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Cornell Economist Robert Frank Answers Your Questions

We recently solicited your questions for Cornell economist Robert Frank, whose new book, The Darwin Economy: Liberty, Competition, and the Common Good, argues (among other things) that competition has made the U.S. economy less efficient. Frank now returns with answers to your questions. Thanks to everyone who participated.

Q. 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 if you tax them disproportionately, won’t that be unfair and encourage them to work less or move elsewhere?-Peter

A.  In The Darwin Economy, I adopt John Stuart Mill’s harm principle, which holds that government can legitimately restrain people only when necessary to prevent them from causing undue harm to others. So I don’t quarrel with your basic premise—that the rich (and everyone else, for that matter) have a right to spend their money as they please, provided they don’t spend in ways that cause undue harm to others.

But many forms of spending cause obvious harm to others.  When someone buys a 7,500 pound passenger vehicle, for example, he puts other motorists at greater risk of injury and death. In such cases, it’s completely legitimate to ask whether there are practical ways to limit harm to others without imposing restrictions that cause even greater harm.

In general, I also believe that it is less intrusive to tax harmful behaviors than to prohibit them. This was the major lesson of our early efforts to curb environmental pollution. Prescriptive regulations, such as telling electric utilities what kinds of coal to burn or what kinds of scrubbers to install on their smokestacks, were not only intrusive, they were also grossly inefficient. In almost every instance, air and water quality goals were met more cheaply and quickly when we taxed pollution than when we tried to regulate it directly. My policy prescriptions in The Darwin Economy are heavily shaped by the lessons of that experience.  I’ll say more about that in response to questions from other readers below.

Q. I find the bull elk example unconvincing. I’m not certain how the link is made between the large antlers and harm to 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? -Seth

A. I employ the antlers example to illustrate Darwin’s insight that when individual and group interests are in conflict, individual interests tend to trump. Given the importance of example to my overall argument, it merits a closer look.

To recap briefly, Darwin begins with the observation that bull elk, like males in most vertebrate species, take more than one mate if they can. If some succeed, others are left with none, so males naturally fight bitterly for mates. Antlers were the weaponry that decided those battles, so mutations that coded for larger ones were strongly favored. Mutations accreted over the generations, and the resulting arms race produced the modern animals whose antlers can span more than four feet and weigh more than forty pounds.

Such antlers make bulls less mobile in densely wooded areas, increasing their vulnerability to wolves and other predators. Their massive antlers are thus a handicap when viewed from the perspective of bulls as a group. If each animal’s antlers were smaller by half, they would be less likely to be surrounded and killed by wolves, and since it’s relative antler size that matters in battle, the outcome of each fight would be the same as before.  Yet bulls are stuck with their oversized antlers, since any individual without them would never win a mate.

In his review of The Darwin Economy in Slate, the UK science writer John Whitfield complained that if big antlers were harmful to bull elk, natural selection would have long since solved that problem by weeding out any bulls whose antlers were too large. Natural selection does indeed impose a limit on antler size. We don’t see bulls with antlers spanning 40 feet and weighing 400 pounds, since such animals would never be able to lift their noses from the turf, much less compete successfully for mates. But that doesn’t alter the point that the current equilibrium antler size is dysfunctional from the perspective of bulls as a group.

That doesn’t mean that big antlers are dysfunctional for elk as species.  As biologists have long noted, sexually reproducing species have far more males than they need, so if many bulls are more easily caught and killed because of their large antlers, that doesn’t much threaten the survival of their species.  But surely any sentient bull would find survival to a ripe old age preferable to being killed and eaten by wolves.

The equilibrium antler size is thus problematic from the perspective of bulls in precisely the same way that the equilibrium stock of bombs in problematic from the perspective of nations engaged in military arms races. There is an equilibrium in military arms races.  But that doesn’t mean that the equilibrium stocks of bombs are efficient. This is a simple and uncontroversial point.  Whitfield subtitled his review, “What The Darwin Economy Gets Wrong About Evolution.” A better title: “What John Whitfield Gets Wrong About What The Darwin Economy Gets Wrong About Evolution.”

Q. You say that “…half of all children still attend bottom-half schools.” Won’t this always be the case approximately? And why is it a problem? -Andrew

A. The example from my earlier post that drew the most questions from Freakonomics Blog readers was the one in which bidding for a house in a better school district was portrayed as an activity that caused undue harm to others. I focused on that example because it provides the clearest illustration of how some forms of consumption are mutually offsetting and hence essentially wasteful.  The key point is that school quality entails a strong relative component. A statement like “this school is good,” for example, is generally understood to mean that the school compares favorably with other schools in some suitably chosen local frame of reference. And, yes, half of all children are indeed destined to attend schools of below-average quality.

I take as given that virtually all families in the middle of the earnings distribution aspire to send their children to a school of at least average quality. (We’d think ill of any parent whose aspirations were lower.) The rub is that the best schools tend to be located in more expensive neighborhoods. In the U.S., that’s partly because school budgets are often funded by local property taxes. But because of peer effects in t
he classroom, it’s also true in countries in which school budgets are everywhere identical. The upshot is that to send its children to a school of even average quality, a family must outbid half of other similar families who are pursuing the same goal.

That’s become more difficult in the U.S. because of a process I’ve elsewhere called expenditure cascades. The first step in that process is that top earners, who have captured the lion’s share of all income gains for the past thirty years, have been building larger, more expensive houses.  (That’s not a criticism—it’s what every group does when it has more money.) Middle-income people rarely seem resentful about the larger mansions of the rich. But those mansions shift the frame of reference for the near rich, who travel in the same social circles. Perhaps it’s now the custom in those circles to hold your daughter’s wedding reception at home, rather than in a hotel or club. So the near rich feel that they too need a house with a ballroom. And when the near rich build bigger, they shift the frame of reference for others just below them, and so on, all the way down the income ladder.

There’s no other way to explain why the median new house built in the U.S. in 2007 had more than 2300 square feet, almost 50 percent more than its counterpart in 1980.  Certainly, it’s not because the median earners are awash in cash.  (The median real wage for American men was actually lower in 2007 than in 1980.)

The upshot is that to achieve the basic goal of sending its children to a school of average quality, middle-income families must now spend a substantially higher fraction of their incomes than before. In a very concrete way, then, greater spending on housing by top earners has caused harm to families further down the income scale. Of course, those families could have avoided taking on additional debt by buying less expensive housing than their income peers.  But that choice would have required them to send their children to a relatively low quality school.

Have middle-income families been harmed unduly? That is, does the harm they’ve suffered rise to the level sufficient to justify government intervention under John Stuart Mill’s harm principle? Since the larger mansions of the rich were the step that launched the expenditure cascade in housing, the answer to that question would depend on how burdensome it would have been for the rich to have built smaller mansions. On the best available evidence, absolute mansion size matters very little beyond some point, so when the rich build bigger mansions in tandem, the effect is largely to raise the bar that defines how big a mansion they feel they need. It is in society’s interest to define property rights to promote efficient resource use. Existing property rights (which include the existing tax system) fail that test, since they encourage patterns of housing expenditure that deliver no significant benefits to wealthy families yet impose significant external costs on all others. The important question, then, is whether it’s practical to do anything about this problem.

Q. Dr. Frank, I first encountered your conversation with Russ Roberts 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 Commissioner 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? -Napping Tom

A. My proposal to scrap the current income tax in favor of a far more steeply progressive tax on consumption was inspired by the analogy between mutually offsetting growth in antler size and with mutually offsetting increases in many forms of consumption expenditure.

Could a progressive consumption tax diminish those external costs without compromising the well-being of the wealthy?  Like other tax units under my proposal, a wealthy household would report its income to the IRS as before, and would also document its annual savings, much as families now do with IRAs and 401k accounts. The difference between those two numbers—income minus savings—less a large standard exemption, say, $30,000 for a family of four, would be the household’s taxable consumption. Tax rates would start out low, say 10 percent, so that the total tax bill for the median family would be as small as or smaller than under the current system. Rates would then rise steadily with taxable consumption, topping out at much higher levels than the current top marginal income tax rates, which cannot approach 100 percent without seriously compromising incentives to save and invest.  In contrast, a 100 percent marginal rate on the highest consumption bracket—over $4 million a year, say—would not only be feasible, it would actually stimulate savings and investment.

Consider a wealthy household had been contemplating a $2 million addition to its mansion and was then confronted with a 100 percent marginal tax rate on additional consumption. Because the tax would raise the cost of the planned addition by $2 million—the original $2 million cost of the project plus the $2 million in additional tax—wealthy families would scale back their plans. If they decided to build additions costing, say, $1 million, their total outlays would be the same as before—$1 for the project itself and $1 for the tax on it. And if it’s true that beyond some point it’s only relative mansion size that matters, these families would be just as happy as they would have been under the earlier tax regime. But in the meantime, the government would have substantial additional tax revenue, which could be used to pay down debt, rebuild crumbling infrastructure, or reduce other taxes.

Q. 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 consumption tax, what are the employment consequences of encouraging increased savings???-Tyler

A. As I see it, Darwin’s conception of the relationship between competition and social welfare includes Adam Smith’s invisible hand theory as a special case. For example, a mutation that favored keener eyesight in an individual hawk was favored by natural selection because it helped that individual catch more prey and raise more offspring. Additional mutations spread over time, resulting in a species whose members now all have incredibly acute vision. This narrative is closely analogous to Darwin’s account of the spread of a cost-saving innovation. The selfish entrepreneur who introduced it gained ground at the expense of rival firms, just as he’d hoped.  But his gains were short-lived. Rivals rushed to adopt the innovation, and as they did so, competition forced price into line with the new, lower production costs. In the end, consumers enjoyed a steady stream of improved products at ever lower prices.

But as with the example of antlers in bull e
lk, some traits serve individual interests at the expense of the interests of larger groups.  So in this sense, Darwin’s more general theory is an addendum to Smith’s invisible hand, theory rather than a replacement for it.

But Darwin’s theory also speaks to the question you raise about preferences. Darwin realized that success in competition depends less on how smart or fast you are in absolute terms than on whether you are smarter or faster than your direct rivals. That perspective makes clear that a brain molded by the ruthless pressures of natural selection should care very much about relative position.

Re: the employment consequences of shifting to a progressive consumption tax, the important point to stress is that employment demand depends on the total level of spending, not on how that total is distributed across different categories. If the tax were phased in gradually once the economy was back at full employment, as I recommend, its effect would be to produce a gradual shift in the composition of spending. At the margin, people would consume less and save more. The flow of additional savings into the capital market would lower interest rates and translate those deposits into additional investment spending. So over time, investment would gradually rise as a share of national income while consumption’s share would gradually fall. That shift would cause productivity and incomes to grow more rapidly, and before long, the absolute level of consumption would be higher on the new trajectory than if we had remained on the original one.

As I asked in my original post, what’s not to like?