The limits of the equity-efficiency tradeoff

Relatively inefficient transfer programs such as public housing, food stamps, and direct price regulation (rent controls, minimum wages) are sometimes justified by arguments which say that it is possible in this way to transfer more to the poor than would be possible without such programs. Conversely, it is sometimes argued (as in the case of gasoline) that prices cannot be allowed to rise to equilibrium levels because such increases will hurt the poor most and direct compensation will not actually be paid. The argument advanced in this paper is that, given enough time, the political process will respond to such policies, and those who advocate inefficient programs for increasing the wealth of the poor will succeed only in lowering the incomes of both the wealthy and the poor. 13 Moreover, this argument is based on a simple and direct model of the political process, one that only requires a weak form of responsiveness to voters' intentions. While the Pareto criterion provides that every inefficient state is dominated by an efficient one, it does not usually imply that every efficient state dominates every inefficient one. However, in our framework, this does hold for policy comparisons, so that a policy could be judged solely by its implications for efficiency. Without regard to equity considerations, one policy which raised social income relative to another would be preferred by each and every person and so would dominate by the Pareto criterion. There was no need for the usual compensation principle arguments, since compensation was not something that could occur but something that would occur. Potential improvements become actual improvements through the action of a responsive political system. In comparing policies for income redistribution, it is only their efficiency implications which are relevant. Copyright Martinus Nijhoff Publishers 1985