Thursday, September 3, 2009

Why Are Sensible Policies Often Politically Unthinkable?

Often economic policies which make good sense and can leave everyone better off are dismissed as being politically unthinkable. How does this come about?

Let us take an example of a Congestion Charge.

Driving into city centres causes negative externalities such as pollution, congestion and higher fuel consumption. People can spend hours of their life stuck in traffic jams, but despite the wastage of congestion they do not want a tax neutral congestion charge which would reduce pollution, reduce the length of traffic jams.

If a government raises revenue from a congestion charge, it can use this money to reduce other taxes. This is why we say this is 'tax neutral' - the overall tax burden hasn't changed. We are just paying different taxes. The only difference is that the taxes are now forcing people to make more efficient choices which lead to less pollution and congestion. (since the London Congestion charge was introduced traffic volumes fell, average traffic speeds increased and pollution levels decreased)

This policy can lead to a net gain for society. Yet, they are often seen as politically unacceptable. Why?

Unfair on low income Groups. When the Mayor of New York proposed a congestion charge on driving into Manhattan, it was attacked as a way to stop poor people driving into Manhattan.
  • However, a congestion charge doesn't have to alter income distribution. The money raised from a congestion charge can be used to reduce other regressive taxes - taxes on low income groups. We shouldn't promote inefficient policies just because they help the poor. We should choose the most efficient taxes and make sure we have the optimal income distribution.
  • You don't have to sit in a traffic jam just to help people on low incomes.
(Whilst we are on income distribution. One of the most bizarre pieces of conventional wisdom is the dislike of inheritance tax. Tax on inherited wealth does the most to reduce wealth inequality, it does nothing to distort economic behaviour. Furthermore, inherited wealth is unearnt (unlike income) and yet the general public will vote for a reduction of inheritance tax - even though it is the super rich who will benefit by far the most.)

Another New Tax. People dislike new taxes. It seems people don't look at the overall tax they pay, but the number of taxes. (as an anecdote, my father probably gets more mad paying 50p for parking his car in a city centre than he does paying £5,000 a year income tax. Another £1 on income tax he wouldn't notice, but 50p parking fee he really does.) But, if the overall tax burden stays the same, it shouldn't matter how we pay for it.

Just an excuse for raising revenue. A very popular criticism on new taxes is that it will be just another excuse for raising revenue. But, the aim of these taxes is not to increase the overall tax burden but, to shift the way we pay tax to be more efficient. Unfortunately, it can be difficult to explain the idea of tax neutral policies. Either politicians don't express the ideas clearly or voters don't believe / understand. But, even if it was partly to raise revenue - it is the taxpayer will benefit through higher public spending, lower government debt or lower taxes in long run.

Other Reasons Good Sense policies are politically unpopular.

Losers are More Vocal.

Policies often benefit society; the social benefits are greater than the social costs, but, one small and powerful group in society loses out. It is this small group which becomes politically motivated to stop the policy.

For example, cutting tariffs leads to an increase in overall economic welfare. The majority of the population will benefit from lower prices, increasing their disposable income. However, the lower prices are relatively small. It won't make a big difference to their standard of living. It is unlikely to swing their vote because import prices are a little lower. However, lower tariffs could lead to unemployment for a few workers in inefficient industries who can't compete under free trade. Their loss is potentially big, so they will lobby their MP to protect their jobs. The number who lose out is very small, but they become highly organised and exert political influence. Therefore we get stuck with higher tariffs even though it doesn't make sense.
  • A good example was the Common Agricultural Policy (CAP). For decades this lead to higher food prices, (hurting those on low incomes most), food surpluses, and damage to the environment just so wealthy farmers could benefit from the large EU subsidies and tariff protection.
  • If there is an increase in net economic welfare it should be possible to ensure a pareto improvement (make sure everyone becomes better off). If there is a net gain to society, part of this gain can be used to help the inefficient factories close down e.g. give workers retraining - encourage farmers to diversify. But, this option is politically difficult because a factory closure costs votes, on the other hand, a improvement in economic welfare widely distributed doesn't usually translate into votes.
Pressure Groups.

The US spends twice as much on health care as any other country. By any standards it is inefficient, bureaucratic and expensive. Despite the huge costs, many are left uninsured. One reason for the high cost / high bureaucracy is the involvement of private health insurers who make a steady stream of profit from the private insurance. An attempt to cut out the private companies who make large profits usually fails because the health insurance companies are willing and able to spend so much lobbying congress to keep the status quo. The uninsured patients or families bankrupt by health care, don't have the economic power and organisation to lobby congress.

Another problem of switching to a single payer system is that people don't like new taxes, the fact they and their firms would save more in reduced private insurance doesn't seem to matter. It is almost as if people would rather pay more through private payments than through taxes.

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