Notions of 'fairness' should not dictate fiscal policy

 

ECONOMICS:What may appear eminently fair to one group may seem profoundly unfair to another

SHOULD WE trouble ourselves with the issue of fairness in our efforts to restore order to the public finances? Most people would probably respond to this question by saying: “Of course we should.”

Indeed, one’s instinct is to suppose that, to pass muster with the political process and be implemented, the package of budgetary adjustments proposed by the Government must meet some sort of fairness criteria.

The campaign by the Irish Congress of Trade Unions (Ictu) is based on the view that the Government’s approach fails this test. There is, it asserts, “a better, fairer way”.

This raises some thorny but important questions, the most fundamental of which relates to the problem of defining fairness.

This is not easily resolved. What may appear eminently fair to one group may seem profoundly unfair to another. Many think it fair that the wealthy should bear the brunt of the adjustment, but the wealthy, who have already seen a large portion of their wealth destroyed over the past two years, almost certainly take a different view.

Many people consider that the introduction of a new, higher rate of income tax would be fair, but those targeted by such a measure can point out that their marginal tax rates are already above the 50 per cent threshold they see as marking the boundary of fairness.

Another problem has to do with how views on fairness are formed. Do notions of what is fair spring from some philosophically based sense of justice, or are they heavily influenced by self-interest? It would be miserable to dismiss the possibility of the former: there are many altruistic people around.

However, you don’t have to be a cynic to think altruism is a minority disposition or to suspect that the idea that leaning heavily on the rich would be a fair way of dealing with the fiscal crisis is popular because most people are not rich or, at least, don’t regard themselves as such.

This prompts one to wonder whether popular notions of what is fair form a equitable basis for policymaking? Do they form a wise basis?

There are many policy areas where what is wise and what is commonly perceived as fair are potentially in conflict. An interesting example is public-sector pay. Given that it has to be cut, the popular prescription is that, in the interests of fairness, the cuts should be graduated from the top, with the highest earners taking the biggest percentage reductions and those at the bottom being spared.

However, all the research into public/private earnings differentials suggests that the margin by which public-sector employees earn more than their private-sector counterparts is at its widest for the lowest paid, but is substantially negative for the highest paid. A policy of applying the steepest cuts to the most senior public-service grades, therefore, runs the risk of reducing their pay relative to equivalent private-sector positions to such an extent that it greatly diminishes the attractiveness of a public-service career for the brightest and best qualified.

Potential trade-offs between fairness and wisdom are also present in the broader choices facing the Government. Should fiscal adjustment be based primarily on spending cuts or tax increases?

Should cuts in spending include cuts in transfer payments? Ictu’s sense of what is fair favours tax increases over spending cuts and is especially outraged by the prospect of social welfare payments being reduced. On the latter front, Ictu is almost certainly joined by a large swathe of the general population (and not just those who are direct beneficiaries).

Here, the first point to make is that the State’s solvency must be paramount: a bankrupt state is no use to anyone, not least those who rely on it for their incomes. When solvency is threatened, fairness (even assuming that it could be objectively assessed) becomes a matter of second-order importance.

Beyond that, notions of fairness must cede some ground, if not priority, to considerations of what works best.

On this question, analysis of the large reservoir of experience in dealing with fiscal crises, accumulated by governments worldwide over the past four decades, is unambiguous: adjustments based on spending cuts are more effective and more likely to boost economic activity than those based on tax increases.

The large corpus of research on this question has recently been added to and its main conclusions reiterated by Harvard economists Alberto Alesina and Silvia Ardagna (Large Changes in Fiscal Policy: Taxes Versus Spending (October 2009)).

One of their findings is that successful and expansionary fiscal adjustments are associated with cuts in transfer payments, whereas unsuccessful and contractionary adjustments are associated with increases in transfers.

Good conscience may well require us to have regard to issues of fairness in designing a response to the current crisis, but it also requires us to go beyond reflexive thinking, to interrogate the basis of our sense of fairness, and to consider the wider and longer-term consequences of pursuing what seems fair.

jim.oleary@nuim.ie