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Should the State Regulate Envy?

Mises Daily: Tuesday, January 15, 2008 by

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[Falling Behind: How Rising Inequality Harms the Middle Class. By Robert H. Frank. University of California Press, 2007. Xiv + 148 pages.]

Falling Behind belongs to an unfortunate genre: books by well-known economists that endeavor to justify crude soak-the-rich policies.[1] Paul Krugman and, from an earlier day, John Kenneth Galbraith are perhaps the best-known authors of such works; but Frank fully equals these eminent figures in his railings against the well-off. Tax relief for the rich fills him with dismay:

Facing enormous federal budget deficits at a time when we are not paying teachers enough, not repairing our roads, bridges, and municipal water supply systems, and not inspecting the meat we eat, can multi-trillion-dollar tax cuts really be a sensible policy? At a time when top earners have been reaping virtually all the fruits of the nation's economic growth, can targeting more than 50 percent of the benefits of these tax cuts to the top 5 percent of earners really be a sensible step? (pp. 111–12)

Frank proposes instead a steeply progressive consumption tax that, at its upper reaches, is confiscatory. His plan exempts savings from tax altogether: the tax burden falls entirely on consumption.

Because high-income families save a substantially higher proportion of their incomes than low-income families, maintaining the current tax burden across income levels would require top marginal tax rates on consumption that are much higher than the current top marginal tax rates on income. (p. 106)

Frank is not kidding: he offers an example in which the marginal tax rate on consumption spending of $1,000,000 per year is 100 percent. This rises to 200 percent for $4,000,000.

Frank's principal argument for his draconian policy is this: for many important consumption goods, such as housing, the choices of other people strongly influence our own preferences. Most people, e.g., do not wish to live in a house significantly smaller than other houses in their neighborhood. If other people build larger houses, they will endeavor to keep up, even though they were entirely at ease before in their less spacious accommodations. Following Fred Hirsch, Frank calls consumption goods of this type positional goods: how much we value them depends on how our holdings compare with those of others.

Why do positional goods create a problem? People want to have larger houses than their neighbors'; but, if the neighbors keep up, they will not succeed in their endeavors. They will instead have spent resources to arrive at a situation in which they are no better off competitively than they were before. Nonpositional goods, such as leisure, the preferences for which are less dependent on comparison with others, suffer in consequence. In a key passage, Frank states his central thesis:

  1. People care about relative consumption more in some domains than others…
  2. Concerns about relative consumption lead to "positional arms races," or expenditure arms races focused on positional goods…
  3. Positional arms races divert resources from nonpositional goods, causing large welfare losses. (p. 3, emphasis removed)

Frank uses a familiar example to help explain his point. Suppose a spectator at a football game stands up in order to get a better view. If other spectators have the same thought and also rise, no one will succeed in improving his view. Moreover, all the spectators will be worse off, if one reasonably assumes that, holding their view constant, they prefer sitting to standing.

Frank's model can be challenged on several grounds. First, he fails to distinguish two different senses in which a good can be positional. In one sense, the term "positional" is equivalent to "contextual"; as Frank says, "if you are not somebody for whom context matters, you are not a normal person" (p. 39).

Whether I think I am living in a good house depends, it seems reasonable to say, on how my house compares with the houses of others in my reference group. But it does not follow from this plausible view that people wish to surpass the possessions of those in their reference group. I may think my cheap apartment not very good because others around me live in expensive condominiums, but this is not to say that I shall feel impelled to try to keep up with my more fortunate neighbors. A good can be positional or contextual in this first sense without being positional in the stronger sense that implies a competitive struggle to surpass, or at least not to fall behind, one's reference group.

Frank's failure to distinguish these two senses of positional vitiates one of his key arguments. Tax policies such as his, that strike at the consumption of the rich, seem motivated by envy. Because people have more than I do, they should be penalized to assuage my ill feeling at finding myself inferior in this way. What is that but envy?

Not so, Frank responds. If people judge their houses and other goods by comparing them with their neighbors', they do not stand convicted of envy. Context is not envy. Indeed not: but if people go on from their comparative judgments to demands to level the superiorities of others, the specter of envy has hardly been exorcised. And envy seems a poor basis for policy.

Frank has overlooked another vital distinction, this one within the second of the senses of "positional" I have distinguished. Let us once more turn to housing, the chief, though far from only, good that concerns our author. Does it not make a considerable difference whether people do not wish to fall significantly behind their neighbors, or whether they wish to surpass them? Only the latter case has the potential to generate the positional arms race that so arouses Frank's leveling passions. Suppose that people are satisfied to keep up with their neighbors. If the less well housed improve themselves to equal their better-housed neighbors, no further action by anyone is mandated. By failing to separate these two different motivations, Frank exaggerates the potential for positional arms races.

What happens, though, if people do have the stronger motivation? What if I cannot resist the temptation to build a bigger house than those around me? If those in my reference group are likewise motivated, will not a positional arms race of just the sort Frank fears ensue? People will waste resources, in a futile effort to come out ahead of everyone else.

Once more, Frank has moved too fast. Suppose someone tries to top his neighbors, and they respond in kind. It does not follow that an arms race, i.e., repeated efforts by everyone to continue the battle, will occur. People may stop at a certain level, believing it too costly to continue. Even if people wish to surpass others, the costs of fulfilling this wish must be weighed against other goods. Here is one example: Frank calls attention to the fact that, because of the importance of the initial impression in a job interview, people spend money on expensive "interview suits." By purchasing an expensive suit, an applicant hopes to gain a step on his rivals; but if his rivals do so as well,[2] he has not gained anything. So far, we have exactly the sort of positional battle that Frank has in mind. But job applicants have not extended the struggle, so that an applicant for assistant janitor will be wasting his time if he appears for his interview in anything less than a handmade suit from a Savile Row tailor.

Frank might here respond that, so far as housing is concerned, people are indeed engaged in an extended positional arms race. Have not the prices of houses drastically risen in the last twenty-five years? Do not people in the middle class find themselves constantly squeezed by the pressure to keep up with their neighbors? The rise in prices is an undoubted fact, but Frank does not consider alternative explanations to the one he favors. Thomas Sowell has suggested another hypothesis: government restrictions on building, not ever-increasing demand for larger houses, explain the high cost of housing.

Where builders are allowed to construct homes and apartments without severe government restrictions, even growing populations and rising incomes do not cause housing prices to shoot up, because the supply of newly constructed housing keeps up with the growing demand, as in Las Vegas or Houston. (Thomas Sowell, Economic Facts and Fallacies, Basic Books, 2007, p. 30)

Sowell's argument seems to me plausible, but its cogency is not here my point. Rather, it is Frank's tunnel vision to which I wish to draw attention. He sees only his own account.

Frank's model suffers from other problems. He assumes that the struggle to attain positional goods will result in an undersupply of nonpositional goods like leisure. This view does not take account of the fact that consumers weigh all goods against one another in arriving at their spending decisions. Perhaps a positional war will take resources from struggles for other positional goods. If so, total "waste," in Frank's terms, will face a limit.

Frank makes still another unwarranted assumption. The sum and substance of his reform proposal is that, because the struggle to surpass others in positional goods does not result in anyone's gaining an advantage, everyone would be better off if the struggle were curtailed. I want a bigger house than yours, but if adding space to my house fails to achieve this goal, because you add to your house as well, a limit on house construction helps us both. The limit prevents us from wasting resources in a futile battle.

This contention wrongly takes for granted that people will be in the same relative positions after the struggle as before. Suppose I add to my house; you match me; and then I add yet more. Perhaps you will drop out of the battle. Not all arms races end in a draw.

Let us put aside all these problems of Frank's positional goods model. The model, by itself, will not give him the progressive consumption tax he wants. Even if we eliminate social "waste" through a consumption tax, why target the extremely rich? Frank needs another questionable assumption for his tax policy. He contends that high spending by those at the top leads to high spending by those just below them. Their increased spending generates more spending by the next lower group, and so on. "Even the gifts that middle-income families feel compelled to give have been affected by the greater affluence of top earners" (p. 48). High taxes on the wealthiest aim at the "cascade effects" of their increased spending.

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"Envy seems a poor basis for policy."

Frank does not offer evidence in support of this view. Instead, he describes several examples of lavish spending by the super-rich and then sets forward his cascades hypothesis. He does not offer us any reason, though, for thinking that each group has in fact acted in response to a change by the group immediately above it in the wealth chain. For all that he has shown, positional arms races, such as they are, may be in large part locally caused. Further, what if there are large gaps in the wealth chain? Perhaps Bill Gates and his few peers are so far above anyone else that no one counts as "just below" them. In that case, increased spending by Gates will not generate cascade effects.

Once more, though, let us assume this difficulty away. Frank still has not provided an adequate justification for his progressive tax. He imagines an objector, who says,

So what? If top earners want to spend the wealth they have generated on bigger houses and cars, why should Congress second-guess them? And if middle-class families can't afford to keep up, why can't they summon the will to live within their means? (p. 114)

In response, he says, "the problem confronting a family is like one confronting a participant in a military arms race. It can choose how much of its money to spend, but it cannot choose how much others spend."(p. 115) Because of the collective effects he has been at pains to describe, people would be better off if a restrictive consumption tax were imposed.

This response takes for granted a consequentialist rationale for policy. We, or at least those of us who are of interest to Frank, would be better off if the government restricted consumption: it follows that the government should do so. But what happened to the view that people have rights that restrict what government may do, even to promote overall "happiness"? Frank does not so much as mention it.


David Gordon covers new books in economics, politics, philosophy, and law for The Mises Review, the quarterly review of literature in the social sciences, published since 1995 by the Mises Institute. He is author of The Essential Rothbard, available in the Mises Store. See his archive. Send him mail. Comment on the blog.

This review originally appeared in The Mises Review, Winter 2007.

Notes

[1] Frank, not content to leave ill enough alone, continues the argument of his earlier Luxury Fever. See my review in The Mises Review, Spring 2000.

[2] I resist the temptation to say, "if his rivals follow suit."