For Baker, the escape route presented itself, oddly enough, in the form of a hung-up telephone. It was 7:50 in the morning, ten days after the election, and Baker was dealing with a red-hot treasury secretary. Donald Regan shouted at him with all the lusty profanity of the Marine he had once been. “Fuck yourself and the horse you rode in on,” Regan snapped and then slammed down the receiver.
Regan was upset that his remarks on the economy at a cabinet meeting the day before had, in fact, been leaked to The Washington Post even though he had gone on the warpath about leaks. He should not have been surprised. He should not have been surprised. But Regan took the matter so seriously that after hanging up on Baker he drafted a letter of resignation. Baker told Reagan what had happened, then volunteered to go mollify the fuming cabinet secretary.
By the time Baker arrived at the Treasury Building, next door to the White House, Regan had cooled down but he still had the letter of resignation ready. Baker told Regan that the president might refuse to accept it, not knowing if that was really true or not. Regan suggested that the two of them have lunch and they shared their mutual frustrations. Regan could not help noticing that Baker seemed worn out and distracted. When the harried White House aide collapsed in a chair, sighed loudly, shook his head, and smiled ruefully, Regan asked what was wrong. Baker described a litany of aggravations—budget battles, hostile press coverage, campaign pressures, and so forth.
“You’re tired, aren’t you?” Regan said.
“You’re damn right I am,” Baker said. “Don, nobody’s ever held this job as long as I have that hadn’t either been fired or gone to jail.”
“You know what we should do, Jim?” Regan suddenly said. “We should swap jobs.”
Rather than laughing away the offhand comment, Baker looked like a drowning man who had just been thrown a life vest.
“Do you mean that?” Baker asked.
Regan paused. “I guess I do.”
Baker stood to leave, looking less harried. “Watch out,” he said. “I may take you up on that.”
As Regan described it later, the words just popped out of his mouth. It was less a carefully considered plan than a reaction to the moment. Regan was ready for a change too. As much as Baker was eager to break out of the hothouse center of the action, Regan found himself drawn to it.
Spontaneous or not, Baker took the idea of a switch seriously. Running the Treasury had not been his first choice. He had thought about secretary of state, but there seemed little chance that George Shultz would move on. He also would have liked to be attorney general, but Ed Meese had endured a year of delay amid questions about his ethics and now finally seemed headed toward confirmation. Baker had no special preparation for the job of treasury secretary—indeed, he had flunked at least one economics exam in college—but it was the second-ranking cabinet position and a chance to finally break out of the job that had been wearing him down.
In classic Baker fashion, he spent the following days methodically weighing the pros and cons, and carefully saved the arguments in his file. On the positive side, he wrote:
Both parties are tired of their current jobs and have spent a fair amount of personal political capital in them.
Both have completed a natural cycle—and the State of the Union would be a natural point for a shift.
Both would be re-invigorated by the shift—as would the Administration, thereby.
Dick Darman prepared another list of factors for Baker to consider under two columns, “Stay” and “Treas,” with each having two subheads, “Upside” and “Downside.” The upsides for taking the position included “Serious, substantive job—back to professional image (not just pol.); better positioning for later.” Another was “Can make own agenda—and stay a ‘winner.’ ” The downsides included “ ‘leaving a sinking ship’ stories” and “not as good as State (but: bird in hand vs. bush).” The notion that treasury secretary would be a stepping-stone “positioning for later” spoke to the extent of Baker’s ambitions even then—what could be better than treasury secretary? Secretary of state? Yes, and beyond that only vice president and president.
Baker talked it over with Michael Deaver, who was planning at last to leave the White House himself. Deaver liked the idea. Baker invited him to his Foxhall Road house in December for lunch with Regan to discuss it. As Baker and Regan outlined their proposed swap, the treasury secretary realized that Deaver already seemed to know about it. With Christmas nearly upon them, the three decided to wait to approach the president until after the holiday.
When they finally broached it with Reagan in January, Deaver recalled introducing the idea of Regan moving to the West Wing with a joke. “Mr. President,” he said, “I’ve brought you a playmate of your own age.”
The idea met with no resistance from the president, who was about to turn seventy-four. Reagan “nodded affably,” recalled Regan, then sixty-six. Asking no questions, Reagan promptly signed off on the switch.
Just like that, the president agreed to a job trade that would stun Washington and reorder his whole administration. With no extended evaluation of whether Baker would make a good treasury secretary or Regan a good chief of staff, Reagan had just staked his second term on a personnel decision that had been presented to him as all but a fait accompli.
In later years, Baker would insist that he genuinely thought Regan would run an effective White House, but others doubted that, even at the time. Stuart Spencer learned about the swap from the radio and assumed that Baker had not asked his advice because he knew what it would have been. “I’d have flipped out,” Spencer said. The longtime chairman and chief executive officer of Merrill Lynch, Regan was used to running things his way. He could be imperious and impatient. He cared a little too much about the perquisites of power. Baker’s maxim about his job was to focus more on the “staff” than the “chief”; Regan looked at it the other way around. And so in his desire to move on and move up, Baker left Reagan with a partner manifestly ill-suited for the job, arguably a disservice to the president he had worked so hard to make successful. One confidant said Baker did not want Regan to fail, but was so eager to get out that he did not focus on what would happen to the White House after he left. “If I was totally honest,” the confidant said, “I don’t think he cared.”
The day after Reagan signed off on the swap, the White House promptly announced it to a shocked capital—once made, Baker was not going to let the decision linger lest it start to draw fire the way his abortive appointment as national security adviser had. His confirmation hearing before the Senate Finance Committee on January 23 turned out to be a “friendly session,” as Senator Bob Packwood of Oregon, the Republican chairman, put it, a serious, sedate affair that Baker navigated readily enough. Susan was in the audience to show support along with three of their eight children. None of the senators expressed doubt about Baker’s qualifications for the job or challenged his judgment. No one questioned his decisions as chief of staff or mentioned his lack of a financial policy background. Instead, they tried to pin him down on tax reform, questions that he dodged with practiced ease. The Senate followed up six days later by voting 95 to 0 to confirm Baker as the nation’s sixty-seventh secretary of the treasury.
Baker was sworn in twice, the first time in the basement of his home on February 3 with Mary-Bonner, now seven years old, holding his mother’s Bible for a quick installation so he could get to work, and then again five days later in more ceremonial fashion in the Oval Office with Reagan presiding. George Bush was out of town, so Barbara Bush came to represent the family at the White House ceremony. Baker introduced his children to Reagan one at a time, nervous enough at one point that he misidentified one of the boys and had to be corrected by Susan. “Isn’t it something to have so many children you get mixed up?” she joked as Reagan greeted her with a kiss on the cheek.
In taking the oath, Baker assumed the same position once held by the likes of Alexander Hamilton, Andrew Mellon, and Henry Morgenthau. The Secret Service, which was part of his department, gave him the code name “Fencing Master” and his distinctive James A. Baker III signature was put on the next printing of the United States dollar. Susan bought him a green tie from Neiman Marcus representing the color of the currency, a fashion choice that would soon become a trademark for the rest of his career. Finally, he had transcended his role of fixer. Finally, he was no longer staff. He was, in Washington terms, a Principal. “He couldn’t have been more thrilled,” said Margaret Tutwiler.
Baker’s mandate was set by the president in his State of the Union address to Congress on February 6 when Reagan called for historic reform. “Tonight,” Reagan added, “I am instructing Treasury Secretary James Baker”—and here he paused to joke, “I have to get used to saying that”—before continuing, “to begin working with congressional authors and committees for bipartisan legislation conforming to these principles.” The deadline he set was soon—a bill by the end of 1985. “Together, we can pass, this year, a tax bill for fairness, simplicity and growth, making this economy the engine of our dreams and America the investment capital of the world. So let us begin.”
WHAT REAGAN WAS assigning Baker to do was both monumental and politically fraught. Cutting taxes, as they had done in the first term, was easy and popular enough. This was different and much, much harder, rewriting the tax code from top to bottom to make it more rational. Any efforts to clean out the system had routinely fallen short over the years. But this time, the stars seemed to be aligned.
In the Reagan era, nearly everyone agreed that the tax code was a disaster. It was pockmarked with lucrative breaks for industries whose lobbyists had adeptly worked the halls of the Capitol, reflecting the power of special interests to game the system. Even tax provisions with more altruistic goals, such as the deduction for charitable contributions, were a reflection of policymakers using the code to drive favored policies, often layered upon each other in piecemeal fashion rather than a comprehensive statement of national priorities. Polls found that Americans no longer considered the federal system fairer than their state or local tax systems.
In 1983, about thirty thousand taxpayers making more than $250,000 a year—including three thousand millionaires—paid less than 5 percent of their income in taxes, according to a Treasury Department study. Corporate America was shouldering a smaller and smaller share of the overall tax burden, just 6 percent in 1983 compared with 25 percent when Dwight Eisenhower was president, a trend accelerated by Reagan’s original tax cut legislation. Another study found that since that bill was passed, 128 large, profitable companies paid no federal income taxes at all in at least one year while collectively earning profits of $57.1 billion, including such corporate giants as General Electric, Boeing, Dow Chemical, Tenneco, General Dynamics, and Lockheed.
All of this was no accident. Business had invested huge amounts of cash in the two political parties. By the time Baker set his sights on the issue, political action committees were contributing eight times as much money to congressional candidates as they were a decade earlier, with a sizable share devoted to the lawmakers who sat on the tax-writing committees in the House and Senate. Every major industry, it seemed, had a champion on the panels and every major tax break had someone who stood to lose and would fight to protect their interests. The status quo was held in place by powerful political gravity. “I sort of like the tax code the way it is,” said Bob Packwood, the Republican whose Senate Finance Committee would have to approve any changes.
The plan produced by Donald Regan’s Treasury Department in November 1984 and left for Baker when he arrived at the beginning of 1985 was a dud from the start. It proposed reducing tax rates by abolishing nearly all deductions, including popular ones favored by many taxpayers and businesses. In effect, it was the way a theoretician, freed of any political considerations, might have designed the tax code. “It was a very apolitical, idealized version of what the Treasury Department believed was appropriate to tax reform,” said Ronald Pearlman, who served as assistant secretary for tax policy under Regan and stayed on under Baker. “It was very controversial. Everyone had criticisms because with few exceptions it went after everything.” When Baker showed up at the Treasury Department, he “was quite hostile” to the plan, Pearlman recalled, less because of its substantive provisions than out of “his political judgment” about its viability. The plan, Baker said later, was developed with “a tin ear for politics.” Baker, who had immersed himself in the politics of Capitol Hill as Reagan’s chief of staff, decided to scrap the proposal and start again.
Settling into his new third-floor office in the Classical Revival building that had housed treasury secretaries for more than 140 years, Baker essentially imported his old White House team to help him do it. Dick Darman would be his deputy secretary and Margaret Tutwiler would be assistant secretary for public affairs and public liaison, his chief policy and political lieutenants respectively. John Rogers would be another assistant secretary. Robert Kimmitt would be general counsel.
Darman, Baker knew, came with baggage. He was brilliant, the brains behind many key policies of the last four years. He was a conceptual thinker in a way that Baker was not, and he was an instinctive contrarian, the one who, if everyone else in the room agreed that something was true, would say, “Don’t be too sure.” But even though Baker had long defended him, there were times when he grew aggravated with Darman as well. On the day that Reagan announced his appointment as treasury secretary, Baker scribbled out some rules of the road:
I’ve got to be the Sect.—can’t take away a “Baker/Darman.” All public pronouncements—JAB III. (Don’t need a “Baker/Darman” situation developing at Treas. like here at W.H.) Dick likes to foster image of “power behind the throne.” Limit total charge of an issue area. Dick should have no “own agenda” w/J Kemp or otherwise. Manage the Dept—R.G.D. Managing RGD is going to continue to be a prob. Be my dep’ty not own persona. If you want to go on this basis—OK. Otherwise something else.
Darman agreed. He was ready for a bigger role and eager to take on tax reform. In a memo he had written before Baker’s job swap, Darman had already identified an overhaul of the tax code as a possible domestic initiative for the second term. For a policy wonk, getting the chance to design and enact it was the opportunity of a lifetime.
But the tension with Baker during this transition reflected the reality of their complicated relationship. Darman despised the idea of being just an “aide.” In private, he groused that Baker would never have been Baker if not for Darman. His resentment at being Baker’s glorified sidekick was so palpable that for Reagan’s second swearing-in ceremony, Margaret Tutwiler and John Rogers teasingly had a special inaugural license plate made for Darman that read: “BAKER AIDE.” They slipped it to one of Darman’s assistants to have it put on his car so they would have plausible deniability. Darman angrily bent the license plate in half. “Dad hated that,” his son, Jonathan Darman, said of the gag plate.
Now was Darman’s chance to transcend his staffer past. As deputy treasury secretary, he would be a Senate-confirmed senior official, more than just an assistant. And so he and Baker put aside the strain and set out to remake the tax code. To develop their own tax reform plan, Baker and Darman reprised their approach to Social Security in 1983, picking out a few key negotiators from both parties and both houses of Congress and inviting them to Baker’s Foxhall Road house to haggle over details in secret.
The players gathered on Saturdays in the den in the basement. But Baker quickly discovered that he could not start from scratch with so many large personalities in one room. Representative Dan Rostenkowski, the Chicago ward-heeling pol who headed the House Ways and Means Committee and would be key to any tax legislation, resisted sitting down with junior members such as Representative Dick Gephardt of Missouri, a Democrat who had been pushing for reform. While Rostenkowski was fond of Baker, he resisted the secretary’s charms. “Jimmy boy, you’re massaging me,” Rostenkowski told Baker. “I have been handled by better than you and your hands are cold.”
Baker and Darman then shifted gears, deciding to write their own plan without Democrats and take their chances by sending it to Rostenkowski and Congress. Baker began holding Saturday meetings with his staff at the Treasury Building to map out a palatable plan, showing up with trademark cowboy boots on his feet and Red Man tobacco in his jaw as they chewed over ideas. Philosophy was out. Politics was in. The question Baker kept asking in one form or another was not Is this the best way to do this? but Can this pass? The challenge was all the more daunting because the plan not only had to lower rates while closing loopholes, but Reagan had made clear that it could not change the bottom line amount of money brought into government coffers. The total tax revenues would have to remain the same. In the vernacular of Washington, this was called “revenue neutral” and it would be the major challenge in crafting a final plan—every decision keeping one tax break would require a tradeoff to make up for the lost revenue.
As Baker had anticipated, Darman’s cantankerous demeanor caused headaches. When congressmen involved in the tax debate wanted to have a principals-only meeting and insisted that he leave the room because he was “staff,” Darman erupted, declaring that he was the deputy secretary of treasury confirmed by the United States Senate, not staff. And as a self-perceived principal, Darman felt little need to confide in subordinates what he was up to. Ron Pearlman, the assistant secretary who was supposed to be in charge of tax policy, would find out from friends on Capitol Hill that Darman had been up there negotiating without telling him.
“There were times of stress and strain between him and me,” Pearlman said. Baker sought to calm him. “The secretary at times would tell me, ‘Cool down, don’t take it seriously, he’s a brilliant guy, I’m the decision maker here, don’t get too uptight.’ ” Pearlman came to believe that Baker had made a devil’s bargain in bringing Darman to Treasury, accepting his deputy’s volatile nature and dismissive side as the price for his intellect and policy creativity. “Baker knew that he brought a lot to the table,” Pearlman said of Darman. “There were times he would go too far, he would alienate someone, he would take a position that didn’t make a great deal of substantive sense. But Baker could deal with that.”
Baker and his team presented their plan to Reagan, with Donald Regan, author of the version they had scrapped, sitting in Baker’s old chair as chief of staff. Over the course of several meetings, the president approved all the major provisions. But suddenly the Treasury Department’s revenue estimates shifted so that the plan would bring in $150 billion less over five years than originally projected. When the Treasury team arrived at the White House to explain to Reagan what had happened, an irritated Baker felt no urge to take the blame.
“Ron, you describe this to the president,” he instructed Pearlman, whose office had been responsible.
Pearlman years later recalled Baker saying it jokingly, but with a real edge. “It was a jab,” he said. “He clearly wanted to communicate to the president this was something he wasn’t involved in.”
After adjustments were made to eliminate the new revenue gap, Reagan finally unveiled the plan in a nationally televised address to the nation from the Oval Office on May 28. “Death and taxes may be inevitable, but unjust taxes are not,” he said as Baker watched. “The first American Revolution was sparked by an unshakable conviction—taxation without representation is tyranny. Two centuries later, a second American revolution for hope and opportunity is gathering force again—a peaceful revolution, but born of popular resentment against a tax system that is unwise, unwanted and unfair.”
Dan Rostenkowski gave the Democrats’ televised reply and he welcomed Reagan’s initiative. “If the president’s plan is everything he says it is, he’ll have a great deal of Democratic support,” Rostenkowski said. “That’s the real difference this time. A Republican president has joined the Democrats in Congress to try to redeem this long-standing commitment to a tax system that’s simple and fair. If we work together with good faith and determination, this time the people may win. This time, I really think we can get tax reform.”
Rostenkowski’s response sent a powerful signal to the nation and spoke volumes about the credibility of Baker’s efforts across the aisle. In later years, with different presidents and treasury secretaries and congressional leaders, tax proposals would be cause for immediate and relentless partisan battling. In this case, Baker was seeking nothing less than a wholesale revision of the tax code, affecting nearly every taxpayer and business in the country, and he was trying to do it in tandem with the opposition party. Rostenkowski had just made clear that he was ready to give it a shot, embracing Baker in a high-stakes venture.
FOR BAKER, the drive to rewrite the tax code was only part of the mission in his new role. One of the challenges he found when he arrived at the Treasury Building was the strength of the dollar, which, odd as it must have sounded to his political team, was not necessarily a good thing for the country.
While there were advantages, a strong dollar meant that American exports became more expensive for foreign customers to buy and therefore domestic firms found themselves all but shut out of overseas markets, especially industries producing steel, textiles, aircraft, automobiles, and agriculture. The dollar had appreciated by 28 percent after inflation between 1980 and 1982 and, after a temporary decline, rose another 14 percent from 1983 to 1984.
As a result, the country was flooded with cheap imports and the trade deficit ballooned to an all-time record of $109 billion in 1984, more than four times as high as when Reagan took office, while West Germany and Japan developed large trade surpluses. This came at a time when Japan’s soaring economic growth was leading to grim prognostications of American decline. The Japanese were conquering world markets with their automobiles, computers, cameras, and video recorders. They were investing their surplus cash buying up American government debt. One prominent economist compared the United States to the husband who spends too much and Japan to the wife who saves. Americans were reading headlines like “The Japanning of America Today.”
In keeping with his free market philosophy, Reagan had taken a hands-off approach to the dollar for most of the first term but as the situation worsened, he faced threats of protectionist legislation in Congress. Finally, in mid-1984, Donald Regan negotiated an agreement with Japan intended to liberalize its financial system and strengthen the yen against the dollar. But it had the opposite effect. Between mid-1984 and February 1985, the dollar appreciated another 20 percent.
Now it fell to Baker to fix the problem. Never ones to let ideology stand in the way, Baker and Darman opted to put aside the first-term laissez-faire policy altogether and intervene more aggressively to weaken the dollar to improve conditions for American exporters and make it easier to pay down American debt. In a memo to Reagan, Baker argued that his effort could be useful in “diffusing protectionist pressures in Congress.”
What Baker wanted to try was something no American official had pulled off before—he set out to secretly craft an agreement with the world’s other leading economic powers to coordinate their currencies. To do so, he had to keep the whole effort hidden from the public, lest a leak set off furious market speculation. So he furtively invited his counterparts and top central bankers from four allies known, together with the United States, as the Group of 5, or G5—Britain, Japan, France, and West Germany—to the landmark Plaza Hotel in New York to negotiate an agreement on exchange rates. On a Sunday in September 1985, when the markets were closed, he snuck them into the hotel without anyone noticing and only allowed aides to notify reporters about the meeting after it was already under way. Needless to say, this was not how finance ministers typically rolled.
Baker convinced the other officials to go along with his plan by scaring them with the prospect of new trade barriers being threatened by populist members of Congress. Sitting together in the Plaza’s ornate Gold Room, Baker and the finance ministers set a mutual goal of depreciating the dollar by 10 percent to 12 percent. The other nations would begin selling dollars in international currency markets to increase the supply and bring down the value of the dollar. The five powers also agreed on specific adjustments to their macroeconomic policies. Japan committed to opening its markets to more foreign goods. West Germany agreed to cut taxes to stimulate economic growth. The United States, for its part, vowed to rein in its out-of-control budget deficits.
The full scope of what was agreed to was profound and largely without precedent. It was the first time individual countries had agreed to change their economic policies to achieve an international goal and the first time that the world’s top central bankers had agreed to intervene in currency markets. The Plaza Accord, as it came to be known, was a key step en route to the globalization of financial markets. Not all of this was publicly announced when Baker and other ministers emerged from the secret talks, however, and it would have caused a big stir if it had been. Still, the communiqué released to reporters, while cryptic, signaled clearly that a significant move had been taken. In it, Baker and the other ministers declared that a weaker dollar “is desirable” and added that “they stand ready to cooperate more closely to encourage this when to do so would be helpful.” Baker followed up in person with the media to hail the agreement. “What’s new is that we’re all here together,” he told reporters.
He was not entirely together with his colleagues in the Reagan administration, though. Baker’s fixation on secrecy meant that some key American officials were caught off guard, not least George Shultz, who as secretary of state (and a former treasury secretary) felt blindsided about major negotiations with top allies, even if they were on Baker’s turf. “Shultz got livid at me,” Baker recalled.
But Baker was determined to keep others out of his lane. Just two days after the Plaza Accord, Commerce Secretary Malcolm Baldrige said at a breakfast for reporters that the United States did not plan a massive intervention in currency markets to reduce the value of the dollar but that in his personal opinion, the dollar would need a 25 percent decrease to make it competitive once again. “I don’t think we would get into massive intervention,” Baldrige said. Which of course was what Baker had just agreed to do with the world’s other leading powers.
Baker slapped him down hard. In a two-sentence memo sent the same day and marked “EXTREMELY URGENT,” he wrote Baldrige: “This is killing us. Please get out a correction saying that you were misinterpreted and that the United States does not and will not comment on intervention.” Baker cracked the whip on Baldrige publicly a few days later when a reporter asked about the commerce secretary’s comments. Baldrige, Baker said, “doesn’t speak for the administration on the subject of exchange rates.” He claimed that “we do not have a target” but added that “a moderate, gradual decline in the dollar would not displease us.”
The agreement worked. By the next day, the dollar slid by about 5 percent and reached its lowest level against the Japanese yen in nearly four years. Between 1985 and 1987, the dollar depreciated by 40 percent. The plan worked so well that just seventeen months later, Baker and his counterparts got together again to apply the brakes. Some of the other powers, especially Japan, were buffeted by the fall of the dollar. Meeting in February 1987, this time at the iconic Louvre Museum in Paris, and joined by the finance ministers from Canada and Italy, Baker and his counterparts agreed to stabilize the dollar at its current, much lower rate by purchasing dollars in international currency markets, thus reducing the supply and bolstering the dollar’s value, and by tightening American monetary policy, thus reducing inflation. As part of the Louvre Accord, Baker also agreed to stop talking down the dollar, which he had done in the past to convince international markets that it would continue to decrease in value.
But in some ways, all these interventions may have worked too well. By weakening the dollar and then locking in a lower rate, the accords had strengthened the yen, enabling the Japanese to embark on an epic buying spree in the United States. In the four years following the Plaza Accord, Japanese investors bought a series of American landmarks, from Columbia Pictures to Rockefeller Center in New York, triggering a political backlash among American politicians and public figures who competed in their Japan-bashing.
Among the bashers was a brash New York real estate developer named Donald Trump. A showman and tabloid magnet who opened his signature Trump Tower on Fifth Avenue in 1983 and his namesake Atlantic City casino in 1984, Trump had lately decided to take his New York brand of notoriety national, making splashy acquisitions and commenting on politics. “A lot of people are tired of watching other countries ripping off the United States,” he said in 1987. “They laugh at us behind our backs. They laugh at us because of our own stupidity.” Trump took out a full-page ad in newspapers including The New York Times arguing that the United States should charge countries such as Japan for protecting oil tankers traveling through the Persian Gulf, an ad developed by the same public relations executives who had been part of Reagan’s Tuesday Team in 1984. Trump even signaled that he might run for president in 1988. “I think I’d win,” Trump told the talk show host Oprah Winfrey. “I’ll tell you what: I wouldn’t go in to lose.”
NEGOTIATING WITH the Japanese was one thing. Negotiating with Dan Rostenkowski was another. With Baker’s plan for tax reform now being considered by Congress, it was time to reach out again to the powerful committee chairman to see if they could reach the deal they could not in the spring.
Rostenkowski was an archetypal figure on Capitol Hill, physically imposing and gruff, an old-school wheeler and dealer who maintained tight control over his committee, dispensed favors to friends, punished enemies, and savored the perks of power as he held court on the lobbyists’ dime at the new Morton’s Steakhouse in Georgetown. The son of a Chicago alderman, Rostenkowski grew up in the machine of Mayor Richard Daley. As a young man, he played baseball well enough to earn a tryout with the Philadelphia Athletics and served in the Army during the Korean War but was already on the road to a life in politics like his father.
He won a seat in the House in 1958 at age thirty, making him the youngest member of the House at the time. He went on to build a power base, helping to write the law that created Medicare and many other pieces of financial legislation. Blunt spoken, with a girth as expansive as his backslapping personality, Rostenkowski became chairman of Ways and Means in 1981, as Reagan was being sworn in, and he was determined to keep the exclusive panel “the Cadillac of committees,” as one of his young protégés, Representative Tom Downey of New York, remembered him calling it. To do so, he had no problem working with Republicans. “Rosty,” as he was universally known, had compromised with Baker on tax cuts and Social Security in the first term and was ready to do so again.
“Rostenkowski and Baker both really wanted to get the deal done and neither of them was obsessed with precisely what was in it,” said Jim Jaffe, a longtime aide to Rostenkowski. “They shared that. They shared a friendship going in.” That did not make it easy sailing. In the months after Reagan unveiled Baker’s plan, the secretary and the chairman engaged in their share of shouting matches. They quarreled over details and strategy. But Baker understood how to manage the relationship.
“Baker really played Rostenkowski like a cello,” Jaffe remembered. Rostenkowski was still eager to show that he could be a power broker like those who had previously held the Ways and Means chairmanship, such as his mentor, the legendary Wilbur Mills. “This is Rostenkowski’s first opportunity to prove he’s the capital-C chairman and Baker’s going to enable him to do this.” Rostenkowski was “still sort of awed by people who wear $800 suits and have a lot of money like Jim Baker. Baker plays him by saying, ‘You are the chairman, you’re the guy who can get this done.’ Baker comes in and says, ‘You’re the man, you know how to get things done, we’re going to get this done together, you tell me what you need me to do and I’ll do it.’ ” The two also bonded over the seeming impossibility of the task they were taking on. “The whole it-can’t-be-done thing made it even more appealing to both Baker and Rostenkowski,” Jaffe said. “They both puffed up their chest and said, ‘You say this can’t be done, but we’ll show you.’ ”
The relationship sometimes left others feeling resentful. Dick Gephardt, one of the early promoters of tax reform, bristled at being shut out. “I have heard more about what the president plans to do on this issue from the press than I have from the president’s representatives who were supposedly consulting with me,” Gephardt griped in a statement to reporters. Baker marked that sentence on a copy of the statement. “Cheap shot,” he wrote. “Politics—just trying to get ink.”
The politics of putting together the bill were treacherous. Baker set four bedrock conditions on behalf of the president—in addition to being revenue neutral, any final measure had to reduce the top income tax rate for individuals to no higher than 35 percent, remove millions of lower-income families from the tax rolls, and retain the popular mortgage interest deduction. That left plenty to fight about. An army of lobbyists in designer loafers mobilized, nervously trolling outside the committee chambers in the Longworth House Office Building as they tried to figure out how to protect the favored treatment of various industries. This would provide the title of the classic book on the legislative battle by the Wall Street Journal reporters who covered it, Jeffrey Birnbaum and Alan Murray: Showdown at Gucci Gulch.
It was perhaps the most complicated legislation considered by Congress in a generation. One lawmaker’s boondoggle was another’s must-have provision. Those from states with high taxes were determined not to let the deduction for such levies be repealed. Every member had a local industry to protect. And every industry had a special pleading. Manufacturers wanted to make sure they could still write off the depreciation from their expensive equipment. Retail businesses could not care less about that but eagerly pushed to lower the corporate tax rate. Baker the Fencing Master was jousting with all sorts of adversaries at once; the challenge was figuring out which lawmakers and interests he could afford to brush off. “Tax reform gets tougher and tougher, and a lot of the press are ready to write us off,” Baker wrote his son Will Winston in September. “But that’s premature, and we still have a chance of getting there—if not this year, certainly during the first part of next.”
Among those who objected to what Baker was doing was Donald Trump who this time was complaining about a matter of more immediate concern to his bottom line. When he arrived in Baker’s office at the Treasury Building for a 4:45 p.m. appointment with the secretary on July 9, he raised hell about the impact of the tax reform legislation on real estate. “He came in there like a stormtrooper,” Baker recalled. Baker finally pointed out the window to the White House. “Look,” he said, “you’re at the wrong building. This building right across the street here, a guy that wants to do this is in that building and you need to go over there.”
The bill Rostenkowski ultimately came up with did not meet all of Reagan’s conditions, much less Trump’s. It lowered the top rate only to 38 percent, included a less generous personal exemption for taxpayers who did not itemize, and raised taxes on corporations more than the administration’s plan. Baker concluded it was better to pass the bill, flawed as it was, and get it to the Senate, where it could still be adjusted. But that was not an argument that worked with Republicans, who balked at voting for what they considered a Democratic measure. Leading the revolt, in fact, was Baker’s old friend Dick Cheney, now a congressman from Wyoming. “We’re going to oppose you on this and we’re going to beat you,” Cheney told Baker. Much as he had with Donald Trump, Baker told Cheney that he should take it up with the man next door. But Cheney was not so easily dissuaded. “It was garbage, it was not a good bill,” Cheney said later. “We didn’t want to have to vote on a bad bill.”
Cheney teamed up with Representative Trent Lott of Mississippi, another conservative leader, and rallied the Republicans. Not wanting to vote directly against Reagan, they decided to vote against the procedural rule necessary for the bill to come to the floor in the first place. Baker tried to get Reagan to issue a statement accepting the bill with the promise that he would keep working to make it better, but his importuning generated no response from the West Wing and Washington began to suspect the White House was preparing to abandon the effort.
Baker appealed directly to Reagan. “Tax reform is one of your top two domestic priorities—and it will likely die if you do not support moving the Ways and Means bill forward,” he wrote the president on December 2. “The bill can be improved in the Senate.” If it is not, “you can veto it.” When that did not work either, the savvy former chief of staff went to Nancy Reagan, sending her a copy of a Baltimore Sun editorial and underlining several sentences that warned that if her husband did not get involved, he would “suffer the worst defeat of his presidency”—and at the hands of fellow Republicans. “Nancy,” Baker wrote, by now close enough to use her first name, “I think this editorial is right on the mark. The President ‘wants the process to go forward’—but there is a real risk that it won’t, because of G.O.P. votes, if he isn’t active early next week in calls & letters to Republicans. JABIII.”
Still, the message did not register. Baker had spent four years running the White House and now could not get it to respond. He was furious. On December 11, his warnings came true and Cheney fulfilled his vow to beat Baker as the House voted down the procedural rule by a vote of 223 to 202. Only fourteen Republicans sided with Reagan and Baker, a stunning rebuke. “Goddamnit,” Rostenkowski shouted into the phone when he reached the stunned treasury secretary. “The rule is going down.” As Baker recalled it later, “that was a very dark day.”
Tip O’Neill announced after the vote that he would only try to salvage the legislation if Reagan personally informed him that he had a list of fifty to seventy-five Republicans who would vote for final passage, a number Baker did not have. He appealed to O’Neill instead with pure emotion.
“Mr. Speaker, when in your lifetime will you have the chance again to take 6 million poor Americans off the tax rolls?” Baker asked.
But O’Neill would not budge. “You know, this is your bill, this was your idea,” he told Baker. “Now you’ve got to produce the votes for it.”
With the biggest domestic initiative of his second term hanging in the balance, Reagan finally engaged in the battle and arrived on Capitol Hill on the afternoon of December 16. Just that morning, Reagan had flown to Fort Campbell, Kentucky, to preside over a memorial service for 248 members of the 101st Airborne Division who had been killed in a plane crash in Gander, Newfoundland. As he addressed the House Republican caucus, he was in an emotional mood. “He got up and talked about sacrifice and patriotism and what it meant to be American and it was pure Reagan—off the cuff, very well done, touched every heart in the room, people in tears,” Cheney recalled. “He got all through and he said, ‘Now, gentlemen, about that tax bill.’ That’s all he said. Henry Hyde jumped up and said, ‘I’m with you, Mr. President, you can count on me,’ ” he added, referring to a widely respected Illinois congressman.
That broke the dam. Baker then spent the afternoon calling Republicans and securing commitments. The president really needs you, he told them. By the end of the day, Baker had Reagan call O’Neill to say that he had the fifty votes. O’Neill then allowed a face-saving amendment, a nonbinding call to change the effective date of the legislation, so that Republicans could say they were voting on a different rule. It passed the next day, 258 to 168, with seventy Republicans siding with Reagan and Baker.
Cheney assumed that Baker had cleverly timed Reagan’s meeting with the House Republicans for right after the memorial service, knowing that the president would maximize the emotional patriotism of the moment. “Obviously, a big part of that was Reagan’s natural talent,” Cheney said, “but you can bet your bottom dollar that Jim had a hand in scheduling the session.” Whether Baker really did manipulate the timing with that in mind, it says a lot that his friend believed that he did.
Either way, it had been a near-death experience. Now Baker had to convince the Senate to get on board.
THE KEY WOULD BE Bob Packwood, the Finance Committee chairman, who had admitted that he kind of liked the tax code the way it was—no doubt at least in part due to the fact that he and his colleagues had helped make it that way. A native of Oregon who studied law at New York University, Packwood had worked his way up in politics in his home state, first in Republican Party organizations and then the state legislature before winning his Senate seat in 1968. In Oregon tradition, he was far more moderate than most of his caucus, supporting abortion rights and gun control. He was the first Senate Republican to come out for impeachment of Richard Nixon. He was also known as one of those senators who took advantage of women who worked for him or lobbied him, a predilection that would later come back to haunt him.
Irascible and self-assured, Packwood had little patience for Baker. He was scornful of the treasury secretary, viewing him as a pain who was interfering in legislative affairs that were Packwood’s to manage. While the two were both Republicans predisposed to pragmatic politics, they would never forge the bond that Baker had across the aisle with Rostenkowski. Instead, the secretary had to try to manage the prickly senator without alienating him altogether.
Other senators found Baker refreshing and welcomed his determination to get something done. “He had a great way of communicating,” remembered Bill Bradley, a New Jersey Democrat who had made tax reform his personal project. “If you’re in a legislative situation, you communicate a lot with your eyes and your head and that kind of thing. Your lips are saying, ‘No, no, no,’ but your eyes are saying, ‘yes, yes, yes.’ Any number of times when somebody was saying something, even if they’re Republican, that was totally idiotic, he would look at me and raise an eyebrow as if to say, ‘I’m not really with this guy.’ And that makes you feel a part of all this.”
If Bradley was a willing partner, some in Baker’s own party were not, including Jack Kemp, the New York congressman and the Republican Party’s most prominent tax cutter other than Reagan himself. Kemp, a driving force behind the first-term tax-cutting legislation, intervened when he became concerned that Baker was selling out. In March, he wrote Baker a letter taking issue with the secretary’s embrace of the latest plan from the Senate. “I was astonished to read in yesterday’s paper that, in your judgment, the current Senate Finance Committee proposal meets the President’s goals for tax reform,” Kemp wrote.
Baker bridled at the congressman’s tone, interpreting the letter as classic Washington ass-covering, a way for Kemp to create a document trail that he could later point to in order to prove that he had spoken out against a flawed final product. “If you are again ‘astonished’ by what you read in the newspaper, please just pick up the phone,” Baker wrote back. “We’ll only get from here to where we both want to go if we talk directly—not as if we are merely trying to establish a written record.”
Baker seemed even more miffed when Bill Archer, a Republican congressman from Houston and a friend going back to their days as children at Camp Rio Vista, took what Baker considered a “cheap shot” by seeming to accuse Baker of misrepresenting the Senate bill. “I’ve got to tell you its [sic] damn disappointing to me to be insulted by my own Congressman, with whom I grew up and who over the last five and one-half years has frequently requested (and received) my cooperation on various matters,” Baker wrote. “Cooperation and common courtesy are two-way streets.”
Kemp and Archer were not the only ones dissatisfied with what was coming out of the Senate. So was Bob Packwood. The proposal was too measly, not ambitious enough, and it was being pecked to death by different senators. Among those with personal interests was Baker himself, the product of an oil-producing state and a family that had made its fortune in part from the energy industry. Throughout the process, from the Saturday meetings at his home to the back rooms of the House, Baker had been protective to some degree of the oil and gas industry, which was fighting to preserve tax breaks it said were needed to encourage exploration and offset dependence on foreign suppliers. The original plan that Baker developed for Reagan did trim tax advantages for energy companies but not by as much as others had proposed. By the time the House bill reached the Senate, Baker was seen as a guard against deeper cuts in the industry’s benefits. “He acted like he was an elected representative from Texas,” observed Jeffrey Birnbaum, coauthor of the definitive history of the reform fight. Still, Bill Bradley, who made an effort to slash subsidies for oil and gas firms, only to lose an 11 to 9 vote, said Baker was not the industry’s main protector, naming Senator Russell Long, the Democrat from Louisiana, another oil state, as his main adversary.
Baker had one other personal interest in the bill that received little attention at the time. Amid the complicated negotiations, Baker found a way to finally exact revenge against the Houston Chronicle for endorsing Mark White over him in the 1978 attorney general’s race. The Chronicle’s decision not to back Baker had bothered him for nearly a decade and now he had the opportunity for retribution by using the tax bill to force the publisher to give up control of the newspaper. The Chronicle was owned by the Houston Endowment, a charitable trust set up by Jesse Jones, the Houston magnate who had worked with Captain Baker decades earlier. Under a 1969 federal law, nonprofit organizations were required to sell newspapers on the theory that it was unfair competition for profit-or-loss businesses. Publishers such as the Houston Endowment were given twenty years to divest themselves of their newspapers.
Ever since then, Senator Lloyd Bentsen, the Texas Democrat who beat George Bush in 1970 and served on the Finance Committee, had been inserting provisions into bills to protect the Houston Endowment from the requirement, provisions that were passed by the Senate only to die in the House. But when the provision was inserted into the tax reform bill, Baker stepped in and had it eliminated. As a result, the Houston Endowment was forced to sell the Chronicle in 1987 for $400 million.
In retirement, Baker owned up to this heavyhanded use of power to settle a grudge, acknowledging that it was “payback” that might look “vindictive” for partisan or personal reasons. But he was content not contrite. “Did I get them back or what?” he responded when asked about it. “I don’t believe in getting mad. I believe in getting even.”
ONCE AGAIN the bill looked to be on the brink of failure. With all the lobbying and special riders, the overall legislation was mired in the same complex swamp that had defeated all previous efforts at comprehensive reform. Finally, Bob Packwood pulled the bill rather than let it come to a vote and be defeated. Baker was frustrated. So was Packwood.
The chairman took his staff director, Bill Diefenderfer, over to the Irish Times, a bar near the Capitol, where the two began downing beer after beer even though it was lunchtime. After two pitchers, Packwood’s confidence, or perhaps his cockiness, had risen several levels and the tipsy senator declared that the problem was that they were not being ambitious enough. They should force the top bracket all the way down to 25 percent, which would give them leverage to be much more aggressive in wiping out special interest loopholes because everyone would appreciate the lower rate. “To hell with it,” he declared. “If they want tax reform, I’ll give ’em tax reform.”
It was an audacious idea, but Baker agreed to go along. Packwood handpicked six other members of his committee from both parties and convened them in secret to work it out, telling reporters—and other senators—that the panel was done with business for the weekend while in fact meeting surreptitiously with the select negotiators. The seven agreed that any issue decided by four of them would be binding on all of them. Packwood and Diefenderfer basically told Baker to butt out.
“Bill and I in essence said, ‘Oh, Jim, shut up,’ ” he recorded in his diary. “Here we are talking to the Treasury secretary—‘shut up, here you’ve got a plan. All we need you to say is “we think it is wonderful.” We’ll get it to the president. Jim, we’re going to wrap this up by Sunday. Don’t fuck it up.’ ” As if addressing Baker, Packwood went on: “ ‘You put in one pro forma appearance before the Senate Finance Committee Republicans and get your little tail out to Tokyo or wherever it is the president is going to be meeting. And leave Darman here to take care of the strategy and the details and we’ll have this done before you get back, but don’t start niggling and quibbling over miniscule details.’ ”
One of the keys to Baker’s success over the years was knowing when to back off. In a feat of legislative wizardry, Packwood delivered on his promise after eleven secret meetings over seven days, producing a radical plan along the lines he had outlined in his beer-fueled haze at the Irish Times. He even passed it out of his previously gridlocked committee on a unanimous 20 to 0 vote one night after midnight. The lawmakers celebrated with champagne while Darman called Baker in Tokyo, where he was accompanying Reagan at a Group of 7 summit meeting.
“Jim, tell him to shut up,” Packwood heard Darman tell Baker. The senator could only hear Darman’s side of the conversation but it seemed that he was trying to get the secretary to reassure the president. “He’s going to like this bill, but he’s got friends who aren’t going to like a lot of this bill. Don’t let them get to him before I have a chance to get to you and explain everything that has happened. Let me emphasize again—he is going to like this bill.”
So did most members of the Senate. On June 24, the upper chamber approved the bill by a stunning 97 to 3 vote, one of the few times in the modern era when such sweeping legislation passed with so little opposition on the final tally. The issue then went to a conference committee with members from both House and Senate who would reconcile the different bills passed by the two bodies. Packwood, leading the Senate team, and Dan Rostenkowski, leading the House team, found common ground on the general principles they wanted in the final bill, but they knew there would be obstacles. “After Danny and I agreed, it became very clear to me that the real problem in this conference wasn’t going to be between the House and the Senate,” Packwood told his diary. “It will be Baker who is pro-energy, pro-Texas and pro-depreciation.”
Baker, however, was not about to let any details get in the way of final passage. Among other things, he was not above playing a little fast with the numbers to get to a bill that, on paper at least, met the revenue neutral goal. One gimmick stipulated that a research and development tax credit that was popular with businesses would expire one year before the end of the period covered by the tax bill, in theory raising money that would no longer go back to businesses for that last year. But everyone understood that Congress would never actually let it expire and, before the deadline, would certainly pass new legislation extending it. Likewise, Baker pressed the IRS commissioner to commit to bringing in an extra $17 billion through better enforcement, a theoretical revenue raiser at best.
Still, Baker was feeling more confident about the bill’s chances. One day in September, he showed up on Capitol Hill dressed in what one congressional aide called a “Nathan Detroit suit,” a pinstripe with wide lapels seemingly borrowed from the wardrobe of Guys and Dolls. He then performed for a group of lawmakers, aides, and reporters a rap number he called the Tax Reform Shuffle, modeled on the Super Bowl Shuffle of that year’s champion Chicago Bears.
They said tax reform was dead. But now it’s alive.
Here’s its story. It began in ’85.
We drew up a plan and sent it out in May
But the special interests said, “Ain’t no way.”
Rosty started hearings before the fall.
They were Gucci to Gucci out in the hall.
December came, reform was off track.
So to the Hill rode the Gipper, to bring it back.
All along it’s been a big tussle.
But we keep doing the Tax Reform Shuffle.
Even Bob had his doubts, but then he saw the light.
For tax reform, he’d fight the good fight.
The Senate came close to stopping this bill.
But low rates and a broad base made it too hard to kill.
The conference met and everybody asked,
“Who can give the most to the middle class?”
Revenues got short; reform was in the red.
So “shoot the estimator,” somebody said.
Rosty and Bob finally agreed.
Let’s take it from those who aren’t in any need.
All along it’s been a big tussle.
But we keep doing the Tax Reform Shuffle.
So tax reform will pass, probably this September.
But there’s just one thing for us to remember.
From the goals of reform there can be no defections.
Not even in a bill of technical corrections!
Tax reform would never be in this position
But for the hard work of your coalition.
We’re pushing this bill, we’re not gonna rest.
When tax reform is law, it will be America’s best.
All along it’s been a big tussle.
But we keep doing the Tax Reform Shuffle.
Ironically, Baker had never even seen the hit Bears video. But he knew a clever idea when he saw it and he had gamely agreed to play along once an aide explained. It was a big hit. “This is this stick-up-his-ass, high-priced Texas lawyer who’s shucking and jiving with the brothers,” remembered Jim Jaffe, the Rostenkowski aide. “It’s very humanizing. For me, that was typical of Baker. This was a guy of many faces, who could play many roles.”
In the end, Packwood and Rostenkowski snuck off to an anteroom and sealed the deal themselves. “Jim is a relatively little part of it,” Packwood said years later, overlooking the fact that he himself had no interest in changing the tax code until Baker mustered political momentum behind the idea. Either way, Baker was elated; all the hard work had paid off. But the White House seemed oddly tepid about one of the most important achievements of Reagan’s presidency. The draft statement about the plan sent over for Baker’s review ended with an equivocal line: “We look forward to studying it in detail.” Baker asked that the line be deleted, and Dick Darman scratched out his own much grander substitute on a piece of paper: “This is a triumph for the American people and the American system.” After the votes, Baker and Darman headed back to the Treasury Building. It was almost midnight. Baker reached into the small refrigerator in his office, pulled out two cans of Budweiser, and popped the tops. The two men clinked the cans together in celebration.
The Tax Reform Act of 1986 collapsed fourteen tax brackets for individuals to two and lowered the top rate from 50 percent to 28 percent, although a surtax would bring that up to 33 percent on the wealthiest. The personal exemption was nearly doubled to $2,000 and more than 4 million working-poor Americans were freed from paying income taxes at all, but deductions for state sales taxes were eliminated, disproportionately affecting many others with lower incomes. For corporations, the top rate was brought down from 46 percent to 34 percent, offset by $300 billion raised over five years by closing loopholes. Overall, the measure raised corporate taxes by a net $120 billion, the biggest tax increase on businesses in history, while cutting taxes for individuals the same amount. Large, profitable firms would no longer be able to avoid paying any taxes.
The House passed the measure by a lopsided and bipartisan 292 to 136 vote on September 25, followed two days later by the Senate 74 to 23. More than 1,500 people gathered on the South Lawn of the White House to watch Reagan sign the bill into law on October 22. “All of us here today know what a herculean effort it took to get this landmark bill to my desk,” Reagan said, singling out the “incomparable” Baker for his leadership.
The Fencing Master had proved the naysayers wrong. “For years to come,” David Rosenbaum wrote in The New York Times, “students of politics will look to the odyssey of the new tax law as a prime example of how the American system of government gets things done.”