Charles Darwin: Fiscal Alchemist? Bring Your Questions for Cornell Economist Robert Frank

Back in 2007, we had a lively debate around a series of excerpts that Cornell economist Robert Frank contributed to the Freakonomics blog. We’re hoping an excerpt from his latest book,  The Darwin Economy: Liberty, Competition, and the Common Good, will spawn a similar conversation.

In it, Frank makes a rather bold prediction: within the next century, Charles Darwin, the naturalist, will unseat Adam Smith as the intellectual founder of economics. Frank believes Darwin’s insights into the nature of competition describe our current economic reality far better than Smith’s invisible hand. Frank argues that we live in a world where competition doesn’t channel self-interest for the common good, but rather into unbridled “arms races” where relative position is pursued above all else: who has the biggest bank? The biggest house? These races rarely benefit group interests. In fact, Frank argues, they have done enormous harm to our economy and provided no lasting advantages or benefits, since gains tend to be relative and offsetting.

Below, you’ll find an essay that Frank has adapted from the book expounding on this theme and offering what he sees as a prescription. He has also very kindly agreed to answer your questions on the ideas he puts forward. So, you know the drill: fire away with your questions in the comments section and, as always, we’ll post Frank’s responses in due course.

Charles Darwin: Fiscal Alchemist?
By Robert H. Frank.

We’re justifiably skeptical of alchemists who claim they can transform lead into gold. And we’d be similarly skeptical of someone claiming that a simple change in the tax code could liberate several trillion dollars annually without requiring painful sacrifices from anyone. But that’s my claim, and it rests on logic and evidence that almost everyone already accepts. I won’t convince you of that in the 800 words the Freakonomics editors have given me. But I hope I can persuade you that my claim merits a look at the more detailed case I present for it in my just-published book, The Darwin Economy.

That case rests on Charles Darwin’s observation that competition favors traits and behaviors only when they promote individual success. Darwin recognized that, as in Adam Smith’s invisible hand theory, individual interests often coincide with those of larger groups. But not always. And when interests at the two levels conflict, individual interests generally trump, often resulting in wasteful arms races. My claim is that simple, unintrusive changes in tax policy can mitigate such arms races, producing enormous gains for everyone.

(iStockphoto)

The massive antlers of bull elk illustrate Darwin’s point. Like males in most vertebrate species, bull elk take more than one mate if they can. Because relative antler size was often decisive in their battles for mates, mutations that coded for larger antlers spread quickly. The resulting arms race eventually stabilized. But although the modern bull’s huge antlers—which can span four feet and weigh forty pounds—promote individual reproductive success, they are an enormous handicap from the perspective of bulls as a group. When chased into densely wooded areas, they are easily surrounded and killed by predators.

Bulls would fare better if each animal’s antlers were smaller by half. Every fight would be resolved as before, and each animal would enjoy greater mobility. Yet any individual with relatively small antlers wouldn’t leave any offspring.

Similar conflicts spawn wasteful arms races in the marketplace. Consider a middle-income family whose goal is to send its children to a good school. Because the best schools are generally those in more expensive neighborhoods, this family must outbid at least 50 percent of all families with the same goal, or else be forced to send its children to a below-average school.

Rising income inequality has spawned expenditure cascades that have exacerbated the resulting bidding war. The median new house now has more than 2300 square feet—50 percent larger than its counterpart in 1980—even though median real wages scarcely rose in the interim. Yet despite the larger outlays, half of all children still attend bottom-half schools. Families have succeeded only in bidding up house prices in better school districts.

The easiest way to curb this waste would be to replace the current income tax with a much more steeply progressive tax on consumption. Households would report their income as under current law, and also how much they’d saved during the year, as many now do for tax-exempt retirement accounts. The difference—income minus savings—less a large standard deduction (say, $30,000 for a family of four) would be the household’s taxable consumption. Rates would start low, then rise steeply as consumption rises. Low- and middle-income families would pay no more than under the current system, but high marginal rates at the top would constitute a compelling incentive for wealthy households to alter current spending patterns.

Evidence from New York and other cities with expensive real estate confirms that even such households respond to price incentives. Under a steeply progressive consumption tax, a family that currently spends several million dollars a year and is considering an addition to its mansion would face a powerful incentive to scale back. The magic of the tax lies in the fact that if they and their peers scaled back in tandem, the smaller additions would serve just as well as the larger ones would have. As with antlers, it’s only relative mansion size that matters beyond some point.

Similar savings would occur in other domains. There’s no evidence, for example, that participants in American weddings, whose average cost now exceeds $28,000, are any happier than their counterparts in 1980, when real outlays were roughly a third as much.

We could kill three birds with one stone by enacting a progressive consumption tax now and scheduling it for gradual phase-in once the economy returned to full employment. Families that planned additions to their mansions or other large projects in coming years would rush to complete them before the tax took effect, so we’d get hundreds of billions of dollars of desperately needed economic stimulus without a penny of additional government spending.  The move would also reassure deficit hawks that we’re committed to putting our fiscal house in order.  And in the long run, a progressive consumption tax would stimulate much needed investment. 

What’s not to like?


Dragline

I will certainly pick this up and read it with some interest, although I am skeptical of the prediction offered. A reader might do well to review the folly of expert predictions that was presented on this blog a couple months ago. But perhaps it will revive Adam Smith's own view that his work "The Theory of Moral Sentiments" was far superior to "The Wealth of Nations".

I will be curious to see the correlation between this work and Beinhocker's "The Origin of Wealth", which was a fascinating inquiry into the use of evolutionary models for economic systems. As pointed out in that work and the works of Steve Keen and others, one of the main problems with economics is its attempt to build on the static equilibria models of Newt0nian physics, when the real world is full of dynamic, ever-changing systems.

Sarah C.

"Half of all children still attend bottom-half schools" - Isn't that like saying "50% of doctors graduate in the bottom half of their class?" Sorry, I had to throw that out there. Gotta love statistics! Seriously though, I really like the tax concept. How can we get this to happen? Call our representatives and recommend the book?

Colin Young

I think that's the point. 50% are always going to attend bottom half schools (technically below median), yet we still keep bidding up prices in better neighborhoods. With different incentives, rather than elevating the prices of houses in better school districts we could elevate the performance of the median school.

James

One problem here is the assumption that a "better" - read "more expensive" - neighborhood automatically equates to a better school.

Another is the assumption that all home buyers have (or plan to have) families with school-age children. Even for those people who do have children, how much of a driver is perceived school quality?

Tyler

Two questions:
1) Is a Darwinistic view of the economy an addendum to the invisible hand rather than a replacement for it? It seems that Darwinism explains how individuals develop their preferences and the invisible hand explains how they act on those preferences.

2) Regarding the progressive income tax, what are the employment consequences of encouraging increased savings?

Tahtweasel

2) It's largely a wash. It doesn't matter whether I want to build a new office park for business use, or a new mansion for personal use. It's all the same to the construction workers.

Mike

Of the three examples, the chasing good schools and larger houses examples weren't the best at convincing. The good schools problem has other causes like government ownership. Chasing bigger houses might have other causes - more people could afford them, thinking of housing as an investment as house prices were increasing, tax benefits to home ownership, and chasing good schools. BTW, progressive property taxes on housing is already in place.

The expensive wedding example was spot on IMHO.

The current progressive income tax code has all kinds of incentives. Wouldn't a progressive consumption tax also be gamed by special interests and politicians? For example, a luxury car might be taxed at a higher rate than trucks which cause auto makers to make "trucks" that are used as cars (i.e. SUVs, mini-vans).

Nanno

I must say I find this very interesting I do have one question however.

Did you account for an estimated impact of the uncertainty there is when overhauling pretty much the entire tax system? That is to say, in the essay above you talk about the predicted reaction WITHIN the new system, but what about the reaction TOWARD a new system?

RDT

I am not sure why consumption is regarded as the bogeyman. One would be wise to remember that none of this exists in a vacuum. Take your wedding example for instance. I have family with a floral business. If wedding costs are reduced by 2/3 in the name of savings for society, who really saves? Well this local florist with 3 stores and 1/3 of the business now drops to one store and lets 2/3 of the employees go, not to mention the affect it has on their suppliers and their employees. What you are advocating is a complete contraction of all the economy.

James

Complete destruction? Hardly. For instance, the newlywed couple might take the amount saved on wedding flowers, and spend it on landscaping for their new home. What the florist loses, the garden center gains - and society as a whole is richer by a bit less trash (the dead cut flowers) to dispose of, and a few more growing plants.

Napping Tom

Dr. Frank,

I first encountered your arguments on EconTalk. While I am of the opinion that individuals making decisions within a free market will generally produce the best outcome for both individuals and society, I do find your arguments about the distinction between markets where individuals seek absolute gain versus ones where they seek a higher relative position in society compelling.

My question has to do with the progressive consumption tax. You speak of its merits in general in your article and on the podcasts. I'd like to know the specifics of your proposal. If you were appointed IRS Commisioner in a post-recession America and could implement your tax plan, what would it look like? What level of consumption would be exempt? What would be the highest marginal rate? How would the tiers that make the tax progressive fall?

m.m

So you're proposing a tax on any income that is not put into savings? That sounds insane to me. The real problem in our economy is that too much wealth is accumulating in too few hands. Those wealthy people are simply INCAPABLE of spending all the money they are making ... so they stick it into "savings." (People call this "investing," but in truth, because there is SO much of it, they've gone beyond useful investing and keep looking for newer and newer places to put it, which funds boondoggles like the mortgage-backed-securities bubble.) What we need is NOT to have these people stop spending money, but rather start moving their money through the economy even more. Right now, the velocity of money in our economy is puttering along like a tortoise. We need to rev it up.

Your plan simply encourages more of the same stagnation we have now. No thanks.

Andrew Moore

"...half of all children still attend bottom-half schools". Won't this always be the case approximately?

"...compelling incentive for wealthy households to alter current spending patterns". What would you expect them to spend their money on? Most people want to consume and so may choose to consume abroad wouldn't they? Or are you proposing a consumption tax on property related things only?

"...the smaller additions would serve just as well". Would they? Wouldn't they be a room or two smaller? And the "better half" houses would still be too expensive for the poorer half.

"...it's only relative mansion size that matters beyond some point". I would have thought this oneupmanship applies to a very small percentage of people.

"And in the long run, a progressive consumption tax would stimulate much needed investment." Would it? I thought it was supposed to "scale the peers back"?

Or have I missed the point? Andy (3 bed house) Moore... I will read the book with interest! Thanks.

Read more...

Shane

Sounds interesting. I wonder have you observed the same kinds of consumption arms race in other developed countries? Does house size bloat everywhere? I ask because I'd like to know if this is a universal human tendency, or if there are cultural factors at play too. (I can imagine, say, a reverse snobbery culture where wealthy people deliberately spend LESS in conspicuous consumption, where a humble lifestyle is considered admirable.)

Also, has your suggested consumption tax been tried elsewhere?

Jack

I'm a fan of the FairTax and so have no problem with taxing consumption in place of income. The problem I have with progressivity is curtailing the big $$ spent on the high end of the spectrum--if consumption drives our economy, and these high end dollars represent a significant portion of overall consumption, then it appears that it could have a damaging effect on the economy. How much different would it be to have a higher standard deduction and a single flat rate? Also, how does this compare with Herman Cain's 9% consumption tax from the 9-9-9 plan, which he claims only taxes services and new goods--how would your proposal reward people for buying used cars and used houses (which you would seem to agree is a good thing)?

DB

I don't understand how a progressive consumption tax could possibly work. Unless we're talking about saving forever and never spending, all income will eventually be taxed.

Because the tax is progressive, the more you spread out your purchases, the less tax you pay. Saving up your earnings over 10 years for a big purchases suddenly becomes a terrible idea.

Also, how would a home mortgage work? Would the entire purchase be counted the year you signed the paperwork or would you just be taxed for your monthly payment? If it's the former, most home buyers couldn't afford the lump sum tax. If it's the latter, then the government is discouraging paying up front - essentially subsidizing home loans even more than they do already.

Seth

I find the bull elk example unconvincing. I'm not certain how the link is made between the large antlers and not being good for the group. Maybe I just don't have enough information.

Is the elk population in decline? If so, is it due to these large antlers?

Artemis

I wonder if that would be the "little or no benefit" that is the automated clothes washing machine, or perhaps the automated dishwasher. Or perhaps in house refrigeration.

These were all created by people trying to compete for that "higher position" by providing a better product. They free many, many hours of time and almost every american has ready access to at least two of the three.

These technologies all also started as something only the "rich" could afford, that may never have gotten traction under your progressive tax.

The same is true of the personal computer.

Yes, let's create a world like that and end all this evil competition.

Peter

I have bought your book and look forward to reading it. How do you address this common question: rich people's money is their own, and they should be able to spend it as they choose, and that if you tax rich people proportionately more that's a) unfair and b) encouraging them to work less or move elsewhere?

164

Is this an attempt to find a new way of making sense of the world according to a preconceived political view of the world now that Keynes has proved less influential to today's economic realities?