It's a winner-take-all market - top money goes to top performing people or products

Washington Monthly, Dec, 1995 by Robert H. Frank, Philip J. Cook

These advantages pale in comparison to the advantages of using consumption taxes to counteract the inefficiencies that arise from winner-take-all markets. For one, a progressive consumption tax would free up hundreds of billions of dollars of resources that are largely wasted through mine-is-bigger consumption races. Consider, for instance, a wealthy family's decision to build an 8,000-square-foot house. It does so not just because spacious living quarters are desirable in some absolute sense, but also because houses that size have become the norm for their income bracket. To have a smaller or less well-appointed house than one's peers would entail social embarrassment. Yet, if all wealthy families had smaller houses (as indeed most do in places like New York City, London, and Tokyo), no one would be embarrassed in the least.

Thus, if a consumption tax led wealthy families to buy 5,000-square-foot houses instead of 8,000, and Toyota Supras instead of Ferraris, no one would really be worse off, and several hundred thousand dollars of resources per family would be freed up for more pressing purposes-deficit reduction, medical research, capital investment, job training, school lunches, drug treatment programs, whatever.

Opponents of progressive consumption taxes will caution that such taxes will cause unemployment, citing the layoffs in the shipbuilding industry that followed imposition of a luxury tax on yachts in 1991. But that was a tax with a glaring loophole that exempted boats purchased outside the country. A general progressive tax on consumption would shift employment from some activities to others, to be sure, but that is precisely the objective.

The need to debate which consumption categories, if any, ought to be exempt can be avoided by having a large standard deduction--by making the first, say, $20,000 of annual consumption expenditures exempt from taxation. This feature would serve two purposes: It would shield necessities like food, health care, basic clothing, shelter, and transportation--from taxation, and it would make the tax progressive. The tax could be made even more progressive by having tax rates that rise with consumption, just as we now have tax rates that rise with income. The so-called "Unlimited Savings-Allowance" proposal by Senators Nunn and Domenici is a tax with all these features.

Armey's tax would move us in precisely the wrong direction. By reducing the tax rates on top earners by more than half, it would steer even more of our best and brightest into winner-take-all markets that are already overcrowded. By giving the top earners much more disposable income, it would also fuel the growth of wasteful consumption expenditures, both by the rich and by others who emulate them. It would greatly worsen the social strains of income inequality.

Robert H. Frank and Philip J. Cook are authors of The Winner Take-All Society: How More and More Americans Compete for Fewer and Bigger Prizes, Encouraging Economic Waste, Income Inequality, and an Impoverished Cultural Life (1995, The Free Press).