Finding New Opportunities

Amid the Economic Wreckage

Robert H. Frank

Royal Society for the Arts

June 10, 2009

Herbert Hoover

Spend More Right Away

John Maynard Keynes

The General Theory of Employment, Interest, and Money, 1936

Even useless activities can be effective stimulus.

But useful activities are clearly better.

A “mere spending program”??!!

What about the long run?

The pundits’ pessimistic projection:

Protracted misery lies ahead.

1. Private consumption won’t recover to 2007 levels any time soon.

2. Tax resistance will keep Obama’s long-term agenda on permanent hold.

Things aren’t as bad as they seem:

Because satisfaction depends more on relative consumption than absolute consumption, most people will adapt quickly to an across-the-board reduction in consumption.

By simply changing what we tax, we can eliminate several trillion dollars of waste from our current system, more than enough to pay for long-term national renewal.

A tax on any activity has two effects:

1. It generates revenue.

2. It discourages the activity.

The current tax system taxes mostly useful activities, such as savings and job creation.

If we instead taxed only harmful activities, we could raise all the revenue we need without requiring any painful sacrifices.

Whether deficits make future generations poorer depends on what we buy with borrowed money.

If we spend borrowed money on productive investments, we make future generations richer, not poorer.

Public Waste vs. Private Waste

Loose Nukes: Not worth locking down?

The National Science Foundation budget?

Nutritional assistance to poor mothers of small children?

Private waste occurs not because consumers get overcharged, but because they get caught up in wasteful “positional arms races.”

World B: You and your family live in a neighborhoods with 3000-square foot houses, others in neighborhoods with 2000-square-foot houses.

Which world would you choose?

World A: You and your family live in a neighborhood with 4000-square foot houses, others in neighborhoods with 6000-square-foot houses.

Which world would you choose?

C: You have 2 weeks of vacation each year, others have 1 week,

or

D: You have four weeks of vacation each year, others have 6 weeks?

Housing = positional good

Leisure = nonpositional good

1.People care about relative consumption, more in some domains than in others.

2. Such concerns lead to expenditure arms races focused on positional goods--those goods for which relative position matters most.

3. These arms races divert resources from nonpositional goods, causing large welfare losses.

The Conflict Between Individual and Group

Robert H. Frank. “The Demand for Unobservable and Other Nonpositional Goods.” American Economic Review, 75, March, 1985, pp. 101-116.

Regulations as Data

Why do hockey players vote in secret ballots for helmet rules, even though they choose not to wear helmets when there is no rule?

Rules Governing Duels

Mandatory Kindergarten Start Dates

Are positional concerns hard-wired?

Day 1

David(age 7)

Jason(age 5)

Day 2

Day 3

Theoretical Considerations

People should care about relative position because it affects material payoffs

– Food in Famines

– Mate access

Neurophysiological Evidence

• Local rank vs serotonin

Local rank vs testosterone

In a poor country, a man proves to his wife that he loves her by giving her a rose. In a rich country he must give a dozen roses.

Richard Layard

$10 million birthday parties

Aerosmith50 Cent

Viking Professional, $5,000.

1989 Sunbeam, $90

Gas Grills Then and Now

Talos Outdoor Cooking Suite, $35,000.

Victoria’s Secret $12.5 Million Fantasy Bra

The Progressive Consumption Tax(a.k.a., the Unlimited Savings Allowance Tax)

Consumption + Savings = Income

Consumption = Income – Savings

Taxable consumption = Income – Savings – standard deduction

The Jones Family

Annual income: $50,000

Annual savings: $5,000

Standard deduction: $30,000

Taxable consumption: $50,000 - $30,000 - $5,000 = $15,000

Tax rate = 20 percent

Annual tax bill = $3,000

(About the same as under the current income tax.)

A family that currently spends $5 million a year is debating whether to build a $2 million addition to its mansion.

If top marginal tax rate on consumption were 100 percent, the after-tax cost would be $4 million.

If it scaled back its addition by half, the after-tax cost would fall to $2 million, and it could save $2 million more than before.

Because others would also scale back their additions, the bar that defines an acceptable mansion would be reset.

Other harmful activities that might be taxed:

Emitting non-carbon pollutants

Mobile phone use while driving

Driving heavy passenger vehicles

Excessive honking

Financial transactions?

Boost government spending by as much as possible, paid for with debt and by raising taxes on top earners.

To minimize the long-run impact of deficits, direct stimulus spending toward productive investments.

“Tax More Tomorrow:” Once the downturn ends, replace the current tax system, which taxes useful activities, with one that taxes only activities that cause harm.

A progressive consumption taxCarbon, pollution, and congestion taxes

Borrow and Consumevs. Save and Invest