BOOKS AND ARTS MARCH 29, 1999
Luxury Fever: Why Money Fails to Satisfy in an Era of Excess
by Robert H. Frank
(Free Press, 326 pp., $25)
Is it a problem when people spend $17,500 for a Patek Philippe wristwatch? Should Americans be troubled when their fellow citizens pay $5,000 per night for a suite at Little Nell in Aspen, or $14,000 for a Hermes Kelly handbag, or $1,000 for gray flannel pants? Robert Frank thinks so. He believes that American society is suffering from "luxury fever." This is not simply a problem of frivolous expenditures by rich people with more money than they can handle. In his view, there is a much deeper difficulty. Frank believes that excessive spending for luxury goods--spending that does not, in fact, make people happier--shows something important about human nature, public policy, and the general question of what promotes well-being. In Frank's view, luxury spending is an example of troublesome and ill-understood behavior in which even reasonable people make themselves, and each other, worse off--behavior that is "smart for one, dumb for all."
Frank wishes to break the "consumption treadmill" by preventing people from needlessly competing with each other (through expenditures that are literally wasteful), so that "trillions of dollars" can be diverted to better uses, both private and public. With the reallocation of those trillions, he argues, we can increase investment, produce much more equality, and also fund an aggressive welfare state, without at the same time compromising economic growth. He thinks that a better understanding of the consumption treadmill shows that the conflict between equality and efficiency is greatly overstated, even illusory. Indeed, he urges that, with a one-line change in the tax code, we can achieve more of both at the same time. This is a provocative and unusual book. It is also a lot of fun, and in places it is hilarious. It deserves a close reading.
Frank begins by tracing what he sees as a recent boom in spending for luxury goods among the rich. To be sure, people have always been willing to spend a lot on luxuries; but Frank finds a significant change, at least "at the top of the income pyramid." In general, he says, luxury spending has been growing four times as fast as overall spending. Frank documents a range of more particular trends, with dramatic increases in the purchase not only of watches and handbags costing thousands of dollars, but also of mansions, or "trophy homes"; of luxury trips (with per diem spending of at least $350); of luxury cars (those selling for more than $30,000); of huge vacation residences; of expensive cosmetic surgery (chosen by more and more, and by younger and younger, people); of increasingly large primary residences (with the average home built in the United States nearly double the size of its counterpart in the 1950s).
What accounts for these remarkable increases in extravagance? Despite sluggish growth in the American economy in the last quarter-century, this has been a period of terrific gains for those near the top of the economic ladder, who are enjoying "unprecedented prosperity." There is also the matter of an important demographic shift: the postwar baby boomers are now entering their peak earning years. Yet Frank lays special emphasis on "the unusually rapid growth in the incomes of top earners in every demographic category"--a consequence, he thinks, of the spread of what he calls "winner-take-all markets."
These are markets in which small differences in individual performance produce enormous differences in economic reward. They are most familiar in the world of sports; but those markets are increasingly pervasive, in medicine, fashion, law, journalism, design, accounting, and elsewhere. The rise of thousands of "winners" has helped produce not only growing inequality, but also a boom in luxury spending. Frank discussed this particular phenomenon at length in The Winner-Take-All Society, written with Philip Cook, which appeared in 1995, and he builds on that discussion here.
These are facts about the expenditures of the rich, but Frank finds similar patterns for middle-income and lower-income earners. The personal savings rate in the United States is down nearly 90 percent since 1980, and consumer debt is on the rise, with dramatic increases in credit card debt and in bankruptcy. Frank proposes a link between this phenomenon and the practices of the rich. "It is natural for people at all income levels to experience new desires in the presence of others who spend more than they do. And even apart from any changes in what we consciously desire, our individual spending decisions are often influenced by the fact that our menu of available choices is so strongly shaped by what others spend." Thus most people spend more, and for more luxurious items, because of the trends set by those at the top.
The general increase in spending for luxury goods, and the sharp decrease in saving, might not be much of a problem if people's expenditures actually made them happier. Yet Frank thinks that this is not the case. These expenditures have "come at the expense of not only lower savings and greater debt but also many other things we value." In a central part of his argument, he denies that consumption as such buys happiness. What really matters is where people stand in their society, not their absolute level of consumption. In particular, cross-cultural evidence shows that reported life-satisfaction "is essentially independent of per-capita income," above a certain threshold level of affluence. (Frank does not specify that level, but he suggests that people do need to have minimally adequate shelter and nutrition, and that happiness is lower in extremely poor nations.) In various nations, including America and Japan, people do not seem significantly happier when per capita income rises sharply. Average satisfaction levels are stable over time even in the presence of substantial economic growth. Above a certain level of income, your relative position (how you compare to others) seems to matter a great deal, and your absolute position (how much you have) seems to matter not at all. Frank adds the suggestion, based on social science, that people can adapt a great deal to good and to bad--and thus new consumer goods, even luxury goods, are likely to do little to increase people's subjective sense of well-being.
Frank is not arguing that money cannot buy happiness. What matters is not what people spend. What matters is what they buy. The best kind of spending involves what Frank calls "inconspicuous consumption," which he defines to include "freedom from traffic congestion, time with family and friends, vacation time, and a variety of favorable job characteristics," such as adequate physical space. Frank contends that inconspicuous consumption will provide "gains that endure." In America, however, people tend to neglect this point and to devote most of their resources to a kind of wasteful and mutually destructive competition for more and better goods.
This, then, is the ultimate source of the problem: the consumption treadmill, a kind of "positional arms race" that Frank finds at the heart of luxury spending. In his view, we tend to spend money because we care about what we have compared to others. Once people get on the treadmill, there is no obvious stopping point, and soon they find themselves spending large amounts for goods that give them little, temporary, or no pleasure.
To break the process, we would have to act collectively; but we can't, and so we don't. Nor are those who purchase luxuries entirely oblivious to this. "Many people are fully aware, at some level, that we might be better off if all saved more and all spent less on houses and cars. But that choice is simply not an item on any individual family's menu. A family can choose the amount it spends on its own house, but it cannot choose the amounts that others spend." Thus luxury spending is a classic case of the struggle for better relative position--better position in the hierarchy--leading to a form of waste that people are unable to prevent on their own.
The irony is that individual purchasing decisions inflict a harm on other people (by forcing the rest of us to want to keep up), and they do so without making the purchasers better off. The most obvious analogy is literally an arms race, where nations acquire more weapons in order to keep ahead of their rivals, even though "when all spend more on weapons, no one is more secure than before." In a general attack on his fellow economists, Frank claims that this sort of problem is not isolated but pervasive.
With respect to competition, Frank stands against Adam Smith and with Charles Darwin, who saw that with respect to evolution, competition can be "smart for one, dumb for all." Athletes find themselves using anabolic steroids in order to get an edge on the competition; students use "cram courses" to prepare for the SAT, producing no change in relative position and hence waste; people talk louder and louder to be heard at a cocktail party; and people who care about status may spend more and more to look good, or not bad, in front of their peers. In a bit of speculative, seat-of-the-pants Darwinism, Frank even offers an evolutionary explanation for why people care so much about relative position, suggesting that evolution would favor people who slightly outperformed others, and cared about doing so.
Sometimes this kind of problem is solved through law. An important example is the environment. In an unregulated market, individual polluters can impose environmental damage on others; they will not reduce pollution voluntarily, because they would bear the full costs, but not the full benefits, of the reduction. Regulation, or a tax on polluting activity, is a necessary corrective. Consider also zoning laws, which prevent merchants from having to compete with "ever larger and more garish" signs; Sabbath norms and blue laws, which "limit the extent to which people can trade leisure time for additional income"; and overtime and safety regulation, which prevents people from "competing for more money at the expense of leisure time and health." Notwithstanding these success stories, American government has failed to provide a general check against competition for ever more expensive goods. Thus Frank urges that his "claim, reduced to its essence, is that the conflict between individual and group is the single most important explanation of the imbalance in our current consumption patterns."
What is the solution? Voluntary self-help won't work. People's judgments are inevitably biased in the direction of conspicuous consumption, partly because they have much more information about it than about inconspicuous consumption, partly because conspicuous consumption is simply so tempting. Nor does Frank believe that ordinary social norms are likely to solve the problem. To be sure, many norms do appear directed against conspicuous consumption: if you buy a Porsche or Mercedes, you may be violating the norms of your community. But the reach of such norms is quite limited.
And so Frank turns to law. If he is right, the most obvious solution is a luxury tax targeted to specific goods which people purchase as part of the consumption treadmill. But Frank rejects this solution on several grounds. Such a tax will have to specify the goods that count as "luxuries"; and the predictable consequence is an interest-group struggle over which goods to tax most heavily. In any case, people are all too likely to attempt to evade any particular tax.
The best solution, in Frank's view, is much more general: a progressive consumption tax. As he presents it, the tax would be calculated very simply, essentially by subtracting savings from income. For example, a family that reported $100,000 in income and $10,000 in savings would pay tax on $90,000--whereas the same family, saving $50,000, would pay tax on a mere $50,000. Frank believes that such a tax would sharply diminish competition over goods that do not make people happier. At the same time, a tax of this kind would shift the use of dollars in more productive and less wasteful directions.
A consumption tax would help ordinary citizens, because it would increase the incentive to devote their resources to things that actually make them better off. It would help the economy, Frank says, because money spent on consumption would now be spent on investment, which is better for productivity, at least in the long run. Indeed, higher taxes would stimulate the economy by diminishing people's incentives to participate in winner-take-all markets. Frank thinks that we could obtain all these goods while also decreasing inequality, because the sharply progressive consumption tax could be used to redistribute resources from rich to poor--without (and this is his most ingenious claim) at the same time making rich people worse off than they are now. Rich people would not be worse off because the only consequence would be to prevent them from competing for luxury goods, which do not, by hypothesis, improve their lives. For Frank, the result of this analysis is to eliminate the alleged conflict between "equity" and "efficiency." It is entirely possible to have both.
Frank concludes with a vigorous attack on "trickle-down economics" and the claim that "we can't afford" certain social programs. He believes that trickle-down economics has things backward, because "a shift to a progressive tax on consumption would be more likely to increase economic growth rather than to inhibit it." And while Frank acknowledges that some social programs have been wasteful, he thinks that many have done a great deal of good, and that we could use a good deal more.
Though he emphasizes environmental protection and health care, Frank is especially concerned about the absence of decent education and job prospects for poor people. He thinks that federal employment programs, funded by a progressive consumption tax, could find many useful tasks for people with little training or experience. In sum, a progressive consumption tax would break competition over relative position without hurting those engaged in that competition, and in the process it would release trillions of dollars for both private and public investment. "The only intelligible reason for having stuck with our current spending patterns for so long is that we haven't clearly understood their sources and how painless it would be to change them."
At the level of theory, Frank's claim can be reduced to a single sentence: since people make many luxury-type expenditures largely or only to improve relative position, we should adopt policies that produce more savings, and more equity, while breaking a form of competition that does little good for anyone, including the rich. Such an argument is both plausible and ingenious, and it is refreshing to find illuminating new arguments offered in the service of a fairer social order. But I am not sure that Frank is right. He overstates the wastefulness of purchases of luxury goods, and he understates the difficulties associated with a progressive consumption tax.
Status and relative position do count. But we do not know when they count or how much they count. Consider overtime and occupational safety laws, which Frank enlists in support of his general argument. Critics complain that such laws are counterproductive, because they end up taking money out of the hands of workers. Overtime laws give employers a disincentive to hire people to do extra work, and occupational safety laws take money out of wages and devote it instead to (often small) safety improvements in the workplace. Frank thinks that even if workers end up with less money, this is not a problem, because workers' relative position will stay constant, and relative position is what workers care about. But the question remains: do the workers whose wages go down because of these laws really care only, or mostly, about relative position? This is far from clear, and Frank offers no direct evidence to support his affirmative answer.
To be sure, Frank's principal concern is with luxury spending, which may be distinctly associated with the acquisition of status. At least some of the time, however, people buy expensive goods because they like them. I have a friend who recently bought an Audi, which is a $40,000 car; and for him there is an especially attractive feature in this car, which is the presence of heated seats. These seats are not observable, and they do not confer status. In fact, my friend appears not to care about status at all; he just likes the car. Many people buy extraordinarily expensive stereo equipment simply because the sound is so good, and they are willing to pay for expensive vacation homes because the surroundings are so beautiful. Frank has no evidence to the contrary.
Frank says, correctly, that the "frame of reference" is set by what others have, and he responds that people are usually wrong to think that such goods will make them happier. People's powers of adaptation are such that a fancy car, stereo, mansion, or diamond will not produce "enduring gains." This, too, is plausible, but it is not clear that Frank has established its truth. Much of his evidence consist of studies of self-reported happiness. Recall that people in rich countries report themselves as no happier than people in much less rich countries, holding relative position constant. But how much can be learned from people's statements about how happy they are? (And on six-point scales!) Relative position may account for people's statements about their happiness on such scales--statements made perhaps after a quick survey of how other people are doing--without also accounting for their actual happiness in life.
Holding everything constant, do we really know that people in the top 20 percent, or middle 20 percent, in a very rich country are no happier, or better off, than people in the top 20 percent, or middle 20 percent, of a significantly less rich country? In any case, subjective happiness is hardly all that matters. Indeed, it is far from clear that happiness should be taken as a subjective concept. Whatever their "happiness," on questionnaires or otherwise, people who have more resources are able (other things being equal) to live better lives, by improving their health, providing better education for their children, protecting themselves from extremes of heat and cold, taking more and better vacations, and generally facing less anxiety for the future. Economic growth may be good for these reasons alone; its principal consequence is not to increase spending on luxuries.
Frank thinks that someone who buys a luxury good inflicts a kind of harm, akin to pollution, on other people. With this claim, too, there are problems. Many people are not much influenced by luxury purchases; perhaps most of us, most of the time, are not adversely affected at all. Indeed, some people affirmatively enjoy seeing luxury goods, even in the hands of others. In this way, people who buy wonderful clothing or watches may actually make their friends and neighbors better off. Frank's analogy to pollution is illuminating, but far from precise. And it is not obvious that any harm inflicted by luxury spending is the kind of harm for which government ought to respond with taxation. Should government really tax people for creating envy in others?
Turn now to Frank's policy recommendation. For many decades many economists, on both the right and the left, have favored a consumption tax over an income tax, partly as a means of encouraging savings. Some people support a consumption tax as a way of encouraging more savings but firmly reject higher rates on the wealthy, usually on the theory that higher rates will decrease economic growth (hence trickle-down economics). And many commentators have urged, long before Frank, that a progressive consumption tax would be a big improvement. (In recent years, Senators Pete Domenici and Sam Nunn have proposed a tax of this general kind which they call the "USA tax.") Frank's distinctive contribution is to argue that an understanding of the consumption treadmill shows that a progressive consumption tax would make many people better off while making few, if any, worse off.
The idea of a consumption tax raises two obvious questions. Isn't such a tax likely to be regressive, to hurt the poor and to help the rich? And how do we know what counts as "savings"? Obviously, wealthy people can save a lot and are easily able to divert income to savings, whereas lower income people, who have to spend what they earn, will pay tax on every dollar. To maintain the distributional burdens of the current income tax, a progressive income tax might have to be combined with a wealth tax (not discussed by Frank), or it might have to include extremely (and politically speaking, prohibitively) high marginal rates on expenditures by high earners. There are hard technical issues here.
In any case, Frank is wrong to suggest that a progressive consumption tax would be "simple." For one thing, a consumption tax would have to replace, or to be squared with, the rest of the existing tax system, including the corporate income tax, the existing system of deductions, the treatment of gifts and bequests, the mortgage deduction, insurance and annuities, borrowed money, and so forth. The transition problems would be serious. For another thing, the distinction between "consumption" and "savings" can be thin. Does a house count as savings? Stocks? Books? Stamps? Diamonds? Problems of this kind have made tax specialists worry whether government can draw the necessary lines.
Frank's apparent remedy is to treat as "savings" only those investments that are put into a specially designated account. But what are the permissible uses of such an account? There are also serious problems of equity. A family that spends $20,000 on cookies and candy will be treated the same as a family that spends $20,000 on repairing their roof and educating their children; and both will be treated the same as a family that spends $20,000 on a party dress; and all of these will be treated the same as a family that invests $20,000 in real estate. It is not easy to defend the judgment that everything should count as "consumption" except deposits into a specifically designated savings account. No wonder that the Domenici-Nunn proposal, though very much in Frank's spirit, is several hundred pages in length.
This raises a deeper problem. If Frank is really concerned about excessive luxury spending in particular, a consumption tax seems to be a pretty crude remedy. Most people spend only a little of their money on luxuries; for most of us, most of the time, expenditures are far more likely for housing, food, and clothing. For this and other reasons, it is not clear that a progressive consumption tax would solve the problems that Frank identifies.
Recall that one of Frank's motivating ideas is that those who purchase certain goods impose a harm on others. Even if it should try, how could government possibly monetize any such harm? In any case, a general consumption tax is not a well-tailored solution to the perceived problem. A consumption tax would cover any and all consumption, much of which inflicts no harm on others. It would not tax the particular injury to others produced by particular acts of consumption. Indeed, a consumption tax could produce an overall increase in savings without much decreasing the particular kinds of expenditures that trouble Frank. At the very least, this cannot be assessed a priori.
Perhaps we will have to say what Frank does not say (but, I suspect, believes): that higher taxes on the wealthy are justified even if such taxes hurt the wealthy. If Frank has not shown as much as he claims, however, he has nonetheless shown a great deal. A progressive consumption tax would have some real advantages over the income tax. People often do struggle wastefully over status and relative position, each competing to the detriment of all. And people do buy things that fail to give much pleasure. Even grown-ups often lack a good sense of what kinds of expenditures, and investments, will actually promote their well-being.
A familiar problem with unrestricted free markets is that they can produce pervasive injustice. A less familiar problem is that free markets often trap people, including the well-off, into wasteful and continuing struggles for better position. It is in the very nature of the problem that even reasonable people may be unable to extricate themselves from those struggles without collective help. In the face of struggles of this kind, free markets should not be identified with freedom, properly understood.
Cass R. Sunstein is the co-author (with Stephen Holmes) of The Cost of Rights (Norton).