When George Osborne raised VAT (sales tax to our American readers) in the UK, it sparked a lot of debate about whether this was a progressive or a regressive move. I’m not going to try and to answer this question, but the debate did get me thinking about why sales tax is so flat. Why is it, for example, that (in the UK) you pay the same 20% tax on a 70p packet of chocolate biscuits as you do on a £5,000 diamond ring?
This made me wonder what it is about diamond rings, and ‘luxury’ (read ‘rich people’) products in general, that makes me feel like they should be taxed at a higher rate than more ‘basic’ things like chocolate biscuits. Maybe I’m nursing some residual class resentment. However I also think there’s a rational case to be made here. In one sentence it’s that the rate at which a product (or service) is taxed should be related to the ratio of its ‘absolute’ to its ‘relative’ value.
Some explanation. The absolute value of a product is the pure satisfaction or usefulness you get out consuming it, in and of itself. A product’s relative value on the other hand, is whatever satisfaction you gain consuming more (or as much) of it, as other people. So, for example, the absolute value of a diamond ring would be whatever pleasure you gained from appreciating its raw aesthetic beauty, even if you weren’t allowed to wear it or show it to anyone. The ring’s relative value would be whatever satisfaction you gained from knowing that not many other people could afford it, and that in some sense you are doing better than they are (or maybe even more importantly, doing as well as other people who can afford similar things).
In this example, it’s fairly clear that most of a diamond ring’s value is relative, rather than absolute. Regardless of what they might say, people don’t mainly buy big diamonds because of the way they look. They buy them to be bigger (or clearer, or however diamonds are measured – I’m an academic, I don’t know anything about diamonds), or as big, as what other people have. If you still need convincing of this, imagine a world where every single diamond was 20% smaller. Would every diamond owner be 20% less satisfied? Unlikely. Diamond prices would probably be about the same, the social ordering of people’s diamond buying would be preserved, and everyone would be just as happy as they are in our world of absolutely bigger diamonds.
By more heavily taxing goods with high relative and low absolute value, we are basically moving towards that ‘smaller diamond’ world. Diamonds would be more expensive across the board, so people would tend to buy smaller stones. However, their relative position in the diamond-owning game would be unchanged, so they would be no less happy. You could make a similar argument for other luxury goods like designer watches or luxury cars.
This seems to me like the holy grail of taxation. You can raise taxes, but no one will be any less happy! You could just use this to raise revenue of course. But you could also use the profits to subsidise the purchase of goods with high absolute value. Things like savings, basic food, and health insurance (in the US), which studies have shown tend to be under-consumed because people are over-consuming visible, status relevant goods like cars and designer clothes.
Now I can see quite a few potential objections to my scheme (and please feel free to add more in the comments), but by far the most important is whether on earth this tax system could actually be implemented. The government would have to look at every product and service on the market, determine its relative versus absolute value, and assign it the relevant individual tax rate – an administrative headache, to say the least.
The purely logistical part of this problem is potentially solvable by, for example, looking at broad product categories as opposed to individual items (e.g. ‘Jewellery and Watches’, as opposed to ‘Cartier Tank Anglaise Watch’). However, much (much) harder is the conceptual problem of determining relative and absolute value. A meal in a fancy restaurant, or a large-screen TV are clearly valuable for the status they grant; but how do you judge how much ‘absolute’ value they also have?
This problem could never be solved to everyone’s satisfaction. Especially as a products’ absolute value might differ for different people. Consider the two examples I gave above. For someone with a refined palate, an expensive meal might provide a lot of ‘absolute’ pleasure, even if no one ever knew they consumed it; just as a film buff might appreciate a big TV, even if they never showed it to their friends. Contrarily, someone with no appreciation for food or the moving image might buy an expensive meal or TV, just because it’s the kind of thing people in their income bracket do. Status concerns aside, they would have been equally happy with a McDonalds hamburger (or whatever the televisual equivalent of a McDonalds hamburger is).
Does this mean we should abandon the idea entirely? I don’t think so. Determining relative and absolute value may always be somewhat subjective, but it is not completely so. Things with high relative and low absolute value tend to share similar properties. They are a) visible (they can’t confer status if no one knows you have them), b) expensive (the fact that you can afford them and others can’t is part of what confers the status), c) either have no practical function (e.g. a diamond ring), or are, in all important respects, equivalent in function to cheaper products of the same kind (e.g. designer watches). ‘Luxury’ products of this last kind also tend to be at the top end of a very wide price distribution which includes far cheaper ‘basic’ versions. Using these criteria, I think we could do a reasonable job of picking out at least the extremes of the continuum between high absolute/low relative and high relative/low absolute value products. These choices might still be somewhat arbitrary, but would they be any more arbitrary than current UK rules which, for example, distinguish between chocolate biscuits and “biscuits coated with…some other product different in taste and appearance from chocolate”, and between pasties served hot from the oven and those kept warm in a rack?