What do we sacrifice with positional spending, and how do we reduce it? The best answer requires talking about taxes. (More)

The Darwin Economy, Part III: Talking Taxes (Non-Cynical Saturday)

This week Morning Feature looks at Cornell professor Robert Frank’s new book, The Darwin Economy: Liberty, Competition, and the Common Good. Thursday we considered why libertarian arguments for efficient markets misread Adam Smith and ignore Charles Darwin. Yesterday we examined why “starve the beast” is good public policy, if you starve the right beasts. Today we conclude with why taxes are the most efficient and least intrusive ways to starve those beasts.

Note: Please welcome Dr. Robert Frank to Blogistan Polytechnic Institute. Dr. Frank is the H. J. Louis Professor of Management and Professor of Economics at the Johnson Graduate School of Management at Cornell University. He has authored or co-authored 11 books, and writes the “Economic View” column for the New York Times. Dr. Frank will join our discussion this week, as his teaching schedule permits. Please check back throughout the day for his comments.

“Which world would you choose?”

Behavioral economists like thought experiments, where they ask subjects to choose between options. Dr. Frank offers three such experiments in his book, all beginning with “Which world would you choose?”

  1. You live in a neighborhood with 6000-square-foot houses, while others in the neighborhood have 8000-square-foot houses.
  2. You live in a neighborhood with 4000-square-foot houses, while others in the neighborhood have 3000-square-foot houses.
  1. Your probability of dying on the job is 2-in-10,000 each year, while others’ is 1-in-10,000.
  2. Your probability of dying on the job is 4-in-10,000 each year, while others’ is 8-in-10,000.
  1. You have four weeks of vacation each year, while others have six weeks.
  2. You have two weeks of vacation each year, while others have one week.

Each of these offers a tradeoff between absolute and relative benefit, but studies show we don’t answer each question the same way. In the first experiment, more people will choose #2, a smaller absolute benefit, but a larger benefit relative to others. In the language of economists, a house is a positional good, where the perceived benefit is at least partly relative to others’ houses.

But in the second and third experiments, most people will choose #1, a better absolute benefit. Workplace safety and vacation time are non-positional goods, where we prefer a better absolute benefit for ourselves, even if others do relatively better. Public goods – roads, libraries, parks, etc. – are non-positional, by their very definition: if everyone can use them equally, no one is advantaged. Finally, studies show that long-term savings and most kinds of insurance are non-positional. We don’t usually talk about them, so our peers don’t know whether or how much we save, or how well we’re insured.

Those same studies show that we neglect spending on non-positional goods, in favor of spending on positional goods. And we don’t even gain by it, as positional spending drives up the cost of positional goods leaving little or no absolute or relative benefit. Simply, it’s waste.

The low-hanging fruit

Libertarians like to complain about government waste, but positional spending waste in the private-sector is the low-hanging fruit of our ailing economy. I could find no studies on how much money Americans waste on positional spending, perhaps because it’s hard to define with precision, but we can make reasoned estimates.

In a 2010 column for the Wall Street Journal, Dr. Frank noted that the top 5% of income earners account for 37% of all consumer spending. Of course not all of that ‘extra’ 32% of spending by the top 5% is positional, but for estimating purposes let’s suggest half of it is. That’s about 15% of overall spending. That’s one number.

For another number, consider Dr. Frank’s evidence on the median size of new homes. In 1970, the median new house measured 1500 square feet. It’s now 2300 square feet, a 35% increase in the mortgage and the cost of furnishings and other stuff. Over that same period, the median family size declined from almost four to just over two. Again, not all of that extra house size is positional spending, but for estimating purposes let’s say half of it is. That’s about 17.5% of overall spending.

In an email exchange this week, Dr. Frank estimated the total excess of positional spending at about $2 trillion per year, or about 14% of our entire economy. By comparison, the federal budget is $3.8 trillion per year, and the ‘super committee’ are looking for $1.5 trillion in deficit reduction over ten years. Our leaders are deadlocked an average $150 billion per year in the federal deficit … while we waste $2 trillion per year in private-sector positional spending at the expense of non-positional goods like workplace safety, savings and insurance, public goods, and time with our families.

The best solution … shhh … it’s the T-word….

Taxes both raise revenue and discourage the activities they tax. To raise revenue and discourage positional spending, Dr. Frank proposes a steeply progressive consumption tax based on individual or family income from all sources, less contributions to savings or investments. The more you earn, the greater your incentive to save or invest rather than spend on bigger, flashier, I’ve-got-more-than-you-ier positional goods. At the very top, he suggests, the consumption tax rate could be 100%. Want to add a $5 million addition to your 8000-square-foot mansion? Under his plan that would cost $10 million, as you could have cut your taxes by saving or investing that $5 million rather than trying to outspend your rich neighbors.

That in turn would reduce spending cascades that roll on down to squeeze ordinary working families. What’s more, the tax revenue and increased saving and investment would benefit all of us. Both individually and collectively, we’d have more money to spend on non-positional goods, many of which would create more productive jobs, such as scientific research to stop or mitigate climate change, and better infrastructure that benefits all of us.

In fact, Dr. Frank argues, sensible taxes are the least intrusive form of collective regulation. Taxes on activities that harm society – from positional spending to pollution to traffic congestion to tobacco use – both raise revenue and discourage those activities, with less loss of freedom than one-size-fits-all regulations. And such taxes are more effective, because those best able to stop the harmful activity will be the first to change their behavior.

Yes, a regressive consumption tax “redistributes income.” Yes, that and other taxes are “social engineering.” But Dr. Frank presents a compelling, libertarian-source-based argument that we do that anyway, including by explicit or implicit agreements in private markets.

Positional spending, not government, is the “beast” devouring our economy. We can’t starve that beast as individuals, but we can starve it collectively. And we’ll all benefit by doing just that.

If we can just talk about the t-word….

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Happy Saturday!