After Scott Sumner surveyed, with aghast, the uselessness of the leather-bound backgammon sets and other luxury goods on the FT’s HowtoSpendit website, he couldn’t help but post an argument for progressive consumption taxes. Sadly, his argument overlooks the most valuable aspect of “luxury” goods—their motivational effect.
Talented people can earn a living with less work and entrepreneurial risk-taking—two things that grow the economy and increase employment. Nevertheless, many talented workers work hard to earn money for the sake of status. As a result, the products, services, and resulting fantasies that seduce talented workers to work harder and take more entrepreneurial risk are critical to the success of the middle and working class.
Higher-earning workers probably work more hours than most workers on average because their marginal hour of work produces more value than it does for others, even if the value of an addition dollar declines in value as a worker earns more. Nevertheless, if motivation were simply a matter of declining marginal utility, it is odd to find that the highest-earning workers choose to participate in the workforce more, on average, and work longer hours than other workers. Similarly, better-educated women have fewer children (a luxury) and postpone birth longer so they can work and earn more. And many of the richest workers continue working despite having more money than their families can spend. Clearly, people work for reasons other than just material wellbeing—chiefly, for status.
While a progressive consumption tax, which Sumner proposes, may be an improvement over a progressive income tax, it will likely have a similar demotivating effect on risk-taking and hard work as higher taxes have had in Europe—a cost Sumner’s argument ignores. In Europe, armies of talented workers run off to vacation—where the value of leisure is untaxed—rather than arduously endeavoring to create the next Google or Facebook, as they do in America.
Europe’s relative lack of effort has had a gradual compounding effect that has grown substantial over time. Unlike the United States, the institutional capabilities of Europe’s employers and employees can no longer produce growth akin to America’s despite access to the same technologies and a similarly, if not a better, educated workforce. In contrast, America’s ingenuity and institutional capabilities have produced outsized employment growth relative to Europe despite median disposable household incomes that are 20 to 30% higher. Through a self-reinforcing feedback loop, relatively diminished European institutional capabilities lower the expected payoff and motivation for hard work and successful risk-taking, which are essential to building institutional capabilities.
In America, a wave of low-skilled immigrants—generally the poorest workers—has been the chief beneficiary of faster growth. The rich on the other hand, have worked more, and while earning more, have largely fought each other to a draw in the race for relative displays of status. As success grows greater on average, avoiding loss of status becomes the chief source of motivation, just as avoiding lost profit is large part of the return on investment. Subzero refrigerators and expensive cars become must-have products. It’s hard to see how the European alternative—or how higher taxes on goods and services that motivate status-seeking Americans to work harder and take more entrepreneurial risks—has proven to be more beneficial to the poor.
Moreover, Sumner’s hypothesis that envy motivates the middle class to tax the rich, while plausible, seems unlikely and unnecessary. Rather, the support of the middle class for taxing the rich seems quite straightforward—it’s just a matter of tax or be taxed and where a bird in the hand—more government benefits today funded by others—is worth two in the bush—namely the hard-to-fathom “opportunity” to work more tomorrow. Even if the opportunity to work more were certain, which it is not, many voters no longer find that opportunity compelling.