The problem with income-contingent fines

Van in Parking Lot

A few weeks ago Last Week Tonight ran a segment called “municipal violations“. The piece highlighted how government issued fines can perpetuate the poverty trap for the poorest members of society. A common response to this problem is to adjust these fines to income so that the rich pay more and the poor pay less. At first this seems like a very fair and reasonable approach but there is some big issues with this type of policy which make it highly inefficient and prompts me to dismiss it as a lazy way to improve social welfare.

Similar policies called “day-fines” are employed in a number of European countries, namely Finland, Denmark, Sweden, Croatia, Germany and Switzerland; countries renowned for their social-left policies. Closer to home, Clive Hamilton of The Australia Institute wrote an article in 2004 called “Making fines fairer” championing the notion of putting in place these income-contingent fines in Australia. So why is it such a bad idea?

The problem begins with our progressive tax system. When such a system is adopted in order to generate necessary tax revenue, policy makers trade-off between two key costs; reduction in work incentives and the cost of inequality. A highly progressive system reduces poverty in our society but comes at the cost of reducing the incentive to work, where a low tax rate on earned income preserves the marginal value of labour but gives rise to intertemporal and often intergenerational poverty traps. Presumably when designing or altering this system, the people, representatives, benevolent dictators or whoever is setting the policy, optimises this decision on behalf of society. Implementing income-contingent fines then creates a second, or double, tax throwing off this fine balance and introducing inefficiencies through the transaction costs involved in administration.

When we design a tax system and acknowledge the cost of breaking municipal laws, we ask ourselves (among other things), “How much tax revenue do we require? What is the minimum our citizens need to live on? What is the appropriate redistribution?” These last two considerations will then take into account the appropriate probability and cost of breaking these municipal laws and thus it seems naive to me to think that by introducing additional redistribution mechanisms we would somehow improve fairness.

An additional question that proponents of this policy need to address is why do poor people who break the law deserve this effective tax brake over those poor people who don’t? This is often forgotten and replaced with the accusation that because wealthier people pay the same amount on fines and fees they unfairly have higher incentives to break the law. This clearly doesn’t take into account the tax contribution made by higher income earners and misleads policy makers away from the true problem associated with these types of considerations. An interesting point to consider is why this comment is scarcely used to address the prices of other goods and services; why not have income-contingent chocolate bars or Lamborghinis?

To conclude let me assure you that I’m not proposing that we shouldn’t redistribute income to the poor; the benefits of reducing income inequality to this degree far outweigh the costs to work incentives. Nor am I arguing our system has been adequately optimised; there are very credible arguments to say it hasn’t. I am arguing however, that when we opt to have a progressive tax system and optimise the degree of redistribution, we allow ourselves the privilege of disregarding the consideration of large scale equity concerns when charging for services. And on the premise it is not optimised, we should then change the taxation framework, not introduce additional compensation channels to which there exists equivalent adjustments with smaller administration costs.

The segment from Last Week Tonight does a very good job at capturing a significant problem in our society. However simple, off-the-cuff policy responses, such as income-contingent fines, can have adverse effects and more often than not, complicated problems such as this require far more measured approaches and intricately designed strategies. In this example, instead of creating a double-tax system, increasing transaction costs and reducing efficiency, we should be looking at other things that we can do to alleviate the problem; re-optimising our taxation system or investigating why private credit lenders are allowed to feed on these poor members of our society.

TL/DR: Income-contingent fines are a poor policy to adopt with a progressive tax system which presumably optimises the trade-off between work incentives and a fair distribution of income. Implementing this double-tax will only reduce efficiency and may have further adverse effects. Complicated inequality problems require a much more creative approach which this band-aid solution clearly doesn’t offer.

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6 thoughts on “The problem with income-contingent fines

  1. As we have talked about before there are reasons for having income-contingent fines other than income redistribution. I would suggest the main reason for imposing fines for certain behaviours is to try and dissuade people from engaging in that behaviour. A person with high income is more likely to consider that the cost of the fine is small and therefore be more likely to engage in the behaviour we want to prevent. By making the fine contingent on a person’s income (perhaps with a fixed minimum) the fine should be able to better fulfill its role of discouraging those behaviours.

    1. I agree fines are set to discourage behaviour, but if this were the sole reason for setting them, i.e. we wanted no offences committed, we would attach a far higher fee for municipal violations – we would criminalise parking in no parking zones for example. I think a much better model of why we set fines is to internalise the cost of infringement; to send a price signal so to speak. I don’t think anyone would argue that the costs of these types of infringements (littering, j walking and public nudity are other examples) is excessively large, and in this respect I think the optimum number of committed offences isn’t zero as the marginal cost of the first few infringements is typically very low with possibly high marginal benefits. Given this I see no reason to make these fines contingent on income and if we do so we aren’t sending correct signals to the cost of these behaviours.

      1. Exactly, so by having income contingent fines we can internalise that cost for everyone in a proportionate way.

  2. The cost of offence isn’t dependant on the income of the offender and if you charge them different amounts you send a price signal that says it does. If you propose to add up the total costs of infringements and then divide that up and weight by income, high income folks will want to infringe less than they do now and low income folks will want to infringe more. The result is a higher proportion of offenders being of low income who pay less than the cost of their infringement, directly subsidised by those high income folks who still offend – that is if you find an equilibrium in the division of course.

  3. Yes but if you look at the demand side, you can think of income contingent fines as a form of (imperfect) price discrimination, allowing the government to extract a higher amount of each offender’s surplus from offending. The government can be thought of as a monopoly seller of things people get fined for in this scenario.

  4. Ok, now that’s something I can reason with. I think it would be unfortunate if the government began to behave like that though; if they did imperfectly price discriminate – 3rd degree I presume – their optimal fee will induce a fewer than efficient number of offences. It would also mean that they’re no longer getting offenders to internalise the costs of the offence, which is really what they’re there for – correcting market failure.

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