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.