anticipating the post-Reagan era themselves are playing for a Bush-Kemp deadlock in Detroit, which is why Senator Richard Lugar of Indiana figures so prominently in the speculation. While Lugar meets Reagan's broad specifications, and has schooled himself in supply-side thinking, there is not the belief that he would gain much of a head start toward the party succession as Vice President. Uncharismatic, he does not have an apparent drive to occupy the Oval Office, which makes him a "safe"  bet to the players of all factions, if there is such a thing. For this reason, many Reagan insiders are betting on Lugar, although the 69-year-old candidate has thus far shown no signs of playing it safe.

The fact that Reagan has the nomination sewn up and the main planks of the platform resolved would seem to suggest a ho-hum convention. But because there is this extraordinary contest for the Vice Presidency, with implications for 1984 and beyond, there is almost a "futures" convention within the convention that will provide ample drama. At this futures convention, Reagan can sit back and observe the peculiar dynamics of a party in convention that cannot be forecast. Even the financial markets, with all their aggregate wisdom, must be patient.

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