Economic dominoes: the seeds of Bush's defeat were sown under Reagan - but not in the way the media think; toppled by tax reform.

MANY factors contributed to George Bush's defeat, but polls report that the economy played the biggest role. In the end, the Bush Presidency was destroyed by economic dominoes toppled by the Tax Reform Act of 1986. Ironically, this disastrous legislation was the work of Bush advisors James A. Baker III and Richard Darman, who were running the Treasury Department at that time.

As experts such as George Washington University professor John W. Kendrick have concluded, the 1986 Act raised the cost of capital, thus reducing productivity growth and taking out a lot of the juice that Reagan had put in the economy. Its biggest effect, however, was in destroying a tremendous amount of real-estate wealth, thereby collapsing savings & loan associations and commercial banks.

The legislation greatly lengthened the depreciation period for commercial real estate. The longer payback period substantially reduced the values of properties. Simultaneously, the act took away the normal tax deductions from most real-estate investors, resulting in negative cash flow, which caused investors to walk away from their investments. A third blow was the 40 per cent hike in the capital-gains tax rate. This made it certain that no investor would hold on for the long haul.

The gratuitous destruction of $1 trillion or more in wealth was a political fiasco in itself. However, the Bush Administration greatly magnified the destructive effects with the 1989 S&L act, which destroyed the value of thrift charters. With the deposit-insurance fund exhausted, the cost of bailing out the depositors was shifted to taxpayers. Fearful of what their stupidity had wrought, the policymakers hid behind allegations of private real-estate fraud, and this is when Mr. Bush's political troubles began in earnest.

In towns and cities all over the country, it had been a mark of local prominence to serve on the board of the bank or S&L. Now these business people, doctors, and lawyers--the backbone of the Republican Party-- are being ruined by government suits alleging breach of fiduciary duty for approving real-estate loans that later declined in value because of the 1986 Tax Reform Act ! It is not the fault of these board members that federal legislation thoughtlessly destroyed the value of real-estate projects that their institutions had financed. But the Federal Government could not care less. The Resolution Trust Corporation and the Federal Deposit Insurance Corporation have set in motion a powerful mechanism for a total miscarriage of justice. They have hired private law firms that bill by the hour to try to recover from thrift and commercial-bank executives and board members, and from their accountants, legal advisors, and insurance companies, as much of the cost of the deposit-insurance bailout as possible--regardless of any real malfeasance.

The lawyers, thus, have an incentive to sue anyone ever connected with a failed financial institution. As Gretchen Morgenson shows in the September 28 issue of Forbes, the government's lawsuits are terrorizing innocent people. In one instance, an allegedly negligent director had been comatose in a hospital bed at the time the allegedly negligent loan was approved. In another instance, the estate of a dead man is being sued--thereby disrupting the education of his children-because of real-estate evaluations that were perfectly sound before the 1986 Act. The RTC makes the incredible claim that 81 per cent of S&L failures involved fraud and misdealings. As Forbes says, "That simply isn't so." Scarcely any of the 2,100 financial institutions that have been closed would have failed had it not been for the 1986 Act.

The persecution of the private credit system by the FTC and the FDIC-- permitted by the Bush Administration-has disrupted local business throughout the country and put the economy on hold. Recently, Alfred J. T. Byrne, general counsel of the FDIC, bragged in the Wall Street Journal that "the FDIC's current litigation load numbers some 34,000 cases, and non-litigation items add 10,000 matters to our legal responsibilities." To handle all the work, he has "a staff of 850 attorneys and 1,200 support personnel" together with "more than 1,400 outside law firms." Democrats on the Senate Banking Committee have encouraged the large number of frivolous lawsuits precisely because. the targets are Republican business men and women.

Deficit Phobia 

THE STUPIDITY of the Bush Administration's approach to the made-in-Washington S&L debacle reflects the Republican establishment's deficit phobia--it blindly destroys its own in pursuing a smaller deficit. Indeed, the real-estate crash that brought down the S&Ls was itself a product of the same deficit phobia. The 1986 Tax Reform Act was constructed on the rotten basis of static revenue estimates, which mistakenly assumed that taking away real-estate "tax preferences" would raise revenues to pay for lower tax rates. Instead, we got a $200- to $500-billion (depending on how it is measured) taxpayer bailout of federal deposit insurance caused by the collapse in real-estate values. It should have been obvious to policymakers that real-estate prices, already under pressure from unexpected disinflation, could not absorb the massive change in tax treatment. And yet the Treasury Department, Congress's Joint Committee on Taxation, and the Congressional Budget Office still employ the people who assumed that they would.

Once the huge costs of the deposit-insurance bailout were in the picture, Budget Director Richard Darman used them to pursue his own agenda. The bailout was a one-time affair of acquiring and disposing of assets, unrelated to the ongoing taxing-and-spending operations of the budget, and conventional accounting practices would have kept the bailout off budget. However, by putting it on budget, Darman gained an additional $300 billion in estimated red ink with which to panic President Bush into breaking his "no new taxes" pledge. This let Darman negotiate the disastrous 1990 budget agreement, a deal in which higher taxes were the price for promised spending cuts and a promised $500billion reduction in the multi-year deficit forecast.

Predictably, Congress spent the projected revenue increase--but the taxes helped to kill the economy, and the revenues did not materialize. The Congressional Budget Office's latest estimates of federal outlays for 199093 are $226 billion higher than its estimates prior to the 1990 budget deal, and federal revenues are $363 billion lower. Consequently, the deficit widened by $589 billion over the four-year period--a swing of $1,089 trillion from the promised reduction. Ironically, interest rates fell despite the massive swelling of the deficit--a big blow to Bush's economic team, which had supported the budget deal on the grounds that the path to lower interest rates was through a lower deficit.

Thus, the failure of the Republican establishment's economic policy and theory is total and complete. It is to be hoped that we will never hear another word from the architects of Bushonomics--who delivered the country to Bill and Hillary Clinton--about how big deficits cause high interest rates. The Bush team doubled the deficit that President Reagan left, and we have the lowest interest rates in three decades, together with an economy that is dead in the water. Jobs, investment, and productivity growth did immeasurably better in Mr. Reagan's high-interest-rate economy. This doesn't prove that high interest rates are the source of economic boom, but it does show that interest rates are not the driving force that the Bush Administration assumed them to be. Michael Boskin and Nicholas Brady put all the eggs in one basket, and it wasn't the right one.

Tax, Spend, Regulate

THE FAILURE of the Bush Administration's macroeconomic policy was compounded by the explosion in regulatory costs and federal outlays. If Americans wanted a tax-spend-and-regulate President for the next four years, they could just as well have re-elected Mr. Bush. Federal regulation prospered under his Administration, gaining control over whole new areas of the economy and private life. The Clean Air Act is vastly inefficient, costing the economy two dollars for every dollar of benefits. The Americans with Disabilities Act has imposed massive costs that make no earthly sense. For example, until recently the underground garage in which I have parked for the past 11 years had one parking space reserved for the handicapped. Never in the 11 years have I observed a car parked in that space. Now, based on an arbitrary formula devised by an unaccountable regulatory bureaucrat, the garage has six permanently empty reserved spaces. At the going price, this is an annual tax on the garage of $14,400. That's just the cost to one garage of one regulation.

George Bush's biggest legislative debacle is the 1991 Civil Rights Act. Worse than a quota bill, the act overturned the 1989 Supreme Court decision that gave white males access to the courts in cases of reverse discrimination. Thus, equality before the law has been breached, and the U.S. now has two separate legal classes: preferred minorities and white males. The ultimate consequences of this development extend far beyond economic and budgetary concerns. At the very least, by turning every hiring and promotion decision into a potential lawsuit, the 1991 Act has greatly raised the costs of employment.

When federal outlays are measured as a ratio of GNP, Mr. Bush's record on government spending looks even worse than it is, because the slow growth in GNP boosts the ratio. Measured in real terms, the compound annual growth rate of federal expenditures under Bush was 3.2 per cent, higher than Reagan's 2.5 per cent or Nixon-Ford's 2.7 per cent, but below Carter's 4.0 per cent and Kennedy-Johnson's 4.8 per cent. If the cost of the deposit-insurance bailout is excluded, Bush's figure drops to 2.6 per cent.

In these comparisons, it is important to note that Reagan's figure includes a defense buildup that helped to bring down the Soviet empire, while Bush's includes a defense builddown. Bush is no Reagan, and liberal pundits who speak of the Reagan-Bush record are dishonestly combining apples and oranges. Indeed, Mr. Bush lost because he abandoned Reaganomics and, like President Carter, made the government grow instead of the economy. If Bill Clinton intends positive change, it will mean going back to President Reagan's policies for making the economy grow instead of the government.

George Bush let Reaganomics go, relying instead on lower interest rates to work magic. When the Republican establishment's favorite elixir failed to deliver, Mr. Bush could have boosted the economy and public confidence by using his regulatory authority to index the cost basis of capital gains for inflation. He even had in his hand a ninety-page legal brief by former Assistant Attorney General Charles Cooper attesting to the appropriateness of the measure. George Bush, however, could not bring himself to use the powers of his office to help the economy, leaving a majority of voters wondering how he could be any better in a second term.