Friday, September 01, 2006

Are the rich a form of pollution?

Brad DeLong reveals his inner Veblen:

I'm enough of a touchy-feely sociology-lover to believe that a good chunk of the utility the rich derive from their conspicuous consumption is transferred to them from the poor.
This quotation goes to the heart of one reason left-leaning economists like Brad and right-leaning economists like me differ in their policy views.

I recall once hearing Larry Summers ask students a provocative question to spark discussion: If there were some policy that would make the rich poorer without affecting the income of anyone else, would you want the government to flip this switch?

Traditional economic policy analysis assumes the answer is no. After all, the policy intervention Summers described is a Pareto-deterioration. But the answer is less obvious if, as Brad suggests, people derive utility from comparisons with others. In this case, making the rich poorer raises others' welfare, even if their material standard of living is unchanged.

In Brad's world, a rich person conveys a type of negative externality, like pollution. High taxes on the rich can be seen as Pigovian. Economists like me complain that high tax rates on high earners discourage their hard work and entrepreneurship. The Veblenesque Pigovian economist replies, "Precisely!"

I must confess that I do not have a good retort to the argument. This is all the more problematic because there is some evidence that having rich neighbors reduces a person's self-reported happiness. (See Luttmer and Weinzierl.) But I am uncomfortable making envy a basis for public policy.

As an alternative to the Pigovian tax, maybe we can deal with this externality by sequestering the rich from the rest of society, so others don't have to see them and suffer by comparison. How about sending them all to, say, Nantucket or the Hamptons for the summer? Oh, yeah, we already do that.

Click here for an update.