Welfare and justice
Econ4620
Alexander W. Cappelen
1
Introduction
• Why do we levy taxes?
– To improve the allocation or the distribution of resources
•
•
•
•
•
Finance essential state functions
Correct for externalities
Stabilize the economy
Finance public goods (or publicly provided private goods)
Redistribute income
• Why do we dislike taxes?
– It creates distortions
– It reduces the income of some individuals
2
How do we determine the optimal tax
level?
• In order to determine the optimal level of
taxation we need to weigh the benefits of
taxation against the costs of distortions
• In order to make such trade-offs we need to
have a clearly formulated policy objective
• We need an ethical theory – a theory of
distributive justice
3
Ethics and decision making
• Ethics – a tool for decision/policy makers.
• The design of institutions and policy decisions have
consequences for a large number of different agents.
• These agents have different interests and will often
disagree about what the best decision is.
• A decision maker has to balance conflicting demands
from different groups.
– Almost all policy decisions will benefit some individuals
and harm others. This is particularly the case for the design
of the tax system.
4
The need for ethics
• We need ethics in order to handle these types of
trade-offs.
• Ethical theories are well-founded answers to the
question of what is good and what is bad.
– What is the best decision all things considered.
• Three fundamental questions:
– Towards who do we have obligations?
– What type of obligations do we have?
– How do we handle conflicting obligations?
5
Social welfare functions
• Economists traditionally formulate policy
objectives as a social welfare function
– Describes total social welfare as a function of
individual welfare or utility
• There exist a number of Pareto-efficient
allocation, but they give different distributions
of resources and welfare between individuals
6
Cont.
• A social welfare function ranks different Paretooptimal allocations:
W  W (U 1 ,U 2 ,....,U n )
U2
A1

Utility possibility frontier
A2
A4 

A3

U1
7
Different welfare functions
•
The fundamental question: how much weight
should be placed on the welfare of different
individuals?
–
•
Should people with low welfare/income be given more
weight than people with high welfare/income?
Two important versions in the two person case:
(1) The utilitarian principle:
(2) The maximin criterion
•
W  U1 U 2
W  min U 1 ,U 2 
Intermediate positions place more weight on the
individual with low welfare.
8
Illustration
U2
U
R
E
U1
9
Utilitarianism
• The dominating ethical theory the last 150 year.
– Jeremy Bentham (1748-1842) and John Stuart Mill (1806-1873).
• Ethical principle
– Choose the alternative that maximizes the sum of individual
welfare
W  U i
• A principle of vertical equity
• Justification: what would an ’impartial spectator’ choose?
– Corresponds to some important moral intuitions, e.g. about how to
settle conflicts.
10
Utilitarianism
• An ethical theory that is well suited for decision
makers
– Has been important for the development of the welfare
state
– An argument for progressive taxation
• Diminishing marginal utility of income
• But can also justify income inequalities
– Has been very important for the development of economic
theory
• Welfare economics
• The theory of optimal taxation
• Cost-benefit analysis
11
How does utilitarianism answer the
three questions?
• Towards who do we have obligations?
• All human beings
• Animals?
• What type of obligations do we have?
– We are obliged to promote the good.
– We should only be concerned with the consequences of different
alternatives
• A consequentialist theory
• Forward-looking
– It is only concerned with one type of consequences:
• Consequences for individual welfare.
• A welfareist theory
• How should we handle conflicting obligations?
– It gives equal weight to all individuals
• An egalitarian theory?
12
Different types of critique
•
In the rest of the lecture we shall discuss some
important types of critique and some alternative
theories of justice
(1) The theory cannot be implemented
-
Utility cannot be measured
Interpersonal comparisons are impossible
(2) The theory does not describe the just distribution
-
Gives too little weight to the worst off
Justifies unacceptable actions
Does not take account of individual desert and responsibility
-
We should not only care about consequences
13
How do we measure utility
• What do we mean by utility?
– Pleasure or absence of pain?
– Satisfying peoples preferences?
• Should we base our calculations on people’s own
evaluations?
– Do people know their own good?
• It is better to be a discontent Socrates than a happy idiot (Mill)
• The tamed housewife and the happy slave
– What do we do with ’anti-social’ preferences?
• Cardinal or ordinal measures?
– We can describe peoples preferences using a
mathematical function, but how do we interpret these
numbers?
• Endogenous preferences
14
Interpersonal comparison
• Even if we can measure individual utility we still
need to compare individual utilities in order to make
utilitarian comparisons.
– How is it possible to say that one person has twice as happy
as someone else?
• The new welfare economics in the beginning of last
century was concerned with what economists could
say without making interpersonal comparisons.
– Partly explains the importance of the Pareto-criterion
• The new public economics, however, assumes
cardinal utility and interpersonal comparisons.
15
Can anything be justified?
• Can we justify any act if the consequences are
good?
• Utilitarianism can justify cruel acts if the
benefits outweigh the costs
– It might be optimal to sacrifices an individual in
order to promote the welfare of others
• Should we not attach any importance to the
character of an act?
16
Desert and reward
• The concepts of desert and reward are
fundamental ethical concepts.
• Many people see the questions of justice
primarily as a questions of ’Who deserves
what?’.
• The relationship between effort and reward has
also been central to several economists and
philosophers.
17
Cont.
• ’Every person, if possible, ought to enjoy the fruits of his
labour…’ (Hume).
• ”Though the water running in the fountain be everyone’s, yet
who can doubt that in the pitcher it is his only who drew it
out?” (Locke)
• ”The produce of labour constitutes the natural recompense or
wages of labour”(Smith).
• ”From each according to ability, to each according to effort”
(Blanqui)
The concepts of desert and reward have little role in public
economics.
– The main reason: consequentialism (utilitarianism)
18
Consequentialism
• Always choose the distribution that gives the best
consequences.
• Forward-looking.
– What are the effects on GDP/total welfare
– What are the effects on income distribution
• Has no room for individual desert
• The only reason to reward is related to incentive
considerations.
• Violates the idea that a reward should be related to
the effort exercised.
19
Non-consequentialist theories
• Tries to capture the idea that effort and historical
information might be important in distributive justice.
• Backwards-looking.
– Who did what?
– What were peoples intentions?
• We can only evaluate a distribution if we know how it
came about.
• We shall discuss to non-consequentialist theories
– Libertarianism
– Liberal Egalitarianism
20
Libertarianism
• John Lock and Robert Nozicks are the most
prominent advocates of libertarianism
• According to Nozick any person is entitled to whatever:
A. He or she legitimately acquires
B. He or she receives as a gift or as a result of a voluntary
exchange
- ’From each as they choose, to each as they are chosen’
• Liberalism gives a specific answer to the question of what
people should be held responsible for.
– People should face the actual consequences of their actions.
– People should be rewarded with what they produce
• Ensures efficiency
21
Liberal egalitarians
• Liberal egalitarians (Rawls, Dworkin, Roemer,
Arneson) argue that we should eliminate inequality
that is a result of factors outside a persons control, but
accept inequalities that are a result of factors under
the agents control.
– Can be seen as a principle of horizontal equity
• Two questions:
– What are we responsible for?
– What does it mean to hold people responsible?
22
What are we responsible for?
• Raises fundamental questions that have important
political as well as ethical implication.
– Can we choose our preferences?
– Can we affect our abilities?
– Are everyone able to exercise high effort?
• Differences between the left and the right (and
between Europan and American politics) can be
traced to different answers to these questions.
23
Inequality and tax policy
• Important to understand the sources of
inequality.
• Is income inequality primarily a result of
factors that are under the individuals control –
such as hours worked – or of factors that are
outside their control (gender, skin color or IQ).
• If inequality only was a result of one type of
factor it would be easy to construct a just tax
system.
24
Equal effort – different wages
60
40
Total income
• Inequality is a result
only of differences in
the wage rate.
• In this situation we
want to redistribute as
much as we can from
the rich to the poor.
20
0
0
4
8
12
16
Hours worked
25
Equal Opportunities – unequal
income
60
40
Total income
• In this situation all
inequality is a result of
differences in hours
worked.
• Do we want to
redistribute in this
situation?
20
0
0
4
8
12
16
Hours worked
26
The ideal
• Income inequality in society would be a result
of both different wage rates and different effort
levels.
• Ideally we would want to eliminate
inequalities due to the first, but not to the
second factor.
27
The problem
• Income tax can only be levied on total income.
The tax authorities do not have any
information about hours worked or effort.
• Progressive taxation then has two effects:
– It takes from those with high hourly wage and
gives to those with low hourly wage.
– It takes from those who work long hours and gives
to those who work few hours.
28
The effect of a progressive tax
• A system with
progressive taxes:
20
15
Total inntekt
– Is an advantage for
people with low wages
and who work few
hours.
– Might be a
disadvantage for those
with low wages who
work long hours.
25
10
5
0
0
4
8
12
16
Arbeidstid
29
Conclusions
• We would want to give individuals the same
income opportunities.
• In reality we are faced with a trade-off
between the income opportunities of different
groups.
• Can we use other instruments to achieve this
goal?
30