Expenditure Cascades
March 23, 2009
Overview
An economy is said to be an expenditure cascade in instances when the fast and speedy income growth among the top earners, or the rich individuals in the society, fuels the additional spending by the poor or low income earners. In other words, top earners in the society experience an extraordinary rapid income growth, while the low income earners experience a lesser increase in their income.
The cascade typically starts at the top; when the top earners experience a speedy growth, they encourage the middle class earners to spend more, and the middle class income earners in turn encourage lower income earners to spend even more. As a result, these expenditure cascades decreases the amount of savings for each family in the given society, obviously because the excess spending leaves nothing for saving.
Causes behind expenditure Cascades
The major reason behind expenditure cascades is Reaganomics. This, in simple terms is referred to the alterations made on the income tax structure which supports top income earners in the society regarding an after-tax purchasing power. The alterations have a notable result of the changes which is an increased purchasing power of society’s top income earners, thanks to a huge increase in their earnings.
Effects of Positional Externalities
Characteristically, a positional externality occurs when a new purchase alters the context in which an existing positional good is evaluated. Further, if a positional good ends up being upgraded, and becomes a well-liked item to own, it is right to term that good as a positional externality, simply because it has altered the context in which the good subsists.
An individual’s happiness in the society can also be affected by positional externalities. For instance, it is very normal for people to focus on the haves and have-nots of people around them. The process of focusing leads the person into a realization of what they themselves don’t own, relative to other people in their class system. It is simply human that this realization can lead to increased dissatisfaction and unhappiness about someone’s life position in terms of possessions.
Noteworthy, expenditure cascades are activated or prompted by consumptions. This is to say, right from the top earners, their consumption will trigger the class directly under them to increase their spending, and the class will trigger the other class under them to equally increase their spending, and the chain continues down to the base. Conversely, the reaction and the urge to increase spending can be dangerous to the people at the bottom of the chain. Typically, even before their spending, they have very little income at their disposal, and even a slight attempt to keep up with the spending chain will worsen the income.
Potential Solutions to the Malady of Positional Externalities
It is highly recommended that each economy embrace a progressive income tax system to curb the tight spot posed by positional externalities which, without saying lead to expenditure cascade. Progressive taxation is whereby tax is imposed according to one’s earnings, thus the more you earn the more you are taxed. By generally increasing the progressivity of the economy’s current tax system, the top earners will end up not only paying more reasonable shares of taxes, but will also reduce their spending, hence reducing the cascade considerably.
The main thing however to create a real and lasting impact on the spending and subsequent saving habits in any economy is the collective effort of all citizens and stakeholders in the economy to cut back on expenditure. When a deficit occurs, which would be very possible, the poor and maybe middle classes will end up suffering unduly to the rich.
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