Who Stole the American Dream?

by Hedrick Smith

  By 2002, even Michael Jensen was dismayed. Executive stock options, Jensen told The Economist, had turned into “managerial heroin” that encouraged CEOs to focus on short-term highs with destructive long-term consequences. “Once a firm’s shares became overvalued,” The Economist explained, paraphrasing Jensen, “it was in managers’ interests to keep them that way, or to encourage even more overvaluation, in the hope of cashing out before the bubble burst. Doing this not only meant being less than honest with shareholders, or being creatively optimistic with corporate accounts. It also encouraged behaviour that actually reduced the value of some firms to their shareholders….”

  Firestorm over “Gnomes of Norwalk”

  But the real political firestorm over stock options was triggered by an obscure quasi-regulatory body, the Financial Accounting Standards Board, or FASB, known in Washington lingo as “Faz-bee,” whose officials SEC chairman Arthur Levitt nicknamed “the gnomes of Norwalk,” because Norwalk, Connecticut, is FASB’s home. In 1993, FASB announced its intention to issue an accounting rule that would end “the freebie” for stock options on grounds that failing to charge options as a business expense was deceptive accounting. To fix that, FASB would require companies to “expense” executive stock options—charge them as a cost against the corporate balance sheet, the same as salaries.

  Corporate America went ballistic. Congress was inundated with phone calls, emails, and visiting delegations of CEOs. Business groups issued “Chicken Little” warnings: The stock market would collapse, companies would fold, unable to recruit top talent without the lure of options; the economy would be irreparably damaged. Arthur Levitt and the SEC, which oversees FASB, were besieged. Corporate leaders argued that options were not an expense because no check was issued and also that options could not be precisely valued because of fluctuations in stock prices. This ignored the fact that companies already valued stock options on their tax returns, as required by the IRS.

  “During my seven and a half years in Washington …,” Arthur Levitt later wrote, “nothing astonished me more than witnessing the powerful special interest groups in full swing when they thought a proposed rule or a piece of legislation might hurt them, giving nary a thought to how the proposal might help the investing public. With laserlike precision, groups representing Wall Street firms, mutual fund companies, accounting firms, or corporate managers would quickly set about to defeat even minor threats. Individual investors, with no organized labor or trade association to represent their views in Washington, never knew what hit them.”

  Business leaders reacted so explosively because making options a corporate expense would make major companies look bad. Big-name Silicon Valley companies had been issuing such a cornucopia of stock options that if they were charged as an expense, company profits would plummet. Merrill Lynch estimated that expensing options would slash profits among leading high-tech companies by roughly 60 percent. At Cisco, the Internet equipment giant, a yearly $2.6 billion profit would have been cut nearly in half.

  Warren Buffett of Berkshire Hathaway, probably America’s best-known investor, accused Corporate America of an “Alice in Wonderland” attitude on stock options. Buffett backed the FASB rule. Expensing options, he asserted, would be more honest because it would expose the naked truth to investors. “Options are a huge cost for many corporations and a huge benefit to executives,” Buffett declared. Failing to value options fairly, he wrote in a Washington Post op-ed piece, “enables chief executives to lie about what they are truly being paid and to overstate the earnings of the companies they run.”

  But Congress bowed to the political heat from Corporate America. In the spring of 1994, Senator Joe Lieberman of Connecticut, then an ardently pro-business Democrat, introduced a Senate resolution that condemned the FASB rule as reckless and warned of “grave consequences for America’s entrepreneurs.” Under intense lobbying from powerful CEOs, the Senate voted 88–9 for Lieberman’s resolution. Although it was nonbinding, SEC chair Arthur Levitt took the Senate vote as a warning shot at both FASB and the SEC. Fearing that Congress would strip FASB of its powers and cut funding for the SEC, Levitt backed down. He directed FASB to withdraw its rule.

  But out of office, Levitt told me how deeply he regretted forcing FASB to retreat. “It was probably the single biggest mistake I made in my years at the SEC,” Levitt said. A decade later, after the Enron and WorldCom scandals, in which dishonest accounting played a major role, there were new pressures in Congress from Republicans as well as Democrats for expensing stock options, but the bills died in Senate gridlock.

  The hand of U.S. regulators was finally forced in February 2004, when the International Accounting Standards Board adopted universal rules to expense stock options. Ten months later, in December 2004, America followed the world standard, adopting FASB’s Rule 123R to expense stock options.

  But business opposition succeeded in stalling the new rule from taking effect until 2006. The decade-long political siege over options testified to the power of business to protect its financial interests.

  JUST BEFORE SITTING DOWN in the glittering East Room of the White House to sign the $350 billion tax cut bill of 2003, President George W. Bush thanked his cabinet, congressional leaders, and “my friend Dirk Van Dongen.”

  To most Americans, Van Dongen was an unknown. He held no elected office or high appointment. He avoided TV appearances. And he enjoyed no celebrity status. But inside the Beltway, Van Dongen was known—and is still known—as a key power player who has been an important influence in tilting Washington policy in favor of business and the super-rich. He is a no-nonsense six-footer in his midsixties, with salt-and-pepper hair and rimless glasses. He’s a master organizer who loves the power game but avoids the limelight. And he had a pipeline into the Bush White House.

  Right after George W. Bush’s inauguration in January 2001, the president’s master political strategist, Karl Rove, had lunch with Van Dongen and asked him to organize and run a tax relief coalition. “They knew I was loyal to Bush,” Van Dongen said later. “I was a Bush Pioneer, which meant you raised lot of money for the campaign—$100,000. I knew a lot of the senior staff.”

  Van Dongen was Rove’s man to orchestrate the business chorus behind the Bush tax cuts. Some business leaders wanted corporate tax cuts right away, but the Rove–Van Dongen deal was individual cuts first, business tax cuts later.

  So in 2001, and again in 2003, Dirk Van Dongen became the field marshal for the business lobbying forces that helped move Congress to pass two massive Bush tax cuts, the first of which delivered more than $1 trillion in lower taxes for the richest 5 percent of Americans and added $2.9 trillion to the federal deficit.

  CHAPTER 9

  THE NEW 2000S POWER GAME

  WHY CONGRESS OFTEN IGNORES PUBLIC OPINION

  Whatever elections may be doing, they are not forcing elected officials to cater to the policy preferences of the “median voter.”

  —LARRY BARTELS,

  Unequal Democracy

  Current U.S. tax policies do the opposite of what most Americans want…. The mystery is how politicians can get away with tax policies that are so out of harmony with the wishes of the American public.

  —BENJAMIN I. PAGE AND LAWRENCE R. JACOBS,

  Class War?

  This is the ultimate Washington insiders-versus-America issue…. Washington derives so much of its power from the tax code—not just congressmen on the Ways and Means Committee, but lobbyists and lawyers.

  —STEPHEN MOORE,

  Club for Growth

  THE ALLIANCE BETWEEN George W. Bush and Dirk Van Dongen—“Dirkus,” the president called him—was formalized on February 23, 2001, in the Indian Treaty Room of “the old EOB,” the gray Victorian-era Executive Office Building, next door to the White House.

  Bush was getting ready to go to Congress to push for his groundbreaking tax cuts that would become not only a hallmark of his administration, but a lightning rod of controversy a decade later in the 2
011 congressional battle over whether the rich should pay higher taxes to help bring down the federal deficit.

  Many people today forget, but even in 2001, the Bush tax cuts were so massive that they were controversial. And before President Bush went public with them, Karl Rove wanted to cement Bush’s political partnership with business on the tax package. So that morning, Bush, Rove, and Treasury Secretary Paul O’Neill walked over to the EOB to sit down with fifty leaders of the Tax Relief Coalition, a new political syndicate of powerful business trade organizations headed by Dirk Van Dongen.

  As president of one of the coalition’s major business groups, the forty-thousand-member National Association of Wholesaler-Distributors, Van Dongen was a veteran of political wars. He was a shrewd lobbying strategist. “Over the years, I got a reputation for knowing how to organize coalitions, how to run them,” Van Dongen explained to me. “My staff serves as the coalition bureaucracy. We call the meetings. We push the paper around. But this is not Van Dongen at the top of a juggernaut without anyone else. This is a team sport. You do not win these things on your own. You gather like-minded stakeholders and create a coalition.”

  The like-minded stakeholders were in the Indian Treaty Room that morning to meet with the new president. The goal that day was to make sure that everyone walked out of that session singing the same tune. “There’s a chorus out there,” said one White House official, “and we’re trying to make sure it’s heard as loudly and clearly as possible.”

  Tax Wars: Insiders vs. the Public

  Most of Corporate America had backed Bush in the tight election of 2000. Now, he was in his honeymoon period, but the fate of his tax proposal was uncertain. Moderates on Capitol Hill, Republicans included, worried that Bush’s proposal for $1.78 trillion in individual tax cuts over the next decade risked runaway federal deficits. At Treasury, Secretary O’Neill was warned by his communications director, Michele Davis, that the public was wary. In a memo, she told him: “The public prefers spending on things like health care and education over cutting taxes.”

  That very morning, February 27, 2001, The Washington Post ran a poll reporting that 35 percent of the public thought Bush’s top priority should be higher spending on domestic programs such as education and health care. Another 25 percent favored strengthening Social Security; 17 percent wanted to spend budget surpluses inherited from Clinton on reducing the national debt; and only 22 percent—about one in five—wanted to cut taxes. And if there was going to be a tax cut, 53 percent favored a small cut over a large cut; and 47 percent worried that Bush’s tax cut would be tilted in favor of the wealthy.

  An NBC/Wall Street Journal poll found that while most people welcomed a tax cut, a 52 to 41 percent majority said it should be only “for middle-and low-income taxpayers so the government has enough money for debt reduction and specific spending increases in priority areas such as education.” An even stronger tilt toward a smaller, middle-class tax cut came in a Los Angeles Times poll on March 8. Even in polls that supported a tax cut in principle, the public wasn’t buying the scale or the financial tilt of the Bush tax cuts.

  The Gang of Six

  Enter Dirk Van Dongen and what he calls “the Gang of Six”—the heart of the Tax Relief Coalition—determined to override the public’s view.

  In the three decades since Lewis Powell’s business manifesto of 1971, Van Dongen’s six groups had become the core of business political power in Washington: 1) the U.S. Chamber of Commerce; 2) the Business Roundtable; 3) the National Association of Manufacturers; 4) the National Federation of Independent Business; 5) the National Restaurant Association; and, of course, Van Dongen’s own 6) National Association of Wholesaler-Distributors. Together, Van Dongen says, they represent 1.8 million businesses, from the Fortune 1,000 to the multitude of small businesses. By 2001, the Gang of Six dominated Washington lobbying.

  In Washington, the biggest political wars are invariably about money, especially taxes. “This is the ultimate Washington insiders-versus-America issue,” asserts Stephen Moore, president of the Club for Growth, a right-wing group that is passionate about cutting taxes. “Washington derives so much of its power from the tax code—not just congressmen on the Ways and Means Committee, but lobbyists and lawyers.”

  Dirk Van Dongen cut his political teeth on tax bills—fighting for President Reagan’s tax cuts in 1981 and 1986, trying to torpedo President Clinton’s tax increases in 1993. As a Republican loyalist and a canny operative with a golden Rolodex, Van Dongen has the inside track; he knows whom to call and how to move things. “Dirk is always well positioned …,” said an admiring Chamber of Commerce official. “His political tentacles run deep.” Others talk about his talent for organization and his skill at leveraging business influence with Congress.

  For the 2001 tax battle, Van Dongen’s Tax Relief Coalition ramped up with surprising speed. Even though corporations would not directly benefit from individual income tax cuts, individual business leaders in the Gang of Six coalition stood to reap huge personal windfalls from a drop of 5 percent in the maximum individual tax rate or a cut in capital gains taxes. Those with small businesses, where company profits pass through to their individual tax returns, got an added benefit. So they were all motivated to push a big tax cut.

  “That coalition was very important,” said Nick Calio, Bush’s chief congressional liaison. “There were a lot of recalcitrant Democrats and some Republicans [in Congress].”

  Van Dongen’s specialty is grassroots politicking. He is a strong believer in district-by-district face-to-face lobbying. His strategy was to mobilize thousands of CEOs of companies in his wholesalers group and in the National Federation of Independent Business to lobby senators and House members back in their home districts. The Chamber of Commerce and Business Roundtable flew in high-powered CEOs to meet with committee chairmen and pivotal lawmakers. Professional business lobbyists buttonholed fence-sitters on Capitol Hill. All pushed the big tax cut.

  The Critics: “Reverse Robin Hood”

  On the other side was a liberal coalition of organized labor, women’s groups, civil rights organizations, Common Cause (the nonprofit public advocacy group), and Ralph Nader’s Public Citizen. They favored a smaller, middle-class-friendly tax cut. In a TV ad campaign, the AFL-CIO attacked President Bush for spending the budget surplus inherited from Clinton on a tax cut tilted to favor the wealthy. “The President has it backwards,” declared AFL-CIO president John Sweeney. The Service Employees International Union staged protests in several cities, trying to mobilize the opposition. “Let’s call it what it is,” Georgia State Democratic senator Vincent Fort shouted to a union rally in Atlanta. “This is reverse Robin Hood. [Bush] is stealing from the poor to give to the rich.” Although opinion polls showed a majority of Americans against the Bush tax cut formula, there was little evidence that much of the public was writing or calling Congress with their views. In fact, Bush was the one urging voters to press Congress—to back his plan. On a swing through the Midwest promoting his tax cuts, the president told audiences time and again, “You’re just an e-mail away from making a difference in somebody’s attitude.”

  In the nitty-gritty of Washington lobbying, the opposition was no match for the Gang of Six. Members knew that in one year, the six big business groups could spend a staggering $2 billion on lobbying and hundreds of millions more on political campaigns, backing President Bush and members of the House and Senate who favored their tax-cutting agenda. Just one group from the Gang of Six, the Business Roundtable, and its 208 corporate members and their executives poured $143 million into the 2010 congressional elections, according to the Center for Responsive Politics, which tracks political money. The business advantage was so great, observed Yale Law School professor Michael Graetz, “you have an 800-pound gorilla battling no one.”

  With a faltering economy in 2001 and rising unemployment, the Gang of Six made the pitch that large tax cuts would jump-start the economy and create jobs. The Bush White House said it wo
uld revive “our sputtering economy.” As it turned out, that economic logic was wrong, but it swayed Congress.

  In terms of who wins and loses in a tax bill, ordinary voters get confused by the crossfire of claims and counterclaims. Tax policy, as one academic study put it, is “a highly technical realm that is ripe for concealment and mystification,” and the Gang of Six and the Bush White House were not above exploiting public confusion or gullibility. Democrats warned that 43 percent of the tax cut would go to the top 1 percent on the income scale. But the White House highlighted the promise of a quick tax rebate for average taxpayers—$300 for single people and $600 for couples. But that pitch masked the larger truth that as the years rolled on, the lion’s share of tax cuts would go to the super-rich.

  With a full court press by the Gang of Six reinforcing the White House push, the Bush bill, offering $1.35 trillion in tax cuts over a decade, passed the House by 240–154 in May 2001. In the Senate, Republicans sidestepped a Democratic filibuster by invoking the process of budget reconciliation—which required them to guarantee there would be no net loss of revenue, an impossibility with such a huge tax cut. The Republican majority ignored that requirement and the looming deficits and passed the bill 58–33.