Smart for One, Dumb for All

We Americans all know that we work too hard, save too little, and buy too many things that in the end don’t really make us happy. In Falling Behind: How Rising Inequality Harms the Middle Class, Cornell economist Robert Frank provides a surprising explanation for why we spend so much to so little avail. From an individual’s point of view, Frank argues, profligate purchasing can be rational; yet when everybody does it, such behavior becomes self-defeating. Identifying a particular group of expenditures—“positional” goods—as culprits, he asserts that the rising inequality we have experienced in recent decades is making our keeping-up-with-the-Joneses problem even worse. And he insists that we can do something about it.

The economist Fred Hirsch introduced the notion of positional goods in his influential 1977 book Social Limits to Growth. The term denotes goods whose value to you depends heavily on how much of them you have in comparison with others around you. As Thorstein Veblen noted a century ago in his writings on “conspicuous consumption,” the rich tend to flaunt their wealth by purchasing highly visible luxuries that others can’t afford. Indeed, once others can afford them, the same items cease being markers of wealth—and the wealthy stop buying them. This phenomenon was recently visible when Tiffany’s—a brand name traditionally synonymous with conspicuous consumption—decided to terminate a highly profitable line of less-expensive jewelry. Despite being a money-maker for the company, the jewelry was so popular with middle-income women that its success threatened the upscale cachet of the Tiffany brand.

Studies have found that across modern cultures, some goods are positional and some are not. Take housing, for example. It turns out that most people would rather own a three-thousand-square-foot house in a town where everyone else had two thousand square feet than a four-thousand-square-foot house in a town where others have six thousand. But vacation time, on the other hand, is different: most people would rather have four weeks of vacation per year, even if everyone else had six, than two weeks with others reduced to only one. The value of house size, it seems, is relative, while vacation time is absolute.

Are positional goods irrational? Do they even belie a moral compass distorted by envy and greed, a vain effort to look better than others? Doubtless they often do. In Falling Behind, however, Robert Frank focuses on cases where comparison and context play a less objectionable role in our decisions.

One of the primary concerns most people have when they move, for example, is the quality of the schools their children will attend. In the United States, school quality often follows directly from the wealth of the community; studies indicate, furthermore, that the achievement level of any particular student tends to be higher when his or her fellow students come from families with high socio-economic status. So if you are a middle-class parent who wants to send your kids to better schools, one solution is to move to a wealthier suburb—which may mean buying a more expensive house than you would otherwise choose. Buying the more expensive house is not irrational, in other words, since you get the schools along with it. Similarly, when you are buying a car, you may be aware that the relative weight of two vehicles in a crash is a significant factor in injuries and fatalities. If others are buying heavy vehicles, you may decide for reasons of safety to buy a larger and heavier car than you would if others drove small cars.

This too is quite reasonable. But it brings up the big problem with positional goods: If others are making the same rational decisions that you are, your individual effort may be thwarted by their simultaneous attempt to advance. As Frank puts it, “What is smart for one is dumb for all.” If most are willing (and able) to buy more expensive homes in order to get their kids into better schools, you may find that buying that more expensive home can’t move you up the ladder but simply translates you laterally to a neighborhood where you and your neighbors are paying a larger percentage of your income on housing than before—while the wealthy now live in even ritzier suburbs. That heavier car you decided to buy, meanwhile, may not improve your security if everyone else also decides to “move up.” And so your new and expensive purchases are not getting you ahead. In fact, you may need to buy the larger house and bigger car just to keep from falling behind.

Looking at the big picture, then, it is clear that we’d be better off if we all agreed not to enter the “arms race” of consumption, because (just as with the military) once everyone upgrades, his or her relative position is unchanged, and no one is better off than before—though all are poorer. Yet people keep on buying more and bigger and better. Why? Because while you can decide as an individual not to upgrade, you don’t have it in your power to decide that we’ll all stop. The inverse of Frank’s formula also holds true: opting out by not buying bigger houses and cars is smart if everyone would do it, but dumb if it’s only you. Individually opting out of buying positional goods that only produce status (and not more worthwhile things like good schooling and highway safety) would be a good idea for Christians.

Falling Behind shows how this arms-race dynamic is exacerbated by income inequality. As Frank illustrates, our valuation of positional goods is contextual, and generally speaking it is households in the income distribution just above or below us that provide our context. Your views of what constitutes an appropriately sized house will probably never be influenced by the fact that Bill Gates’s house is forty thousand square feet. But the views of other very wealthy people are affected, and their choices in turn form the context for less wealthy folks behind them. In this way comparisons “filter down” through the income distribution.

Things get even worse when we consider that inequality has been growing in the United States in recent decades. Over the past quarter-century, the richest among us have enjoyed the greatest percentage increase in income and wealth. According to Frank, this increase in inequality has accelerated the spending-for-status race. As those toward the top of the income scale move up further and faster, those further down the chain are pulled along relentlessly, and the middle class is left buying more expensive houses and cars and other positional goods—and being worse off for it.

Frank argues that being worse off comes in various forms: longer work hours and shorter vacations, reduced savings and growing debt, more worry—and less sleep. At the same time, cash-strapped voters elect representatives who support tax cuts and reductions in public services. We spend more and more on context-sensitive goods, which requires that we spend less and less on those things that are context-insensitive, largely because “we can’t afford them.” As Frank puts it, even though our society gets wealthier, we close our public libraries on Sunday.

If we could collectively slow this arms race in positional goods, we’d have more leisure time and fewer costly expenditures whose benefits just aren’t worth it. And the only practical way to stop the arms race, Frank argues, is through a collective decision—government, in other words.

Economists recognize a long list of government actions designed to correct for “market failure”—that is, for situations where decisions based only on individual incentives create an undesirable overall result. Consider a classic example from introductory economics. Family A, when deciding whether to vaccinate its children, does not consider the social benefit to Family B (namely, that their children are less likely to get sick if the children in Family A get vaccinated). And Family A may decide not to vaccinate. If the decisions of individuals are based on simple self-interest, what results is an underinvestment in vaccinations at the societal level. That’s why even many avid free-market types advocate government subsidies for vaccinations. Similarly, we require all car owners to buy auto insurance and all children to go to school.

Of course we shouldn’t pass a law against moving to a bigger house. But in Falling Behind, Frank does propose a partial solution: fund government by taxing expenditures. To do this he proposes a graduated consumption tax. How would this work? At tax time, each household would compute its “taxable consumption” for the year: income minus savings and a standard deduction of $7,500 per person. Thus if a family of four made $85,000 a year and saved $15,000, their taxable consumption would be $40,000. The tax owed by each household would be a percentage of this taxable consumption, starting with 20 percent for the first $40,000, and rising to 100 percent at $1 million and 200 percent for any consumption over $4 million per year. Thus the family of four making $85,000 would pay $8,000 in taxes, while a family of four making $8.5 million a year would pay—well, almost certainly more than they do now. Probably a lot more.

It is a fundamental principle of economics that we discourage whatever we tax. Any income tax discourages productive work; but a progressive consumption tax would do three additional things that Robert Frank believes you should value. First, by discouraging consumption somewhat, it would turn back the clock on the arms race for positional goods, making the next generation of “weapons” more expensive and thereby slowing upgrades—and increasing overall welfare. Second, it would give us a truly progressive tax system, while putting an end to the injustice of taxing the poor (Frank’s plan sets $30,000 of household income as the zero-tax floor for a family of four). Third, it would redirect the income of the rich into productive investment, creating jobs.

This last feature of the tax is attractive to many conservatives. In fact, after reading an op-ed Frank wrote in the New York Times several years ago, Milton Friedman sent him a friendly letter and an article Friedman himself had written in 1943, endorsing the progressive consumption tax. Friedman’s more restricted vision of government would no doubt lead him to endorse lower marginal tax rates than Frank’s more robust plan would call for-but that disagreement is no reason not to change the tax system.

Moving from our current hodgepodge of taxes to a truly progressive consumption tax would be enormously contentious politically, but it makes a lot of sense. What’s beyond question is that instituting a consumption tax would be more just than using lottery profits to fund schools, as a number of states do now. The lottery is our most regressive way to raise government revenue; in truth, it’s hard to imagine one that would be worse. In the war of all-against-all that today’s consumer capitalism sometimes resembles, Robert Frank has outlined an arms-control treaty that would enrich us all.

Published in the 2008-03-14 issue: 

Daniel K. Finn teaches economics and Christian ethics at St. John’s University and the College of St. Benedict and is the director of the True Wealth of Nations research project at the Institute for Advanced Catholic Studies.

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