In 1997, President Clinton and Republican leaders in Congress--sensing voter disgust with partisan bickering--cast aside their philosophical disagreements long enough to balance the budget. That historic agreement, which included a cut in the capital-gains tax and expansion of individual retirement accounts, was enough for most investors to declare the year a success.
But don't look for a similar bipartisan lovefest in 1998. With no "must-do" issue on their plate, Democrats and Republicans are now itching to renew their political warfare over everything from reforming the tax code to spending a possible budget surplus. Meanwhile, the economic crisis in Asia is sure to spark pitched battles in Congress over the U.S. role in a bailout of troubled Pacific Rim economies and a prospective trade pact with South America. Asia's turmoil is "a real invitation for the demagogues in Congress to play on people's fears," says David Rothkopf, a former Clinton Administration trade official now at Kissinger Associates.
One fight will be over U.S. participation in a $57 billion rescue of South Korea by the International Monetary Fund. Fearful that the crisis could spread to China and Japan, Treasury Secretary Robert E. Rubin bypassed Congress by committing $5 billion from a Treasury currency fund. "We saw a deteriorating situation that we thought had important ramifications beyond Korea," says a senior Treasury official.
But Rubin and his top deputy, Lawrence H. Summers, intend to renew their call early next year for Congress to contribute to a new IMF fund, which may be needed soon if the Asian problems get worse. Many Hill mavens believe getting approval for these new funds will be difficult, especially since Asian countries will be trying to dig their way out of trouble by stepping up exports to the U.S. One certain no vote will come from Representative Bernard Sanders (I-Vt.), who rails against lending billions abroad "while it is very hard for American small-business people to access affordable loans."
The outlook for Asia will likely determine Fed policy as well. For more than a year, Federal Reserve Chairman Alan Greenspan has resisted internal pressure from hawkish colleagues to brake the surging economy by raising interest rates. However, with wages rising, Greenspan and other Fed officials began hinting last October that they were ready to nudge up rates.
But soaring imports from Asia, along with dropping Asian demand for U.S. exports, could cut U.S. growth by half a percentage point, to around 2.5%. This could enable the Fed to put off any rate hikes, especially if inflation remains tame. Given the tight labor markets, the Asian slowdown "hit at a good moment," says Fed Vice-Chair Alice M. Rivlin.
On the other end of Constitution Avenue, Republicans and Democrats can be expected to wage war over a favorite issue: the tax code. Emboldened by dramatic hearings into Internal Revenue Service abuses, Senate Finance Committee Chairman William V. Roth Jr. (R-Del.) will press for--and win--new restrictions on the nation's tax collector, such as shifting the legal burden of proof from audited filers back to the IRS.
But the IRS-bashing will be a warm-up for the GOP's real goal: a fundamental overhaul of the tax code itself. In the coming year, Republicans will press for broad-based reform, though they still haven't mustered a consensus within the party on just how they would rewrite the current system. House Majority Leader Richard K. Armey (R-Tex.) will renew his push for a 17% flat tax, while House Ways & Means Committee Chairman Bill Archer (R-Tex.) favors a national sales tax. Don't expect a new tax system before the '98 congressional elections, but count on lots of rhetoric as the GOP tries to convince the public that radical reform is needed.
POPULIST PROGRAM. Across the aisle, House Minority Leader Richard A. Gephardt (D-Mo.)--with his eye toward the Democratic nomination in 2000--will push a populist program that cuts taxes for families earning $60,000. Meanwhile, Senate moderate Bob Kerrey (D-Neb.) favors a plan to encourage savings through creation of a super-IRA that shields all investment income from taxes until earnings are withdrawn.
Not to be outdone, President Clinton has already created an Administration task force--led by Summers and National Economic Council Director Gene B. Sperling--to come up with proposals of their own. But Clinton has set some specific ground rules for any tax initiative: It must be simple, fair to the middle class, a boon to economic growth, and it must not widen the deficit. That rules out any major tax cut as well as a flat tax, which Clinton claims would favor the rich.
Any revenue-neutral tax reform would also create losers as well as winners, and Clinton has never been willing to deliver bad news to voters. Even reformers such as Kerrey acknowledge that such moves are fraught with peril. "You almost have to repeal democracy to do this," he admits. "Unless you hold the line on [revoking] all the deductions, you can't do the reforms."
But reformers hope that this year the budget might--for the first time in two decades--move back into the black. "The big political change is that you can think about buying off the losers with the surplus," says one White House adviser. The problem: A surplus could quickly melt away if the economy slows significantly.
The GOP has its own ideas about what to do: Cut taxes. Their first target will be the marriage penalty, which forces some couples to pay more than they would as singles. The GOP can't repeal the penalty--which would cost $20 billion to $30 billion a year--but they may begin to phase it out.
Such goals pale beside those Clinton and congressional leaders shared a year ago. But with odds for cooperation dim, modest aims may be the best that can be achieved.