In a paper that has been around since 2004, and that has not attracted, in my opinion, anywhere near the attention it deserves, Robert H. Frank makes the case that more progressive taxation benefits the economy (at least for indebted nations such as New Zealand and the United States), society, and the environment.
The reason lies in the peculiar characteristics of what he calls “positional goods” – those goods whose primary consumption benefit is that they signal ones place in the social pecking order:
The problem with positional goods, is that they are tools in a ‘positional arms race’ that can be just as dysfunctional and ultimately futile as the military arms race. In economic terms, then, positional goods may impose considerable negative externalities on other people (i.e. my consumption of a positional good may impose costs and unhappiness on you and others).
I may, for example, be able to increase my social status by buying a larger house, but if everyone else does the same thing, I end up – positionally – no better-off and lumbered with increased debt and stress. If this happens across a whole society, then the indebtedness of that society increases, the social impacts of financial stress (e.g. overwork, increased relationship breakdowns, drug & alcohol abuse, child neglect, crime etc.) increase, and the ecological impact of that society increases. We can think of many other examples of positional arms-races too: dress codes for job interviews (if I wear a fancy suit, I may get an advantage, but if everyone does, it just becomes an expensive entry requirement); ‘protecting’ one’s family on the road with a large SUV; credentialism in the job-market etc.
Given the nature of positional goods, Franks argues, making taxation less progressive (i.e. giving relatively greater tax-cuts the the rich) leads to “expenditure cascades” – even if the tax-cuts only affect a very small proportion of the population (as in the case of some of the tax-cuts in the U.S. that he examines). The mechanism is this: The tax cuts allow the persons at the top of the social heap to increase their spending on positional goods. This sets a new level of status-consumption expectations that trickle down through the social & income heirachy: the ultra-rich deciding to move up to a mansion with 20 extra rooms may manifest itself in an increasing average floor-size for “ordinary” housing, and so on. For those families facing a need to increase expenditure to maintain their place in the positional hierarchy, while real-incomes fall, the options are increased debt and/or increasing household working hours. There is another paper by Frank & Adam Seth Levine on expenditure cascades here.
Franks then shows evidence from the United States that suggests that outcomes such as these were precisely what did happen in response to tax changes that made the tax-system less progressive in the decades from the 1970s onward.
Of course, the global financial crisis hadn’t hit when Frank wrote in 2004, but given the role of unsustainable mortgage debt in the crisis, the implication is now clear: as well as making U.S. society worse off, and increasing its ecological impact, making the tax-system less progressive also contributed to the global financial crisis!
A quick look at data for New Zealand suggests similar dysfunctional mechanisms have been at play here.
OECD data shows that income inequality (and poverty) in New Zealand, increased substantially from 1985 and Reserve Bank figures show household debt has ballooned along with house prices (unfortunately NZ does not have good household debt data from before the 1990s) . I’ve written about New Zealand’s unsustainable external debt before. At the same time, New Zealand’s economic growth has been lacklustre and our ecological footprint has continued to grow (we haven’t even met the inadequate Kyoto emissions targets).
Our economic policies since 1984 have failed by almost every conceivable measure, including those used to justify them. It’s time to try a new direction – one that might include a more progressive tax system.