2.5 Policies to Redstribute Income Flashcards
What are transfer payments and how do they help alleviate poverty?
Transfer payments can be used to redistribute income and provide different types of assistance to groups in the economy to improve their living standards. Examples of transfer payments include child support assistance, unemployment benefits, and payments to the disabled. Transfer payments prevent those unfortunate enough not to have the skills needed to find work from living in extreme poverty and allow those who have children or who are disabled to maintain a decent standard of living, increasing incomes for the poor and helping to close large income disparities.
How can government spending on essential goods and services help reduce income inequality?
Government spending on essential goods and services that are socially desirable and that generate positive externalities of consumption, such as health care, education, sanitation, and water supplies can ensure that the poorer members of the economy have access to essential goods and services increasing living standards. This policy would reduce income inequality by allowing the poor a means to increase their skills, productivity, and therefore incomes.
evaluation: What are the potential drawbacks of implementing transfer payments and government spending policies?
Both policies above would cost the government large sums where funding would carry a severe opportunity cost. If the money had to be borrowed, taxes in the future would have to rise. If regressive, indirect taxes such as VAT or fuel duty go up to part fund this spending, the poor will suffer, worsening income inequality, contradicting the intentions of these policies. If the government funds these policies through cutting spending in other areas of the economy such as public transport, once more the negative impacts could well be suffered by the poor who rely on such services.
How can progressive income taxation help reduce income inequality?
Governments could implement or adjust progressive income taxation, increasing taxes on workers with salaries in the highest income tax bands using the extra tax revenue to finance transfer payments and extra government spending on health and education. This will reduce disposable incomes for the rich and increase incomes at the lower end for the poor thus reducing the level of income inequality.
Evaluation: What are the potential drawbacks of implementing progressive income taxation?
Draw the Laffer Curve as-well
By increasing taxation levels specifically for those who earn higher incomes, incentives in the labour market could be distorted preventing entrepreneurial risk-taking activity to the detriment of the economy. The Laffer curve illustrates this point: Laffer argued that by raising income taxes on the rich, eventually tax revenue actually falls as tax rates increase. Higher taxes promote tax evasion and/or tax avoidance by individuals whilst also incentivizing the highly skilled workers and entrepreneurs to emigrate to countries where tax rates are lower. Not only will this reduce expected tax revenue for governments to use in redistributing income but it could also dampen the productive potential of the economy as innovation and entrepreneurial spirit are limited and hours worked fall.
How can a minimum wage help reduce income inequality?
Draw Minimum Wage Diagram
A minimum wage can directly boost the incomes of the poorest in society. By governments imposing minimum wages at equitable levels, producers are burdened without impacting the government’s fiscal position. A minimum wage would be set above the equilibrium wage rate in the labour market acting as a wage floor protecting workers with low skills against wages that would not promote a decent standard of living in sectors such as retail, supermarkets, leisure, recreation, and manufacturing. With higher wages, those at the lower end of the income spectrum will be able to move out of relative poverty by improving both their material and non-material standards of living, closing the income gap in a country.
evaluation: What are the potential drawbacks of implementing a minimum wage?
Draw Minimum Wage Diagram
Minimum wages can distort efficient labour market outcomes and cause unemployment, harming those it is supposed to protect. Those with low skills may ultimately find it very difficult to find work at a higher wage rate when their productivity is not enough for firms to justify employment at the minimum wage. Thus this policy could actually increase unemployment, known as classical unemployment, and make the gap between rich and poor even worse.
What is the Lorenz curve and how does it relate to income distribution?
Draw the Lorenz Curve
The Lorenz curve is a graphical representation of income distribution in an economy, plotting the cumulative percentage of income earned by each percentile of the population on the horizontal axis against the cumulative percentage of the population on the vertical axis. A perfectly equal distribution of income is represented by a straight line from the bottom left corner to the top right corner. The further the Lorenz curve is from this line, the more unequal the income distribution in the economy.
How can policies to redistribute income reduce income inequality?
In theory, policies to redistribute income and promote equality would shift the Lorenz curve to the left, closer to the line of perfect equality, indicating a reduction in income inequality. This can be mathematically shown using the Gini coefficient, which would move closer towards 0, indicating a smaller distance between the Lorenz curve and the line of perfect equality and a more equal distribution of income.
evaluation: Are there any limitations to using the Lorenz curve and Gini coefficient to measure income inequality?
The Lorenz curve and Gini coefficient do not take into account the non-monetary aspects of inequality, such as differences in access to healthcare, education, and other non-material goods and services. Additionally, they do not account for the distribution of wealth, which can differ significantly from the distribution of income. Furthermore, the Gini coefficient may not accurately reflect the level of inequality in an economy if the middle-income groups are relatively large, as the coefficient will be skewed towards the middle.
What are some potential drawbacks of implementing progressive income taxation?
Evaluation: By increasing taxation levels specifically for those who earn higher incomes, incentives in the labour market could be distorted preventing entrepreneurial risk-taking activity to the detriment of the economy. Higher taxes promote tax evasion and/or tax avoidance by individuals whilst also incentivising the highly skilled workers and entrepreneurs to emigrate to countries where tax rates are lower. Not only will this reduce expected tax revenue for governments to use in redistributing income but it could also dampen the productive potential of the economy as innovation and entrepreneurial spirit is limited and hours worked fall.
How does the state of government finances affect policies to reduce income inequality?
Evaluation: If the government is suffering from high levels of debt and persistent budget deficits, it may not be viable to greatly increase transfer payments or spending on health and education to reduce income inequality. In fact, the reverse is likely to take place, whereby welfare spending and health/education spending will be cut in order to reduce the national debt, cuts that increase income inequality.
How do incentives affect policies to reduce income inequality?
Evaluation: Excessive government intervention may reduce the productive capacity of the economy by taking away incentives for workers to gain education, skills, and qualifications. Laffer’s criticisms are significant in this regard, as they suggest that policies to redistribute income may not always be effective in reducing income inequality. Therefore, policies to reduce income inequality should focus on progressive taxation, set at an efficient level that promotes work and risk-taking activity, while also providing enough revenue to the government to reduce inequality. Additionally, policies to increase transfer payments or spending on unemployment benefits must be carefully balanced to avoid creating a welfare mentality and dependency that may harm the productive potential of the economy.
Why might reducing income inequality conflict with economic efficiency?
Evaluation: A certain amount of income inequality can provide strong incentives for those on lower incomes to gain education, skills, and qualifications to boost productivity and earn higher incomes. Therefore, targeting low income inequality levels through excessive government intervention can take away these incentives, reducing the productive capacity of the economy and long-run growth rates. It can be argued that there is no single target for income inequality, and that reducing inequality should not conflict heavily with economic efficiency, or else government failure will result.
