As a DM, I occasionally fudge damage, either increasing (if the encounter is far easier than anticipated - not through player ingenuity or character ability but my own error) or decreasing (if I goofed and made the encounter way overpowering without providing appropriate info which may have permitted the players to develop alternative plans - including running away) damage dealt. Only in the case of major combat encounters, such as against the BBEG, or where the player does something really stupid ("I'm going to wrestle the ancient red dragon barehanded!") will I never fudge the dice regarless of the consequences. On those occassions where I let the dice fall where they may, the original party members were killed over the course of three adventures and the replacement characters, once the original party was gone, had no reason to carry on the fight against the campaign villain. (I decided to create a 'personal' villain, one which threaten the PCs but who was not necessarily a threat to anyone else.) Since then, I have come to favour continuity of character - allowing players to develop a character and his place within the setting.
The attitude which I try and foster is not one where the players sat "Thank goodness we survived" but "What are the consequences of our survival", regardess of whether they were victorious or not. Slaying the ogre chieftain and then having to deal with the power vacuum and the upstart orcs is, I feel, much more rewarding than simple survival. And fortunately, my players agree!
