Review of Robert H. Frank's "Luxury Fever" by Peter McCluskey

November 14, 1999

Luxury Fever starts with an interesting argument that economists have been wrong to assume that people value absolute wealth highly. The book provides clear evidence that much behavior can be better explained by the desire to have high relative status, and that this reflects an accurate perception of what will make them happy.

This substantially weakens the standard arguments for free markets (although it doesn't justify radical change), by demonstrating that there is a large class of wasteful behavior designed to maximize people's status which everyone would be better off avoiding if they could get everyone else to agree to avoid it also. This includes standard examples of luxuries such as fur coats, but it also includes behavior such as programmers working long hours to insure that they get respect from others in their office.

His theories provide fresh perspectives on economic growth which make it harder than ever to determine how valuable such growth is. Most of the standard justifications for growth assume that people living in the wealthier world that will result will be better off. Frank shows that those benefits are pretty much limited to a longer lifespan, which may not be enough to offset the harm done to people whose jobs are obsoleted by the change. But as long as individual nations or cultures control their own growth rates, rather than controlling global growth rates, there are strong benefits to choosing growth: the feeling of being part of a high status nation, and the military security that wealth produces.

Unfortunately, when the book turns to practical implications, its quality declines rapidly.

He makes a good argument that consumption taxes would be better than our current tax system, but he doesn't improve on previous arguments for a consumption tax enough to reach many of the people who are resisting such a change.

He then launches into a sloppy tirade against the belief that increasing marginal income tax rates will reduce economic growth.

He does have a good argument that supply-siders have greatly overstated the effect of tax incentives on how hard people work. But when he looks at other effects of tax rates, he departs from reality.

For example, Frank tries to argue that tax rates have minimal effect on tax avoidance:

If a rational tax avoider knows about a legal deduction or exemption, she will almost surely claim it whether her tax rate is 40 percent or 60 percent. She may spend a little more effort searching out exemptions when the tax rate is higher, but her tax consultant is unlikely to advise her differently in the two cases.
Does Frank really believe that tax avoidance is just a matter of searching for exemptions? For instance, does he really believe that a person debating whether to buy a yacht or buy stock in Cisco will ignore the difference between getting 40% of the capital gains and getting 60% (or that people rarely choose between yachts and stocks)? Maybe his ideal tax code won't have this problem, but he does a good job of explaining why politicians who want good sound bites will be very slow to adopt his improved tax code.

Frank claims that recent research showing that economic growth correlates negatively with inequality is "at odds with the predictions of trickle-down theory". As the use of the pejorative label suggests, he is blatantly setting up a straw man here. While supply-siders may advocate policies that tend to increase inequality as a side-effect, that does not in any way indicate that supply-side theories make any predictions about how inequality will correlate with growth. One simple hypothesis that would explain the observed correlations without detracting from supply-side theories is the hypothesis that the correlation is caused by the influence of special interests using political power to defend their above-average incomes by means that are inefficient for society as a whole.

Frank doesn't even provide a clear explanation of why high tax rates would help reduce the problems of competition for relative status. It would appear to increase the status of government officials whose status is already relatively high. The Winner-Take-All Society, a good book which Frank co-authored prior to writing Luxury Fever, gives a plausible argument that high tax rates will modestly reduce some of the wasteful competition to become one of the best lawyers or to form the next Microsoft. Possibly Luxury Fever means to apply this logic to status seeking behavior the same way it applies to seeking winner-take-all profits, but the more a Bill Gates is driven by the desire to be the most successful software producer rather than by the desire for absolute wealth, the less obvious it is that tax incentives will alter his behavior. Higher tax rates on investment would slow down the transfer of capital to companies like Microsoft, but Frank wants to tax consumption, not investment.

What practical implications could Luxury Fever have examined if it were more interested in novel ideas rather than fighting the usual battles? Simple things like conscious attention to frowning on such luxuries as expensive cars or restaurants would be a good place to start.

Frank complains that Bill Gates may have spent as much as $100 million building his latest house. But I suspect that is a much smaller fraction of the $40 billion net worth he had when the book was written than has historically been the norm for the super-rich. One possible explanation is that the SEC's disclosure rules force him to advertise his wealth in a way that is less wasteful and which, due to SEC oversight, a person competing for his status would have trouble dishonestly imitating. Would applying this kind of disclosure requirement to more people reduce the incentives towards buying luxuries?

But this doesn't deal with the problem of people overworking themselves to gain status, and I'm not optimistic that there are good solutions to this problem.

The URL of this document is