Economist calls for progressive consumption tax over flat tax growth

BALTIMORE -- A Cornell University economist is calling for the adoption of a progressive consumption tax over the controversial flat tax proposal as a way of curing America's most pressing economic ills: income inequality and slow growth.

Robert Frank, the Goldwin Smith Professor of Economics at Cornell, outlined his antidote for the nation's stalling economy today (Feb. 9) at the annual meeting of the American Association for the Advancement of Science (AAAS) in Baltimore at a session on "The Sense of Justice: Origins of Moral and Legal Behavior."

In his remarks, titled "Economic Justice in a Winner-Take-All Society," Frank offered a stinging rebuke of the flat tax concept.

"The problem of our time is not depression but the multiple evils of rising inequality, budget deficits and slow growth," he said. "Yet the quintessential policy prescription of this era -- the so-called flat tax, which would cut the tax rates on top earners by more than half -- is no more likely to cure these problems than monetary contraction was likely to cure the great depression."

Frank contends the flat tax would "worsen the social strains of economic inequality, fuel the growth of wasteful consumption expenditures by the rich, and steer more and more of our best and brightest students into winner-take-all markets that are already overcrowded."

According to Frank, a flat tax of 17 percent would have allowed Disney CEO Michael Eisner to deposit an extra $50 million in the bank in 1993. Flat tax proponents say this windfall for the wealthy is healthy and would ignite economic growth. But Frank notes that such trickle-down theories have dangerous side effects that threaten the economy by undermining the nation's employment demands and supporting runaway salary growth.

"As the rich get richer, more and more individuals are drawn to the pursuit of a limited number of superstar positions in what I call winner-take-all markets," said Frank, who along with co-author Philip J. Cook, ITT/Stanford Professor of Public Policy at Duke University, introduced the concept in their newly published book, The Winner-Take-All Society (Free Press, 1995).

"The lure of the top prizes in winner-take-all markets has steered many of our most able graduates toward career choices that make little sense for them as individuals, and still less sense for the nation as a whole, "said Frank, who holds appointments in Cornell's Johnson Graduate School of Management and the College of Arts and Sciences. "In increasing numbers, our best and brightest graduates pursue top positions in law, finance, consulting and other overcrowded arenas, in the process of forsaking careers in engineering, manufacturing, civil service, teaching and other occupations in which an infusion of additional talent would yield greater benefit to society."

The flat tax, Frank asserts, fails to provide any correction for this winner-take-all phenomenon. He notes that if tax rates drop for the wealthiest -- society's top performers -- more contestants would be attracted to these markets. On the other hand, a progressive tax, like a consumption tax, would respond directly to the winner-take-all predicament.

"A higher tax on these top earners would cause fewer of our most talented people to compete for limited slots at the top," Frank continued, "and the people likely to drop out would be those whose odds of making it into the winner's circle were smallest to begin with. Thus the value of what gets produced in winner-take-all markets would not be much reduced if higher taxes were levied on winners' incomes; and any reductions that did occur would tend to be more than offset by increased output in traditional markets." Frank predicts that a progressive consumption tax would lead to greater equality of incomes and higher economic growth by reducing the rewards of landing superstar positions and thus reducing overcrowding in winner-take-all markets.

But perhaps the biggest dividend would be that it would free up hundreds of billions of dollars of resources that are largely wasted through "mine-is-bigger consumption arms race."

"If a consumption tax led wealthy families to buy 5,000 square-foot houses instead of 10,000, 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, etc.," Frank said. "The elegant hidden feature of the progressive consumption tax is this ability to create resources virtually out of thin air."

Frank's consumption tax would have a large standard deduction: the first $20,000 of annual consumption expenditures. Such a feature would make the tax progressive and shield from taxation necessities like food, medical care, basic clothing, shelter and transportation. Just as current tax rates rise with income levels, consumption tax rates would rise with consumption levels.

"The adoption of the flat tax in anything like its current form would move us in precisely the wrong direction," Frank concluded. "It would exacerbate income inequality and would retard economic growth rather than stimulate it. The case for this tax rests on the outmoded understanding of the forces that allocate both talent and reward in a winner-take-all society."

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