Happiness, Fortune, Wealth,… what we generally call Welfare, have always been controversial issues in the world. They are not only a constant worry of each individual person but they are also a concern for society in general and for the people who govern it. When looking around us sometimes we wonder why and how there are resources being wasted when we know that people would benefit immensely from them, or why and how society can accommodate individuals and families that differ greatly in what they have and on what they can attain for their life. The problem is that both the best administration of resources and the way they are distributed among society are like an economic and political puzzle whose pieces do not always fit together. Today, I will try to explain this puzzle with a box, a dot and a line.
On the two pictures above you can see a box drawn, one has dots inside and the other has a line. I would like you to imagine that the box is your society (it can either be the world, your country, your city) and I would like you to answers two questions (don’t think very hard on the answer, focus on the first thing that comes to your mind). The first question is: which dot do you prefer in the first picture? Dot A, B or C? My guess is that you chose dot B, most people tend to go for the middle option, it is intuition. This B dot will represent Equality, more specifically, because we are inside the box, this dot means that everybody in society has the same Welfare. The second question that I have is: do you prefer to be on the line or outside the line in figure 2? If I let you know that the line represents a society where in order to make a persons’ Welfare better I would have to harm at least another persons’ Welfare (pareto Efficiency), meaning that everybody is in their best Welfare position taking into account all other people in society, you would probably also tell me that you wanted to be on the line.
Now that you understand what is in question inside the society I will introduce the government that has the hard task of balancing the dot and the line. Often, the task of governments is i) to comply with their society request of being on the line, because we all want to have the best Welfare our society allows, while ii) making sure that there are no big discrepancies in the midst of society and by this I mean being in dot B. But what are the available actions that the government has to turn the box both Efficient and Equal?
Starting with Efficiency, the government is essential because it helps to fill gaps in society. Visually, if the government was not helping, our line would not be a continuous one, it would have little jumps on it. The way the government has to fill these gaps is by intervening directly and indirectly in the society through the provision and purchase of goods and services, through the exertion of influence and regulation, and through taxation and subsidies.
The provision of goods and services is essential when it comes to Efficiency because it fills the gap in supply that exists naturally in some goods and services (public goods). You can think of a great number of examples such as schooling, healthcare, parks, street lights that are all provided by the government and that would not be provided otherwise. The acquisition of goods and services by the government from an external source is also crucial for the increase in Efficiency because it can allow governments to provide society with the good or the service while saving money and ameliorating the way the service is provided. Regulation and information will avoid agreements from firms that can lead people to be misled by companies, which also increases Efficiency.
The issue is that in order to be able to take these actions to get society on the line, the government needs money. The most known way to generate this revenue is through taxes (there are other ways such as printing money that I will leave out). Taxes can have diverse classifications, but for this purpose we will divide them into Distortionary and Non-distortionary. A distortion that comes from a Distortionary Tax, however, means that we will no longer be on the line, so the government should use Non-Distortionary Taxes. Unfortunately, when Margaret Thatcher tried to introduce such a Tax in 1990, known as a poll tax (everybody pays the same amount irrespective of their social and economic situation), people shut the government down with major protests (poll tax riots). Progressive taxation, considered a fair tax because you pay according to your economic and social situation, falls on the Distortionary category, meaning that you are no longer on the line.
When it comes to Equality the issue becomes a bit more complex to analyze. The government could assure that society was operating in dot B if it was responsible for the distribution of everything such as food, schooling, cars, to everyone; governmental facilities would now also include big warehouses. Nevertheless, the costs and logistics of this operation would be immensely big turning it into something not feasible. Another way to achieve this point is by redistributing the initial amount of money that each individual has. This can also be done through taxation and subsidies; services such as social security are a way of the government to redistribute money in society, for example when you become unemployed you receive a subsidy. The problem is that this redistribution method only works if we are on the line, which do to distortions makes it very difficult to achieve.
It is not an easy balance to obtain, and the tools that are available can both mitigate and increase the issues that naturally exist. Society accommodates both Inefficiency and Inequality because there are no available tools that can make both problems disappear.