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Thursday, December 22, 2005

Are Tax Cuts for the Wealthy Wasteful?

Here's the latest from Robert Frank from an Economic Scene in the NY Times. He disputes the idea that tax cuts for the wealthy improve the utilization of our scarce resources:

Tax Cuts for the Wealthy: Waste More, Want More, by Robert Frank, NY Times: With President Bush's proposed tax cuts for top earners struggling to get political traction in early 2001, Representative Tom Osborne, Republican of Nebraska, rose to the White House's defense on the House floor. "The bottom line is that it's your money," he said, "and you know how to spend it much better than anyone in Washington, D.C." In the years since, variations of this statement ... have kept opponents of high-end tax cuts consistently on the defensive. ... in part because it appeals to voters' common sense. After all, people have an obvious incentive to exercise care when spending their own hard-earned dollars. Why would a faceless bureaucrat in Washington, who is spending someone else's money, be nearly as careful? The "it's your money" line is also buttressed by widely reported examples ... Famously, the Pentagon once spent $640 for a single toilet seat and on another occasion paid $435 for an ordinary claw hammer.

But paying more than the market rate is just one form of wasteful spending. Another ... form is to pay a fair price for something that serves little purpose. This second form of waste is considerably more common in private spending than in public spending...  A case in point is a decision on many minds at this time of year, that of how much to spend on a wristwatch. ... The most coveted among them are elaborate mechanical marvels with multiple "complications," special features that enhance their accuracy. ... The Grande Complication, by Jean Dunand, sells for more than $700,000, but lesser entries by Patek Philippe, Rolex and other manufacturers can be had for $5,000 to $100,000.

Unlike toilet seats and claw hammers, these watches are costly to produce, so buyers who pay high prices for them are not being ripped off. In another sense, however, their dollars go largely for naught. For despite their mechanical wizardry, none of these watches are as accurate as a battery-powered $30 Timex, whose quartz crystal mechanism is unaffected by gravity. ...[B]uyers of these watches [are] men from 30 to 50 who want "this 'power tool,' this instrument on their wrist that distinguishes them from the pack." The problem is that if a watch is to distinguish its owner, it must sell for more than the watches worn by members of the pack. So when the pack spends more, the price of distinguishing oneself also rises. And in the end, no one gains any more distinction than if all had spent less.

Other forms of high-end private spending are driven by similar forces. ... David H. Brooks, the chief executive of a company that supplies body armor to the American military in Iraq, invited 150 of his daughter's friends to the Rainbow Room atop Rockefeller Center in Manhattan, where they were serenaded by 50 Cent, Don Henley, Stevie Nicks and other luminaries during a birthday party reported to have cost $10 million. ...[T]he parents involved are not behaving abnormally. They are merely spending their own money ... to provide a special occasion for their daughters. For a party to be special, however, it must somehow stand out from other parties that define the norm. Here, too, the problem is that expensive birthday parties have become a growth industry. ... no matter how much parents spend, the number of parties that achieve special status will be no greater than when everyone spent much less.

On balance, then, there is little reason to expect large tax cuts for wealthy families to have resulted in a more efficient allocation of our nation's scarce resources. For one thing, not all of the dollars used to finance these tax cuts would have been spent wastefully by government. Most of the money recently cut from the food stamp program, for example, would have been spent by poor families to buy food at fair market prices. And even though government does buy some items at inflated prices - body armor whose price includes a profit margin large enough to finance a $10 million birthday party? - many of these items serve vital purposes. In contrast, most of the tax cuts financed by recent budget cuts will go to families that already have everything they might reasonably need. This money will be deployed in the quest for "something special." Yet because special is an elastic concept, the number of families that succeed in this quest will be little different from before.

I should note that it is not the pattern of spending that brings about an inefficiency, though the article leaves that impression. So long as the supply and demand for, say, lavish jewelry intersect in competitive markets, it is efficient in standard economic terms. However, the argument in the article is a bit more subtle. He is asserting a market failure in the spending of the wealthy - the fruitless race to achieve special status. When the wealthy attempt to achieve special status and all follow suit, in the end there is no value to the spending because status is not improved. And if no value is created over and above what a lower level of spending could have achieved in terms of status, it is wasteful. Therefore, taking a dollar from a rich person and giving it to a poor person to spend on necessities in the private sector can improve efficiency.

    Posted by on Thursday, December 22, 2005 at 12:57 AM in Economics, Income Distribution, Taxes | Permalink  TrackBack (0)  Comments (18)


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