THE THEORY OF DECLINING MARGINAL UTILITY REVISITED Some Theoretical Background The essence of economics is choice: the most effective use of limited resources. The theory of marginality has been one of the most powerful (and influential) analytical concepts of economics. The understanding that there is a profound difference between subjective value and objective value and that both are lessened by abundance, first developed by Karl Menger and Eugen Bohm-Bawerk in Austria and Stanley Jevons in England, to explain price, was a concept which eluded Marx and his cohorts. The result was the absurd belief that value simply reflected embodied labor, without regard for utility, demand, style, quality, or managerial talent devoted to the production of a given good. Marx's adoption of this defective Ricardian notion led half the world into seventy years of impoverished lives and impoverished thinking. One wonders what the history of the Soviet Union might have been had Bohm-Bawerk's seminal writing appeared seventeen years earlier and been known to Marx and Engels as they wrote Das Kapital. But the influence of marginality did not end with the explanation of price and value. Jeremy Bentham made use of it in his theory of utility, arguing that with an abundance of any good, the utility of the nth item was bound to be less than that of earlier units. In Basic Theory courses it is common to use the example of men at work on an acre of land, or a father's purchases of ice cream cones for his children on a zoo visit during a hot day. The first man (or first cone) yields enormous gains to productivity (or satisfaction [utility]). The second, third, and perhaps even the fourth also provide substantial returns in either production or satisfaction. But as one gets on to the eighth, ninth, or tenth man or ice cream cone, the additional returns to productivity, or utility, start falling off rapidly, until at some not distant point the men may start getting in each other's way, and the taste for more ice cream turn to satiety and even disgust. This latter phenomenon economists call disutility. Welfare Economics and the Graduated Income Tax Out of these useful beginnings, Welfare Economics, based especially on the insights of Vilfredo Pareto, quickly introduced the concept of the diminishing marginal utility of money. This became the foundation of the notion that the graduated income tax may be the fairest of all forms of taxation since the rich obtain less satisfaction (utility) from their millionth dollar than the poor get from the few dollars redistributed to them through the dole. Of course, welfare economists have since an early date been quick to admit that it is theoretically impossible to compare utilities from one person to another. But they insist that the principle stands: the rich lose less than the poor gain through the redistribution of wealth. And there the analysis has been left to stand, rearing its head in the recent Presidential and Parliamentary elections in the U.S. and UK where Dem. and Labor candidates are quick to insist that it is not only fair, but economically sound to tax the rich a bit more to expand social services to the poor. A Couple of New Elements It is widely recognized that government does not produce new wealth; though its police services protect wealth and the infrastructure of roads, bridges, airports, and other necessaries of exchange which it is beyond the abilities of individual businesses to invest in, certainly multiplies a nation's wealth-producing capacity. And to the extent that government invests in human capital through education and public health, it makes an enormously valuable contribution to future wealth. The fact remains however, that aside from investment in education, health, defense, police forces, and infrastructure, government outlays reduce rather than promote the wealth-producing capacity of a nation. Most non-socialist economists consider that it should be a prime objective of government to concentrate on doing what only it can do, or do best, leaving the private sector to assume as many of the tasks of mankind as we can devise ways for it to do -- relying on government oversight, where necessary, to assure honest and non-monopolistic behavior on the part of private enterprise. Public Policy and Taxation Theory Naturally, government must rely on taxation for the resources it devotes, wisely or otherwise, to the public sector. It follows, that in order to maximize private investment and minimize distortion of private choice in what and how much to produce, taxation should be as efficient and neutral in its effects on savings and investment as possible. And for most of the past eighty years, at least since the adoption of the 18th Amendment, the graduated income tax has been assumed to meet these criteria. At this point it is well to reflect that all this theoretical superstructure is built upon the essentially subjective notion that the marginal dollar has less value than early dollars, or even dollars well within the margin. Some Questions Regarding Declining Marginal Utility The certainty of diminishing marginal utility may have appeared to be a settled fact to comfortable, upper middle class university-based economists whose true interest was pure philosophical thought, rather than the accumulation of wealth as a token of having won in the race for worldly success, or the building of an industrial empire as the most ego-engaging activity of a power-driven life. But any thoughtful person, even a truly thoughtful economist, should know that this isn't strictly, or even necessarily so. When an individual has set himself the goal of becoming a millionaire by age thirty (or whatever) and is only a few thousand, or tens of thousands, short of this goal, who is to insist that those marginal dollars, or pounds, francs, or marks have a lesser utility to the accumulator than they could possibly have to another well inside the accumulator's margin? The case can just as plausibly be made that under such conditions those marginal units have an even greater utility on the margin as the projected target comes within sight. Nor need this modest revisitation of the grand theory of diminishing marginal utility be restricted only to real or potential millionaires, or crass, large-scale capitalists. The same principles apply to humbler folks saving for their first new car, down payment on a home, or capital to open a dreamed-of small shop or restaurant. The nearer one approaches any goal, the greater the risks one is willing to assume or effort one is prepared to make to achieve it. Which is why the revolution of rising expectations in developing countries is always such a threat to the established ruling class. When class overthrow is out of the question, no one realistically worries about it. It is when power is within reach that the temptation becomes greatest. When feudal kings began diverting themselves with court music, drama, rich food, and mistresses, the most likely participants in grabbing for power were the marshalls and major domos of court (the Stewarts of Scotland and the Capetians of France being prime examples). When Samurai, displaced from their traditional warrior vocation begin making money as the new industrialists, Shoguns beware. And it is when the comfortable middle class is threatened from below that Facism appears most attractive. It is not only historically, but theoretically wrong to take for granted a gradually diminishing marginal utility for anything: money, greed, domination, or goods (what after all motivated the Robber Baron Capitalists of the Nineteenth Century in their frequent attempts to "corner the market"?) Where then the diminishing marginal value of goods? Economists of all people should understand the ultimate fungibility of goods, money, appetites, and power. The noted French economist Leon Walras explained the notion of General Equilibrium almost a hundred ago. And in a day when we accept the concept of Social Product Differentiation (the willingness of a society to pay a bit more for goods or services to protect a national life style, just as individual consumers are willing to spend a little more for branded products whose taste and quality they know: Austrian and Swiss farmers producing high cost milk, while maintaining as a by-product the beauty of the carefully mowed slopes of the Austro-Swiss Alps; Canadians paying a bit more for Canadian TV and Canadian magazines, eschewing American advertising and thus holding on to their distinctive Canadianess; Japanese consumers paying substantially more for rice, citrus, and meat to keep their own farmers in business and maintaining a notably greater degree of political and social stability). Economists, of all people, should understand that there is no distinct barrier between the economic and the social (or the political) [see Timmins: The International Economic Coordination Instrument: The OECD Experience. University Press, NY, 1985]. In short, the time has come to reexamine the foundations of our thinking about declining marginal utility. Just as in Evolutionary theory, we are now rethinking the concept of gradual evolution and the survival of the fittest, to encompass the notion of "punctuated" evolution and chance extermination of otherwise fit species, perhaps we should recognize that whatever justifications have in the past been given for taxing the better off more at the margin, with these new insights, the time has come to recognize that the boundaries of tax increments have been set by arbitrary political judgment having no relationship to valid economic theory at all. Not to mention the fact that the theory of diminishing marginal utility, notwithstanding the important insights it affords, does not take account of the discontinuities and inter-personal noncomparabilities discussed above. Applicability of Fractals & Chaos Theory In this connection, application of Chaos Theory to Economics is raising other complex questions about the smooth curves whose use economists have in the past, for the sake of simplicity, taken for granted in analyzing economic functions. It now appears that even when events have been occurring according to trend in a more or less gradual and predictable fashion, the data may abruptly, and with no forewarning, jump beyond their previous parameters into a new, and for a time, completely chaotic and unpredictable range, until finally settling down once more into a new rhythm [see Timmins, Fractals & Chaos Theory: The Limits of Economic Forecasting . SWEA Abstracts , 1987]. The Search for Mechanisms to Minimize the Incomparability of Defective Marginal Utility Theory We are living in an age where it is increasingly recognized that government is too large, too intrusive, and too inefficient to make many of the social judgments it has grown accustomed to making. Even while having not fully plumbed the theoretical failings of marginal utility theory, there is enough common sense recognition of the shortcomings of the graduated income tax, that the search is now on for market mechanisms which will leave as many decisions as possible to individuals, the role of government being restricted to establishing incentives and disincentives to achieve national goals. This has in fact been widely understood for some time, based in part on the backward slanted supply curve associated with the Supply Side Economics which led to the Reagonomics of the 1980s. And even before this, the Federal Reserve Board has made it a practice, except in wartime, carefully to avoid using its powers to establish differential downpayments and repayment terms on major items like cars, refrigerators, and yachts (Regulation W), this being seen as an arbitrary substitution of Fed judgment for individual judgment regarding what is a "good" expenditure and what is less good. And, of course, imposition of differential downpayments and repayment terms also impacts specific sectors of the economy more than others, affecting producers as much as consumers. Thus the Fed prefers to use its Reserve, Rediscount, and Open Market operations which affect the overall level of national economic performance, leaving individual choices of what goods are to be purchased to individuals. This is precisely why so many economists are urging the adoption of a Value Added Tax in place of income taxes, freeing individuals to decide what they will buy and when. What isn't spent, isn't taxed, resulting in less distortion of savings and investment decisions at the margin and providing an incentive to investment instead of consumption. Moreover, a VAT can, under the GATT, be rebated on goods sold for export, amounting to a substantial subsidy to export sales. At least one candidate for the 1992 Democratic nomination for the Presidency, favored a combination of a VAT and a flat tax with no loopholes, instead of the graduated corporation and personal income taxes which, depending on the comfortable, but false, notion of diminishing marginal utility, not only violates each of these desiderata but amounts to double taxation, putting a powerful damper on American savings and investment.