Common Sense Economics

Robert Frank, via Mark Thoma:

If you pay higher taxes, you obviously have less money to spend on what you want. So the prospect of a tax increase naturally inclines people to think that they’ll be less able to satisfy their desires.

But once incomes rise beyond a modest absolute threshold, many of the things that people want are what economists call positional goods. These may be things that are inherently in short supply, like gorgeous waterfront property; or things whose value depends heavily on context, like precious stones or sure-footed sports cars. Because positional goods are in short supply, they go to the highest bidders. The tendency to overlook that fact distorts how people think about the effects of higher taxes.

The cognitive illusion occurs because most financial setbacks that people experience in life stem from events that affect them alone. They may suffer health emergencies, for instance, or problems at work. Marriages may fail, jewelry may be stolen, and floods may damage homes. In each case, the effect is to limit the ability to bid for positional goods.

Because an overwhelming majority of financial setbacks occur for such idiosyncratic reasons, it’s natural to think that the income decline from higher taxes would have similar effects. But a tax increase is different. It affects all participants in the bidding for positional goods. And because it leaves everyone with less to spend, it has essentially no effect on the outcomes of those contests. The same paintings and the same marina slips end up in the same hands as before.

All I have to do to believe taxes should be higher on very wealthy people is to see how much properties in the Hamptons sell for.  There isn't anybody working hard enough that they deserve to be able to buy a $20 million weekend home.