Executive Summary: President Reagan's soaring approval rating and his stunning lead in match-ups with Walter Mondale and John Glenn have a perverse effect on the financial markets and the economic outlook. He wins politically with his "down payment" on the deficits, but casts a cloud on the markets by opening a wedge on tax loopholes. With a cushy lead the White House plays it safe and stands pat on fiscal and monetary policies and assumes the economy is safely on track. A parallel is the Eisenhower stand-pat campaign of 1956, a big Ike win, but GOP congressional losses and a static stock market. The deficit issue hurts the Democrats by forcing them to pledge higher taxes; Mondale panics over the "promises gap" and repeats McGovern's error of 1972. 1984 looks rosier than ever for the President's re-election, but without competition from the Democrats, prospects for vigorous expansion fade a bit. The President needs a push.
The Collapse of the Democrats
The most important development of the new year is the surprising early collapse of the Democratic Presidential contenders and President Reagan's stunning lead in the public-opinion polls. While this cheers the White House and the President's many supporters in the business and financial community, it isn't a spur to a near-term resumption of the bull market. And it tends to reduce chances of vigorous economic expansion for the rest of the year.
The problem is that Reagan's lead is so cushy comfortable that his campaign strategists believe they need do nothing on economic policy in the near-term and can perhaps avoid doing anything adventurous throughout the entire campaign. There is the added danger that the President may be nudged into giving away more than he should in parrying Democratic thrusts on the deficit issue. He already did so in his State of the Union message, at the last minute pushed into making a "down payment" on reducing out-year deficit projections. This increases the likelihood there will be a revenue-raising tax bill this year. The Administration, through Treasury Secretary Regan, characterizes these "loophole" closing measures as being modest. But even these will cloud the horizon and marginally reduce the path of the expansion. The President's about-face certainly heartened the Old Guard Republican taxers, who already see the supposedly minor concession from the White House as an opening wedge to bigger tax boosts. Senate Budget Committee Chairman Pete Domenici is already talking about closing $50 billion in loopholes over three years where Treasury had been thinking in terms of $33 billion. January's 50-point stock market decline reflected the President's strategic retreat on the deficit issue.
The President's lead in the polls also works to reduce White House pressures on the Fed to ease now on monetary policy. While there is concern around the President that the Fed's continuing deflationary policies are excessive and a burden to the recovery, the weakness of the Democratic candidates offsets this anxiety, reducing the need to press this issue with Volcker. The President didn't mention the Fed or monetary policy in his State of the Union message, evidence the White House, at least for the time being, will tread water here.
Secretary Regan, who had been the only public critic of the Fed in recent months, challenging the Fed's tightness on monetarist grounds, suddenly reversed himself after a number of meetings with Volcker and said he would be happy with the Fed as long as it henceforth hit its M1 targets. The concurrent revival of the M1 target by the Fed, a target Volcker has little confidence in, led to supply-sider suspicions that the Fed Chairman made this move to pacify the monetarists in the Administration, leaving only supply-side criticisms of the continuing deflation. In acceding to this Regan-Volcker accord, the White House further demonstrated that it believes the economy is safely on track and the President can concentrate on re-election politics. This subtle shift of emphasis, which distracts from the continuing need to nurture and encourage the recovery, may not lead to recession. But it casts a cloud over the financial markets and subtracts from output and employment, which can not be recaptured even if there is a revival of interest in new growth initiatives by the White House down the line. Such a revival may not come as long as the Democrats are putting so little pressure on the President.
Any doubt about the President's strength was removed January 25 with the report of The New York Times/CBS News Poll. The poll showed him leading Walter Mondale by 48-to-32 percent and John Glenn by 51-to-29 percent in direct presidential match-ups among the public at large. Earlier match-ups showed him running barely ahead of Mondale and Glenn; Gallup had the President leading Mondale 46-to-41 percent and Glenn 45-to-44 percent just a week earlier.
The discrepancy occurred, it turns out, because Gallup and other pollsters had been asking the match-up questions after respondents had been asked a series of other questions about the President's specific handling of domestic and foreign policies. Such questions, relating to Lebanon, deficits, etc., have the effect of loading the dice against Reagan. In the same way, a New York Times/CBS News Poll in Iowa — with an eye on the February 20 precinct caucuses, showed the President with a much narrower lead over the Democrats. But the Times pointed out that some of the differences "apparently result from concentrated Democratic campaigning in the state rather than from inherent differences."
In nationwide approval ratings, the President stands at 57 percent, the highest of any President at this stage of his first term since Eisenhower in 1956. The Times turned up a surprising 27 percent job approval rating from blacks, double that of earlier polls. Richard Wirthlin, the President's pollster, has him leading in all but eight states versus Mondale. Newsweek magazine finds a scant 20 percent of voters strongly disapproving of Reagan's performance, down from 35 percent in September 1982; Wirthlin finds only 16 percent in this category, demolishing the widely held assumption that the hardcore anti-Reagan vote is at least a third of the electorate.
The parallel with Eisenhower is worrisome, especially to congressional Republicans. Against the enigmatic, intellectual Adlai Stevenson, the popular Ike ran a stand-pat, retrospective campaign with no specific economic program for his second term. Eisenhower crushed Stevenson with almost 58 percent of the popular vote. But the Democrats retained control of the Senate and House, picking up one seat in each. It's the plan of action that provides the coat-tail effect, not the man, and in 1956 the national platform offered GOP candidates nothing to sell. The Dow Jones Industrial Average moved sideways during the year, opening at 488 and closing at 499.
In August of last year, two dozen supply-siders met at the home of Rep. Jack Kemp to consider economic strategies for the presidential campaign. The likelihood that Reagan's campaign strategists would choose an Eisenhower-type, retrospective campaign was the basis for discussion. It was assumed that Reagan would win with such a campaign, given the weakness of the Democratic field. But he would not win a mandate for new economic growth policies nor make GOP gains in the Congress. A second Reagan term would tend to follow the pattern of Elsenhower's second, noteworthy for its pleasant sleepiness.
Another assumption, though, was that the President's Democratic contenders would put forward a plan of action, including the Bradley-Gephardt flat-tax reform that would bring the top marginal personal income-tax rate to 30 percent. With a forward-looking program, the Democrats would steadily cut into Reagan's early lead. By the spring of 1984, anxieties would rouse the President and his campaign team to a competitive spirit that would lead to a more adventurous economic platform come August and the Dallas GOP convention. Reagan's juices would start flowing again and as in 1980 he would turn to the supply-siders for a forward-looking agenda of fiscal and monetary ideas. These would energize the campaign and give a lift to GOP congressional candidates.
This scenario does not look nearly so promising because of the dismal efforts of the Democratic contenders. The performance of the eight Democratic candidates at the Dartmouth debate of January 8 was symptomatic of the vacuum in Democratic ranks. Of the group, only Jesse Jackson displayed a semblance of leadership, the ability to articulate a vision of the future that is based on conviction, not one that has been stitched together by public-opinion pollsters.
None of the candidates really put forward a coherent economic plan of action. Instead of taking the opportunity to speak directly to the New Hampshire voters with a strategy to rival the President's, they lapsed into trying to win debating points against each other. It was astonishing that neither Mondale, Gary Hart nor George McGovern — who have each endorsed the Bradley-Gephardt flat tax — ever mentioned this politically attractive idea. And nobody directed any fire at the Fed's high interest-rate policies, preferring to uniformly attribute the high rates to the Reagan deficits. In doing so, they trap themselves into austerity policies that inevitably drive them toward pledges to raise taxes. The deficit issue actually hurts the Democratic Party.
Mondale was said to be the winner of the "debate," not because he caused any excitement among the rank and file, but because he didn't lose many debating points in the lackluster affair. He was ultimately the biggest loser, though, in the sense that John Glenn's needling of him for his multi-billion dollar promises to the social pork-barrel crowd led him to make a major mistake that will haunt him hereafter. Glenn had charged that Mondale's promises of export subsidies to American industry would cost U.S. taxpayers between $50 and $130 billion. On January 24, The Wall Street Journal in a frontpage leader reported that experts put the figure closer to $18 billion, but that Mondale's "promises gap" in its entirety seemed to come in at about $45 billion. Mondale was stung by the Journal's account, insofar as it now gives his opponents, including the President, an independent citation of the bill for his promises. Mondale wrote a long complaining letter to the journal on the 30th. But it also led him to issue, on January 26, a plan to raise revenues through higher taxes, the first such proposal he's made.
John Glenn had in December taken this "courageous" step, to use his word, by embracing a 10 percent across-the-board surtax on personal and corporate income as a means of combatting the dreaded deficits. Mondale attacked Glenn's position immediately, arguing such a surtax would weaken the economy by reducing incentives, and Glenn proceeded to lose ground every time he pressed his idea.
Public-opinion pollsters cannot find any serious concern about the deficits in the public at large, by the way. When asked if they are concerned about the deficits, voters say they are, and in great numbers. But when the electorate is asked simply what worries them most in the area of public affairs, deficits do not make the list of the top 10. And when asked, as in the New York Times/CBS News Poll, if they would pay 10 percent more in income taxes to cut the deficit, only 24 percent reply in the affirmative.
In mulling this situation, Mondale was led to make the same mistake that George McGovern made in 1972, when he thought he could divide the electorate by promising zero-sum tax breaks to Americans who made less than $17,000 a year at the expense of those who made more. Mondale, the consummate coalition politician, has now made a similar error. As the journal reported January 27, the Mondale tax plan would:
• Enact a 15% minimum corporate tax, close some still to be designated tax loopholes and end what the aide called some tax "abuses," which also weren't spelled out.
• Impose a 10% surcharge on taxes paid by people with adjusted gross incomes of more than $100,000. That would save about $5 billion, the aide said.
• Eliminate, for adjusted gross incomes of more than $60,000, the 10% tax cut that took effect Ju/y 1. The aide estimated this would save about $6 billion annually. "We believe the vast majority with incomes over $60,000 received massive benefits from the Reagan tax cut," he said.
• Repeal indexing on higher incomes while retaining some form of indexing on low-to-moderate incomes...The aide said this would amount to a $10 billion tax cut for the less affluent. And he said the proposal would recoup $30 billion of what he said would be a $40 billion to $45 billion annual tax loss starting Jan. 1 when indexing is scheduled to begin.
• Establish a "tough compliance program" to recoup $10 billion lost annually because of tax evasion, the aide said. Mr. Mondale would hire additional Internal Revenue agents, as a start, the aide said.
In 1972, soon after he was demolished by Richard Nixon, George McGovern was asked why he thought his "demogrant" tax plan was so poorly received by the voters. He replied that he had never met so many people who were making less than $17,000 a year who hoped some day to be making more than $17,000 a year.
President Reagan, the consummate consensus politician, barely waited for the Mondale plan to cool before he indirectly challenged its premises. On January 31, he told a cheering crowd in Chicago that "As the political rhetoric heats up this year, there will be those trying to appeal to greed and envy....Make no mistake, that is what they are trying to do. They suggest our tax program favors the rich. Well, this is the same antibusiness, anti-success attitude that brought this country to the brink of disaster....Raising taxes and threatening the recovery is no answer (to the deficits)."
It's a marvel to see Reagan so eager to take this "fairness" issue head on. It is a winning issue when played against the politics of "greed and envy." But it still isn't enough to debate once again the policies that were debated in the 1980 campaign, even though the outcome will be the same, a Reagan victory. As things stand, the deficits, not economic growth, are the focus of the Administration's concerns about 1985 and beyond. The President vows he will not raise taxes, much, to reduce the deficits. But there are no policy initiatives beyond what is in place aimed at restoring the economy to a faster growth track that would bring down the deficits. Supply-side attempts to interest the Administration in a flat-tax reform as a centerpiece of the 1984 campaign were shunted aside into the President's proposal to have the idea studied, with a feasibility report due after the elections. Monetary policy is left to the Volcker Standard, which we must assume is bent on preventing the economy from moving on a higher growth path.
Where the President and his team could be thinking of real GNP growth of 6 or 7 percent this year and next, they are instead thinking of 4 or 5, safe, steady numbers that will presumably prevent a reignition of inflation. The President's re-election is in the bag. Why do anything risky? Only a month ago we could easily envision a rosy 1984 in every respect. If anything, the President's political prospects are even rosier. But with the competition from the Democrats wilting, prospects for the economy have faded a bit. Even the sleekest of greyhounds needs a mechanical rabbit to go all out. The President needs one too.
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