OK. I'm still tired. But thinking about things in a more contracualist mode made me realize that I was confused. But it's not my fault. It's Layard's. His “pollution” tax argument turns on a deceptive change of subject.
Every time [people] raise their relative income (which they like), they lower the relative income of other people (which those people dislike). This is an “external disbenefit” imposed on others, a form of physical pollution. [p. 152]
So Layard prescribes a tax on income to provide a disincentive to work:
Thus a tax on noxious emissions will reduce this emissions, and a tax on income from work will reduce work. [p. 153]
But, hey!, the analogy fails entirely. Work is not the “pollution.” Income is not the “pollution.” Moving up in relative income is the “pollution.” So, if the proposed Pigovian tax was going to be analogous to a tax on noxious emmissions, it would have to be a tax on upward income mobility, not on income from work, per se.
When Layard goes on to explain why these taxes are “corrective” rather than “distorting,” he claims that they are “performing a useful function that we were unaware of,” which is to “preserve our work-life balance.” [p. 153]
But hold on! Work-life balance is a totally different subject from the negative external effects of upward moves in relative income. This is easy to see. Imagine a world where everybody works 120 hours a week, never gaining ground in terms of relative income, but never losing it, either. This is a world with zero “pollution” from relative income gains, because there aren't any, but a terrible work-life balance.
The “arms race” argument, that everybody would be better off if we mulilaterally agreed to work less and read more Proust, is about work-life balance. To argue that a tax on labor income would increase utility for arms race reasons is fine. But it has nothing to do with relative income gain “pollution.” In order for the negative externalites argument to go through, Layard has to show that a tax on income increases utility by decreasing income mobility, not by creating a better work-life balance. These are separate issues, but be illegitimately conflates them. He pulls a conceptual bait and switch. So, besides failing for all the more technical reasons about the reciprocal nature of externalites, Layard's pollution argument fails at a more fundamental level, because he provides no evidence that his prescribed tax is even relevant to the “problem” it is supposed to solve.
And just consider that every time someone retires and begins to live primarily off savings, someone else's relative income goes up. Here we have relative income gain (and attendant “pollution”) brought about by a choice to work less. Because change in relative income is largely a life-cycle thing, most people move up and move down through the distribution in a similar pattern. If people move up, creating supposed negative externalities, then they later move down, creating offsetting positive externalities.
So, it looks like the “arms race” argument really is the only one worth taking seriously. And it, unlike the pollution argument, it isn't really an argument involving meddlesome preferences. It's a regular old collective action problem. So the post below is confused, starting with a discussion of meddlesome preferences, and ending with a discussion of coordinating on utility maximizing general rules. But this just reflects the fact that Lord Layard is confused, too. Or trying to pull a fast one. Anyway, the “pollution” argument in Happiness is, as stated, not just wrong, but nonsensical.
And it annoys me that it took so long to see this. And that Layard argues that it is an argument that demands a “revolution in what is called 'public economics',” and “provides an important new element in the case for progressive politics as such.”