The "Northeast Strategies" Jude Wanniski June, 1980

Executive Summary: The political reapportionment due in 1982 already casts a shadow on the Northeast, which will lose political power as a result of its population loss. A "last chance" mentality takes hold among Northeast/Midwest liberals in this year's clash over the White House and Congress. The worry: Unless new redistribution schemes can be put in place before reapportionment, the shift of wealth to the Sunbelt will accelerate, especially as the rise in the price of oil benefits oil-producing states. Felix Rohatyn designs the strategies for the liberals: Rep. John Anderson calls for an end to Sunbelt severance taxes on oil, foreshadowing a long, regional struggle over energy taxation; Senator Kennedy couples a call for wage-and-price controls with a new "Marshall Plan" for the cities based on Rohatyn's penchant for state capitalism. Rep. Jack Kemp unveils a populist Northeast strategy, "greenlining the South Bronx," that Ronald Reagan contemplates as a campaign strategy.

The "Northeast Strategies"

There were several "terrors" during the French Revolution, but the bloodiest was the famous "Reign of Terror" that lasted from the Law of Suspects, September 17, 1793, to the execution of Robespierre, July 28, 1794. Most of the 18,000 heads that fell belonged not to aristocrats, but to the bourgeoisie. A principle cause was the collision of the paper money inflation with price controls. In "The Age of Napoleon," Will Durant writes of the period:

The economy was itself a battlefield. The price controls established on May 4 and September 29 were being defeated by the ingenuity of greed. The urban poor approved the maxima; the peasants and the merchants opposed them, and increasingly refused to grow or distribute the price-limited foods; the city stores, receiving less and less produce from market or field, could satisfy only the foremost few in the queues that daily formed at their doors. Fear of famine ran through Paris and the towns.... The mayor (went) to the Convention and voiced (a) demand for a..revolutionary army to tour France with a portable guillotine, arrest every Girondin, and compel every peasant to surrender his hoarded produce or be executed on the spot.

The liberals of the industrial Northeast are not yet as desperate as their Parisian counterparts were in revolutionary France. Their frustration increases as they repeatedly discover the difficulty in getting one region to willingly give up resources to another. For decades they have been arranging coalitions — New Deal, Fair Deal, Great Society — that have partly aimed at transferring wealth from the rest of the nation to the Northeast. Yet the relative decline of the Northeast not only continues, but threatens to accelerate in the 1980s.

"The Northeast has fewer people in 1980 than it did in 1970, the first time in the history of the census that an entire region lost population," Rq* Robert W. Edgar, Democrat of Pennsylvania, wrote to President Carter on March 27 in a complaint about budget cuts. "During that period, 3.4 million people left the Northeast-Midwest region for the South and West.... Our region lost 830,000 factory jobs between 1970 and 1979 while the South and West gained 1,860,000.... Income grew two to three times faster in the South and West than in the North. Taxes at the state and local level in many of the states of our region rose two to four times the national average, as a result of the loss of taxpayers."

People vote with their feet, and the net effect of the migration of the Seventies and the 8.4 percent population growth of the nation during the decade is a serious shift of political power from the Northeast. Because political reapportionment will not reflect this power shift until 1982 at the congressional level and 1984 in the Electoral College, a now-or-never political mentality is taking hold among the Northeast liberals. They have got to hold the White House and the balance of power in Congress for one more fling at getting the rest of the country to pay their bills. After 1982 it will be hopeless.

The doomsday scenario circulating in the Northeast is a dreadful one. All those experiments in creative, deficit finance have left the region buried in debt, while the people of youth, talent and enterprise who are the likeliest folks to pay off the bonds are drifting south and west. Worse, the Northeast staggers under a mountain of unfunded pension liabilities, and instead of sticking around to spend their pension checks in the Northeast, the elderly are also heading South and West. With more of the region's dwindling resources going for pensions and debt service, the politicians can only make ends meet by raising taxes and cutting public services, which only contributes to the exodus and the dwindling tax base. And the Northeast, the "Frostbelt," is hurt most as the price of oil relentlessly rises.

Meanwhile, the people in the Northeast read about the 400,000 citizens of Alaska enjoying a $4 billion annual bonanza in state severance taxes on oil production. Imagine the frustration of Mayor Koch in New York City who can't fill a pothole or repair the subways, hearing that the Alaska legislature is handing out cash dividends to citizens of the state and eliminating the state income tax. And North Dakota contemplates a 6% percent increase on its severance tax so it can drop its school tax and lower its income tax.

On April 19 in Washington, the Northeast-Midwest Congressional Coalition, representing Democrats and Republicans in 18 states, anguished over this new economic blow to their region. The Coalition observed that the decontrol of oil prices would bring major tax benefits to the oil-producing states that they could use to lure new industry from the Frostbelt. According to the Treasury Department, by 1990 the states will get increased revenues of $127.7 billion from severance taxes on energy sources — oil, coal, shale, natural gas — and that 90 percent of this would go to Alaska, California, Kansas, Louisiana, New Mexico, Oklahoma and Wyoming.

"The United States faces a shift in national wealth which threatens our economic and social stability," were the opening words in Felix G. Rohatyn's address to the Fordham University Annual Dinner on April 24. And when Mr. Rohatyn speaks, the Northeast liberals listen. His Fordham address was ominous.

A partner in the investment banking firm of Lazard Freres & Company, Mr. Rohatyn also chairs the Municipal Assistance Corporation in New York City. A modern-day Robespierre, his task for several years has been to design clever stratagems to "recycle" funds from the rest of the United States — indeed, the rest of the world — with which to finance the debt of New York City in particular and the Northeast in general. The "portable guillotines" he proposes sending out are of the variety that sever a taxpayer from his wallet. And his influence is extraordinary, largely owing to his 1974-75 success in outfoxing Treasury Secretary William Simon and getting the federal taxpayers to bail out the New York City bondholders (chiefly David Rockefeller and Chase Manhattan). "Felix the Fixer," as Mr. Simon calls him, coaches not one Presidential candidate, but two, each with different Northeast strategies designed by Mr. Rohatyn: Sen. Edward M. Kennedy, Democrat and Rep. John B. Anderson, Republican and Independent In the Fordham address, we can hear him prepping his two candidates:

Much has been made recently of budget surpluses at the state and local government level. However, over 60% of state surpluses in 1978 were concentrated in 'those 8 states accruing more than 90% of revenue increases from oil decontrol over the decade. Like a domestic version of OPEC, the oil producing states can use their vast revenues to lower other taxes, increase services, attract industry by almost unlimited means; their economies as well as the economies of surrounding states will get significant boosts.

And, like a domestic version of the Third World, the Northeast and Midwest, importers of fuel, needy for additional federal assistance, will bear the burden since, after all, this is a zero-sum game. It is really not very difficult to see where this inevitably leads. Half the country nearly bankrupt, many of its major cities pools of unemployment and unrest and the other half swimming in oil, industry and wealth. This is not the stuff of a stable democracy; it is not the stuff of a union of states. For a union to survive there must be a sense that both burdens and benefits are shared on an equitable basis. Otherwise New Jersey can refuse to pay its share of the defense budget and New York can charge neighboring states for every drop of water flowing across its borders. Nor is it in the interest of Oklahoma and Louisiana to witness the demise of Michigan and New York; they will not be thrilled by the influx of population and they will inevitably share in the support costs.

When we hear Mr. Rohatyn worry about the interests of Oklahoma and Louisiana, we can almost hear the tumbrels begin the roll. He will help them by taxing them:

The governor and the mayor, together with our business and labor leadership, must lead a coalition of northeastern and midwestern cities and states to accomplish that without which we have no hope of survival: to bring to our older cities and states a permanent stream of additional federal aid and revenues without which our cities cannot function and our local economies cannot flourish.

Within a week, Rep. Anderson was stumping in Detroit on the Rohatyn issue and The New York Times of May 2 headlined: "Anderson Asks Curb on Severance Taxes; Seeks a Redistribution of Revenue That States Raise From Gas, Oil and Coal Production."

The most astonishing part of the story that followed was Mr. Anderson!s rationale, which employed an argument that the liberals ridiculed when it was employed against enactment of the "windfall profits tax." According to the Times:

He said that severance taxes on energy production, when used as a general source of revenue, created "higher energy prices" that were "passed along equally in the form of lower energy production."

"Such beggar-thy-neighbor policies do not serve the national interest," he added. "They only serve to fractionate and divide the nation."

Unwittingly, Mr. Anderson has stumbled into the supply-side model, seeing that a tax on energy production in the Sunbelt is paid in the Frostbelt, just as the tax of price regulation on the French peasantry was ultimately paid by the urban poor. In contest, the "windfall profits tax" was passed because the President was told that decontrol of oil prices would add $1 trillion to the oil industry revenues in the 1980s. The "windfall" tax plus normal corporate and income tax bites of the $1 trillion will take $700 billion, according the Chase Manhattan. The American Petroleum Institute is less optimistic, figuring decontrol will now leave the industry with less than 18 cents on the dollar. The practice of projecting an inflated revenue figure for the industry, then assuming that the industry can "afford" to give up a bigger slice in taxes, is illusory when there are so many tax bites on a discovered barrel.

There is an increased incentive to explore and produce, and with newly discovered oil fetching $32 a barrel net of the "windfall" tax, a record number of drilling rigs, 2,800, are now at work in exploration and development; an estimated record 58,000 wells will be drilled in the United States in 1980. The projected rate of discovery and development, though, is not nearly up to the levels that would forestall increasing dependence on imported crude oil.

Mr. Rohatyn has no doubt discussed the severance-tax issue with Sen. Kennedy, but has kept him on a separate track. Sen. Kennedy has been pushing a "wage/price freeze" at the suggestion of Mr. Rohatyn, probably with the same logic that led to the "Reign of Terror." The ability of the South and West to charge higher prices and pay higher after-tax real wages puts the Northeast at a competitive disadvantage; a "freeze" thus benefits the Northeast at the expense of the rest of the nation. Or so the illusion goes. 

Sen. Kennedy's newest Northeast gambit, though, is his "Marshall Plan" for the "re-industrialization" of America, which is also of Felix Rohatyn design. The Times of May 21 reported from Newark that Kennedy proposed "setting up an 'American reindustrialization corporation' that would use both Government and private capital to stimulate broadscale new investment in United States businesses and technology." Kennedy "talked of 'a new economic partnership' between government, business, labor and academia."

He said that the endeavor should have greater vision and purpose than even the projects that led to the development of the atomic bomb and the conquest of space. He said that the scope of the program should be at least as large as the Marshall Plan (and) promised that he would move to establish the corporation within the first 100 days of his Administration.

The corporation, he explained, would be a quasi-public institution, administered by a board whose members came from both the public and private sector. It would be empowered to provide grants, loans, guarantees and subsidies to individuals, businesses, industries, research organizations and cities interested in new economic development or revitalization of existing industries or businesses. The corporation's funds would come from Congress and from borrowing in capital markets, with an initial budget of about $1 billion.

"Our goal must be nothing less than the re-industrialization of America," he said. "The corporation will have the authority to issue and sell stock so that all Americans will have the opportunity to own a piece of their nation's future."

In short, Sen. Kennedy proposes an ultra-elitist redistribution scheme along state-capitalist principles, which, when similarly formulated by Mussolini was called "fascism." The "quasi-public institution," perhaps chaired by Mr. Rohatyn himself, would consist of the best and the brightest of informed opinion (The Trilateral Commission?). It would be able to borrow in the capital markets. That is, it would be able to reach into every little savings bank in the country, pull out resources and leave an I.O.U., and then "relend" the resources to worthy "individuals, businesses, industries, research organizations and cities."

A portable guillotine. And Business Week magazine, which has become the organ of state capitalism in the last decade, was almost breathless with excitement:

To attack the problems of declining economic vigor, productivity, and international competitiveness, Kennedy wants a labor-management-government "partnership," somewhat akin to West German and Japanese models, and creation of a quasi-government American Reindustrialization Corp. to funnel direct loans, loan guarantees, and grants to beleaguered U.S. industries.

Another Carter challenger, Representative John B. Anderson (R-Ill) who is seeking the Presidency as an independent, came out for much the same policy after discussions with New York financial executive Felix G. Rohatyn, a longtime advocate of an industrial aid agency patterned after the old Reconstruction Finance Corp. Although probable Republican nominee Ronald Reagan has yet to address the issue, an adviser, former Deputy Treasury Secretary Charls E. Walker, is pushing to establish a national guarantee authority....

But the White House has allowed the reindustrialization issue to slip out of Carter's hands and into the grasp of his rivals. Kennedy is terming the industrial decline and sagging U.S. competitiveness "the deepest economic crisis since the Great Depression." This type of political heat may in the end force Carter to come up with a broader blueprint for rebuilding the nation's industrial base.

Robespierre has all bases covered, just about. President Carter will have to swallow at least a piece of the Kennedy plan in the Democratic platform. In the fall campaign, John Anderson will be making sure the issue is aired. (College students especially are thrilled by elitist schemes, grand designs cooked up by philosopher kings). Even Ronald Reagan has the idea circulating in his camp now that Charls Walker, who was John Connally's chief economic adviser, has come aboard. Mr. Walker advocates government "soft-loan" windows as a solution to just about any problem in the political economy. Reagan campaign director William Casey, who has a soft spot in his heart for soft-loan windows from his tenure as chairman of the Export-Import Bank, assisted Mr. Walker in acquiring the chairmanship of the tax-policy committee in the Reagan campaign. Both Mr. Casey and Mr. Walker are announced opponents of the Kemp-Roth 30 percent tax cut which, due to Mr. Reagan's stubbornness, happily remains campaign policy. Reagan has a "Northeast Strategy" of his own, an economic growth strategy of which Kemp-Roth is an integral part.

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It would be difficult to document, but easy to believe that the South Bronx produces less tax revenue per capita — Federal, state and local -- than anyplace else. The South Bronx is surely near the top of the Laffer Curve.

Imagine that you could draw a green line around the South Bronx and declare a tax holiday within its boundaries. For a period of years, 15 or 20, all enterprises in the South Bronx would have a significant portion of their tax bill waved. Because the criteria would be established by law, entrepreneurs would not have to go before a "quasi-public" elite board of wise men to get a hand-out, revenues or capital collected from the rest of the nation's taxpayers or savers. They could just move within the boundaries of the South Bronx and crank up an enterprise. Or, they might suddenly discover that investors outside the South Bronx were now willing to inject capital into the South Bronx, given the increased potential for return. If we can assume there are individuals of entrepreneurial potential in the South Bronx, we might imagine the improvement in tax climate would be sufficient to initiate some degree of business growth. Where there was no tax base at all, revenues would now begin flowing to all levels of government from that portion of the tax bill not waived. At the same time, we might imagine that the individuals employed in such new enterprise would cease being consumers of tax revenues collected in the rest of the city, state and nation.

This is the concept behind Representative Jack Kemp's "Inner-City" bill, introduced on May 1. The "Urban Jobs and Enterprise Zone Act of 1980" H.R. 7240, would essentially "greenline the South Bronx" in the fashion outlined. Local governments would select the areas of urban decay, which would have to meet poverty and/or unemployment criteria.

A key provision would require the local government to demonstrate good faith itself by agreeing to a moratorium on a specified amount of its own tax collections in the greenlined area. This is precisely the opposite strategy of the urban programs of the past 30 years, which would send resources to a city if the city demonstrated that it was already taxing itself oppressively. The more a community crushed out internal initiative, the more it was rewarded by Uncle Sam, which agreed to increase the level of taxation outside the city in question in order to finance the rewards.

The ink was barely dry on Kemp's bill and it was attracting the attention of the inner city. On May 9, William Raspberry of The Washington Post a black whose column is nationally syndicated, devoted his column to the idea.

If you believe, with the Carter administration, that inflation can be cured by creating a recession that curtails production and throws people out of work, what follows won't make much sense to you.

But if you believe that what America needs is more people gainfully employed, more people producing goods and services, then you might be interested in the Urban Jobs and Enterprise Zone Act introduced by Rep. Jack Kemp (R-N.Y.)....

It certainly seems a more positive cure than a deliberately generated recession.

The Congressional Black Caucus, which has been proposing a dead letter for years — massive Federal spending on the inner cities (another version of the "Marshall Plan") began buzzing about this idea, although nervous about the political implications of coalescing with Republicans. Margaret Bush Wilson, chairman of the N.A.A.C.P., said she would ask the organization1 economic task force to analyze the proposed legislation, and that whether or not the idea could be supported "is almost less important than the fact that the Republicans are thinking about the inner city."

Rep. Robert Garcia of the South Bronx, a liberal Democrat, circulated the idea and found Jack Kemp's name "raised a red flag," but when he discussed the idea without mentioning Kemp's name he got enthusiastic responses, and this persuaded him to co-sponsor the legislation. And Kemp, who had sent a copy of the legislation to Ronald Reagan, got back a handwritten note. "He loved it," Kemp told the Washington Post.

With George Bush dropping out of the GOP race on May 26, Reagan can turn his attention to the July convention and his three highest priorities: picking a running mate, shaping the campaign platform, writing his acceptance speech. Each of these will be influenced by his decision to go to the heart of his opposition's strength with a Northeast strategy. If Ronald Reagan can cut into the South Bronx, he can win anywhere. It would also mean that the Republican Party could win anywhere, this being an "urban strategy" as much as it is a Northeast strategy. The long-awaited major political realignment is on the horizon, close enough to be grasped. And just as financial markets bottomed out in the summer of 1932, at the nomination of Franklin Roosevelt and the last major party realignment in the United States, the summer of 1980 should bring the beginnings of a major bull market.