The July 2008 issue of this magazine was dedicated to “Luxury Economics,” focusing on the “Middle East’s appetite for surprising, exotic and authentic experiences.” A separate article in the same issue did not fail to note the move in the UAE to introduce a value added tax. Does luxury increase “happiness”? And does taxation decrease it? Paradoxically, the answer to both is “no” according to some new views. In a nutshell, luxury, once tried, becomes necessity and taxes can reduce materialism — a common theme in many religions — and help citizens preserve a healthy work/life balance. Let us examine each assertion in turn.
Historically, economists have related well-being to the level of incomes while development theories typically stress economic growth as the ultimate objective. The Gulf Cooperation Council (GGC) economies score well on both counts. The recent hike in the international price of oil has been associated with high government revenues and a corresponding fast rate of economic growth. And citizens have not only enjoyed traditionally high levels of incomes but, under popular pressure, recently managed to get unprecedented salary increases for reasons unrelated to their work effort and productivity.
However, it has been found that once wealth reaches a subsistence level, its effectiveness as a generator of well-being is greatly diminished — as if a “hedonic treadmill” were in operation: you keep moving just to stay in the same place. In other words, aspirations increase along with income and, after basic needs are met, relative rather than absolute levels of income influence well-being (“happiness”). If this is to be accepted, distributing the oil revenues across the population in some uncritical or untargeted way may have only a temporary effect on “happiness.”
The emerging theory of “happiness economics” aims to understand what determines the well-being of people. The theory has consequences for understanding happiness both as an individual as well as a societal goal. “Happiness economists” aim to change the way governments view well-being and how to allocate resources. And a new concept has been developed, the GNH (Gross National Happiness) that is broader than the conventional GNP (Gross National Product) or GDP (Gross Domestic Product).
If income alone is a poor approximation for happiness, what should economists take into consideration? The four pillars of GNH are the promotion of equitable and sustainable socio-economic development, preservation and promotion of cultural values, conservation of the natural environment, and establishment of good governance. What should one then look out for?
First, social comparisons. Happiness is derived from relative income as well as from absolute income. If everyone gains purchasing power, some may still turn out unhappier, if their position compared to others becomes relatively worse — as the case is with recent universal handouts given by the GCC governments. This effect does not necessarily turn economic growth into a zero sum game entirely, but it can diminish the way people perceive the benefits of their own hard work.
Second, adaptation. As people get used to higher income levels, their idea of a sufficient income grows with their income. In this case, if people fail to anticipate that effect, they will feel they work more than is good for their happiness.
Third, changing tastes. Individual preferences are not constant. They are increasingly mutable, shifting constantly according to the latest fashion, adapting cultural norms and what neighbors do. In turn, the perceived values of one’s accumulated possessions are subject to depreciation, ultimately having a negative effect on happiness.
All these considerations make sense. Humans adapt, often rapidly, to their current situation. They become habituated to the good or the bad. They are sensitive to the status they have relative to what they perceive others enjoy. More generally, despite the fact that external forces are constantly changing one’s life goals, happiness for most people is a relatively constant state. Regardless of how good things get, people report about the same level of happiness over time.
This has led some economists to argue that taxes can serve another purpose besides paying for public services (usually for public goods) and redistributing income (usually to the poorer citizens). This additional purpose of taxes is to counteract the cognitive bias that causes people to work more than is good for their happiness. That is, taxes could help citizens preserve a healthy work/life balance.
In short, money does not add much to happiness: Lottery winners are an example as, within a year, they are said to return to their former happiness level. And those handicapped in, say, a motor vehicle accident, usually return to former happiness levels, despite their loss of function. Some studies have suggested that a sense of “higher calling” or “purpose” can add to someone’s happiness. If so, perhaps the development of a national vision and the introduction of taxes in the GCC countries may cause the citizens to look outside themselves and become happier — even though they may consume fewer luxury goods.
Professor Zafiris Tzannatos is Advisor to the World Bank and former chair of the Economics Department at the American University of Beirut. The views expressed are his own and do not necessarily represent those of the World Bank.