Let Them Eat Rates

Ever since George W. Bush announced that he subscribes to something called "compassionate conservatism," people have been trying to figure out just what this slogan really means. There are two broad possibilities. The first is that conservatism is inherently compassionate, in which case the adjective simply points out one of conservatism's lesser-known qualities. (The descriptive function of "compassionate," in this case, would be the same as that of "tough-actin'" in "tough-actin' Tenactin"—i.e., not to imply the existence of a weak-acting Tenactin but rather to accentuate a quality already present in the basic product.) The second possibility is that "compassionate" conservatism actually differs from garden-variety right-wingery (in the way that, say, Diet Coke differs substantively from regular Coke).

"I'd probably pick the first one," says Larry Lindsey when offered a choice between the two possibilities. He ought to know. As chief economic adviser to Bush, a notoriously empty vessel, Lindsey has perhaps the largest role in defining "compassionate conservatism" and, hence, in defining the fiscal policy of the Republican Party in the post-Clinton era.

Lindsey's résumé does not reflect the usual career path of a man seized by a concern for improving the lot of the poor. Lindsey received his economics Ph.D. at Harvard, where he was a protégé of the prominent conservative (and onetime Reagan chief economic adviser) Martin Feldstein. After leaving Feldstein's tutelage, Lindsey went to work for Ronald Reagan's Council of Economic Advisers. He subsequently served as a domestic policy adviser to President Bush, was appointed a governor of the Federal Reserve, and has since hung his hat at the American Enterprise Institute for Public Policy Research, a conservative think tank. Lindsey, in short, has spent most of his adult life in the company of white guys in dark suits who have a passion for reducing taxes and government.

Yet there have always been signs of soft-heartedness in Lindsey that belie his establishmentarian conservative background. Brad DeLong, a former Clinton adviser who taught with Lindsey at Harvard, recalls an incident in which Lindsey stuck up for the graduate assistants in his department. Harvard had a rule limiting graduate assistants to teaching one class per semester. This regulation was in place ostensibly to protect the grads from a heavy work load but, in practice, spared Harvard from paying for their health insurance. Lindsey fought for the health insurance.

But Lindsey is not one of those conservatives whose generosity of spirit is limited to those with whom he comes into daily contact. He has spent an extraordinary amount of time (for a Beltway Republican, anyway) thinking about the condition of the non-rich. He is working on a book examining whether markets work in inner cities. During his tenure at the Federal Reserve, Lindsey delved into the Community Reinvestment Act, a measure designed to force banks to provide loans to poor neighborhoods, and he surprised community activists with his support for the notion. "If you want a guy who actually is a compassionate conservative, it's Larry Lindsey," says Richard Medley, a Democratic Wall Street investment adviser who knows him.

Lindsey's sensibility is reflected in the tax proposal Bush unveiled in November. The compassionate premise in Bush's plan is that even the poor face high "marginal" tax rates. As they earn more, they lose the benefits of the Earned Income Tax Credit (EITC). So, in the worst case, a worker with a very large family whose job-related income goes from, say, $20,000 to $35,000 could face a "tax" (in the form of lost EITC benefits) of close to 50 percent on the increase, almost what a millionaire pays.

Lindsey wants to reduce the marginal tax rates faced by low-income workers. This is the quintessential compassionate conservative issue: an interest in tax cuts that benefit the country club set but are also aimed at what Lindsey calls "the waitress who makes $25,000 a year." It is also a brilliant political tactic, demonstrating that conservative economics does not limit its beneficence to the well-to-do.

But there is less here than meets the eye. Poor workers do not face high marginal tax rates because they are heavily taxed. Rather, it is just the opposite—the marginal rates occur because of low tax rates and hard-won benefits for the poor. The EITC, a refundable tax credit, is mainly designed to encourage poor people to get jobs, by supplementing their wages. But at some point on the income-distribution curve, the government must cut off its largess; otherwise it would be sending checks to Bill Gates. Therein lies the problem: Government must begin weaning workers from the wage subsidy as they earn more. So while the EITC provides a positive work incentive for its low-end beneficiaries, it seemingly provides a negative work incentive for its high-end beneficiaries, who would derive a greater government benefit if they earned less from their employer. That, at least on paper, would discourage certain workers from moving up the economic ladder.

But look deeper. First, there's not a lot of evidence that this apparent incentive effect matters much. Sure, in theory, the loss of a benefit would discourage workers from earning more money. But studies show that while the EITC is effective in inducing the poor to find jobs in the first place, the prospect of losing their EITC check doesn't seem to prevent workers from trying to earn more. Second, there's no known way around this problem. Unless it wants to give benefits to the entire population, the government must phase out the tax credit somewhere, which means somebody is going to have to pay a marginal "tax"—that is, the loss of a benefit—as they earn more. Economists call this the "iron law of welfare." (This is the reason, by the way, that liberals support universal programs such as Medicare, as opposed to income-tested ones. With a universal program, you get the benefit no matter how your income changes.) And third, most of Bush's proposed tax cut doesn't address the EITC phase-out problem at all. It just proposes lower rates generally, which are already low or nonexistent for the working poor.

A small portion of the marginal rates on the working poor comes from normal taxes. But low-income workers simply do not pay very much in taxes, so tax cuts are not a very effective way of improving their condition. Lindsey is attached to a cause (the lot of the downtrodden) and to a solution (tax cuts) that do not match. And, indeed, Bush's tax plan does very little to reduce the marginal rates faced by low-income workers anyway. If Bush's plan were implemented, more than three-fifths of the tax benefits would go to the richest tenth of the population. The soaring Lindseyesque rhetoric mouthed by Bush—"We will take down the tollgate on the road to the middle class"—is not borne out in the substance of Bush's tax plan. It simply cannot be.

This emblematizes a larger, and more complicated, truth about Lindsey. He may be larger of heart than most right-wingers, and he may not be ideologically committed to the short-term interests of the wealthy, but he is still ideologically committed. And being compassionate, as conservatives used to like to say of liberals, is not the same as being correct. "One of Larry's problems," says his former colleague DeLong, "is that he's a true believer."

He has to be. Lindsey believes in supply-side economics—which is a hard faith to sustain without a deep, almost religious, resolve. Supply-siders hew to a distinct view of the world, according to which people are extraordinarily responsive to tax rates. Since high tax rates serve to massively discourage work and innovation, they say, it naturally follows that tax cuts can have enormously positive economic results. Supply-side economics gets its name from the fact that its adherents more or less disregard any consideration of demand in the economy—whether consumers are able and willing to buy goods—and focus entirely on the willingness of producers to supply them. This leads to tax cuts—which make it cheaper for producers to supply—as the all-purpose solution. Many conservatives have used this theory as a cover to do what they have wanted to do all along—namely, to advance the short-term interests of the wealthy—but Lindsey holds to the doctrine in an entirely benevolent spirit.

While his beliefs may be honest, however, the same cannot always be said about his arguments he deploys on their behalf. During the past year, for instance, Lindsey has argued that the current economic boom is in danger of ending, and so, in order to avoid a recession, we should enact an across-the-board income tax cut in order to put money into the hands of consumers. Bush himself has adopted this line of reasoning, characterizing his tax cut as "insurance against economic recession."

Now, it is very clear why a supply-sider would argue for tax cuts during an economic boom: Supply-siders think tax cuts are the proper response to any circumstance—fast growth, slow growth, depression, high humidity, or alien invasion. But rather than limit his sermon to the supply-side choir, Lindsey is trying to make a more mainstream, demand-side argument that tax cuts are needed to stimulate the economy. This is pretty silly: If you need to stimulate the economy during good times, what should you do during bad times? Furthermore, Lindsey does not explain why, if we need to stimulate the economy, we should do so through income tax cuts. Such cuts tend to benefit the wealthy, who are more likely to save their money. If you really want to boost consumer spending, you're better off enacting tax cuts and government spending that put money in the hands of the middle and lower classes—not cutting marginal rates.

Lindsey has a way of hiding his true views in order to play to the crowd. In a Wall Street Journal op-ed earlier this year, he maintained that surplus revenues "belong to those who earn them" and, therefore, must be devoted to tax-cutting. This was a politically convenient argument in that it echoed the talking points of Republicans in Congress. But, from an economic point, it is sheer nonsense. If you believe that the most efficient use of the surplus is, say, paying down the national debt, then no economist would counsel using the surplus for a non-optimal purpose just because it "belongs" to somebody.

The central fallacy of "compassionate conservatism" was identified by, of all people, Wall Street Journal editorial page editor Robert Bartley. Compassion, he wrote, "emphasizes the intention behind social programs rather than their real world effect." Maybe Lindsey is supporting a failed and unworkable fiscal policy not out of a greedy desire to placate the wealthy but out of a genuine belief that it will uplift all of humanity. But here's the problem: It won't.