Sunday, January 29, 2012

Saving the rich through higher taxes

Robert Frank, an economist this blog has encountered on numerous occasions, takes to today's New York Times to advance a novel argument: the rich would be better off with higher taxes. His argument rests on two foundations. First, that higher taxes woud result in improved government services:
...Higher spending on many forms of public consumption would produce clear gains in satisfaction for the wealthy. It’s reasonable to assume, for example, that driving on well-maintained roads is safer and less stressful than driving on pothole-ridden ones.
Of course, this assumes both that the tax increase would be used to fund useful projects rather than various boondoggles, and that increased government spending produces improved outcomes. But if this were true, government welfare and housing projects would not be synonymous with social dysfunction and the country's schools would be world class. 

The heart of his argument, however, is that happiness/contentment is assessed by humans from a relative rather than an absolute perspective: 
Beyond some point, there seems to be little gain in satisfaction from bolstering your private spending. When mansions grow to 15,000 square feet from 10,000, for instance, the primary effect is merely to raise the bar that defines an adequate home among the superwealthy.  
...If you pay higher taxes, you obviously have less money to spend on what you want. So the prospect of a tax increase naturally inclines people to think that they’ll be less able to satisfy their desires. 
But once incomes rise beyond a modest absolute threshold, many of the things that people want are what economists call positional goods. These may be things that are inherently in short supply, like gorgeous waterfront property; or things whose value depends heavily on context, like precious stones or sure-footed sports cars. Because positional goods are in short supply, they go to the highest bidders. The tendency to overlook that fact distorts how people think about the effects of higher taxes. 
The cognitive illusion occurs because most financial setbacks that people experience in life stem from events that affect them alone. They may suffer health emergencies, for instance, or problems at work. Marriages may fail, jewelry may be stolen, and floods may damage homes. In each case, the effect is to limit the ability to bid for positional goods. 
Because an overwhelming majority of financial setbacks occur for such idiosyncratic reasons, it’s natural to think that the income decline from higher taxes would have similar effects. But a tax increase is different. It affects all participants in the bidding for positional goods. And because it leaves everyone with less to spend, it has essentially no effect on the outcomes of those contests. The same paintings and the same marina slips end up in the same hands as before.
First off, most goods purchased by people are not positional goods. But let us say that provisional goods account for 75 percent of all purchases. Even then, the rich are made worse off; if a tax increase results in the status quo prevailing in terms of positional goods, they will still be made worse off with regard to the other 25 percent of purchases. With this alone Frank's argument begins to unravel.

But let us more closely examine the provisional goods cited by Frank, which he divides into two categories: those goods that are in limited supply (such as beachfront property or the works of a great painter) or those whose value depends on context (essentially being used as displays of conspicuous consumption to assert one's superior material standing).

With regard to the former, one can readily think of numerous goods and services requiring more than just a modest income whose value is intrinsic rather than simply due to context. Take Frank's sports car example. While the pleasure of owning a Ferrari may partly lie in the fact that few others can afford one, the car also brings value that is intrinsic (such as design or performance). Would the owner of a Ferrari be equally content being forced to downgrade to a Mercedes due to a tax increase if previous Mercedes owners then had to downgrade to a Toyota? Doubtful.

Other examples abound. Is the pleasure of a meal at a three star Michelin-rated restaurant derived solely from the knowledge that not everyone can afford such an experience? Is a vacation to Fiji only enjoyable because others must content themselves with a trip to the local water park? If not, then Frank is obviously wrong. While there may be numerous goods whose value is at least partly derived from the message it sends to others or the knowledge that the owner is part of an exclusive club, there are very, very few where the benefit is not at least partly intrinsic.

With regard to positional goods that are in limited supply, meanwhile, Frankly is flatly wrong when he asserts that a tax increase would result in the status quo prevailing: no it would not.  When it comes to such positional goods, be it a slip at the marina in Cannes or a Rembrandt, it is absolutely not true that a tax increase would leave everyone with less to spend. Rather, a tax increase would only leave Americans with less to spend, while having no impact on foreigners.

Given that many (most? all?) positional goods, such as Miami real estate or the previously cited examples, have international competition for them this is no small consideration. One can't help but think that if Frank were not completely blinkered by his ideological blinders that he would have realized this. 

No comments: