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.

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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?