3.4. Policies towards income and wealth redistribution

Question 1

What does Equity mean?

Answer 1

Fairness

- normative concept

Question 2

Horizontal Equity

Answer 2

When individuals with the same circumstances are treated in the same way
- e.g. high earners pay more income tax than low earners

Question 3

Vertical Equity

Answer 3

When individuals with different circumstances are treated differently
- e.g. higher earners pay more income tax than low earners

Question 4

Efficiency

Answer 4

the use of scarce resources in the most economic or optimal way (achieving productive and allocative efficiency)

Question 5

Problems with achieving Equity and Efficiency

Answer 5

• Fairness (equity) can cause inefficiency
• Efficiency can cause unfairness (inequity)
• government policies (e.g. indirect taxes on demerit goods) to improve efficiency might lead to an inequitable outcome (e.g. unfairness due to regressive impacts on poorerpeople)

Question 6

Price Stabilisation

Answer 6

government intervention to maintain stable prices

for a commodity.

Question 7

Buffer Stock (DRAW)

Answer 7

a method of price stabilisation, where the government purchases and stores products when supply is high (S2) to prevent prices from falling and sell some of its stock when supply is low (S3) to prevent prices from rising.

Question 8

Price Stabilisation Advantages

Answer 8

• Avoids fluctuating prices for consumers.
• Avoids fluctuating incomes for producers.
• Greater stability encourages producers to invest.

Question 9

Price Stabilisation Disadvantages

Answer 9

• Cost of buying excess supply.
• Cost of storing excess supply.
• If the target price is too high, it encourages over production.
• If the target price is too low, it encourages under production.
• Too many consecutive bad years (low supply) means stock may run out.

Question 10

Transfer payments

Answer 10

• a payment made to people who are less well off. It is paid for out of tax revenue and helps those most in need.
• It is not linked to economic output (therefore not part of national income).
• Examples: state pensions, unemployment benefits.

Question 11

Means tested benefits

Answer 11

benefits given to people based on their income

Question 12

Universal benefits

Answer 12

benefits given to people regardless of their income

Question 13

Tax credits

Answer 13

a type of means tested benefit given to people on low incomes to boost their income and raise their standard of living.

Question 14

Progressive income tax

Answer 14

a tax system where tax as a percentage of income increases as income rises.

Question 15

Inheritance tax

Answer 15

Def: a tax paid on inherited money or assets (e.g. property).

Examples:

• Thailand: inheritance above 100 million Baht is taxed at 10%.
• UK: inheritance above £325,000 is taxed at 40% (unless left to your partner)

Question 16

Capital gains tax

Answer 16

a tax paid on the profit made from the sale of an investment (e.g. shares) or property.

Examples:

• Buy shares for $10,000. The shares rise in value to $25,000. Sell the shares. Tax is paid on the $15,000 profit from the investment.
• Buy a property for $250,000. Property rises in value to $400,000. Sell the property. Tax is paid on the $150,000 profit from the property.

Question 17

Negative income tax

Answer 17

a payment of money to people on low incomes instead
of making them pay income tax.
- Similar to tax credit.

Question 18

Poverty trap

Answer 18

a situation where the tax and benefits system contribute to keep people in poverty.

Question 19

Poverty trap analysis

Answer 19

• An unemployed person pays no income tax and receives welfare (benefits) from the government.
• If the unemployed person accepts a low-paid job, they will lose some/all of their welfare (benefits) and have to start paying tax.
• Where the gap between welfare and low paid employment is small, there is a disincentive for people to work and instead stay on welfare, hence they
  remain trapped in poverty.

Question 20

Inter-generational equity

Answer 20

the fairness in the distribution of income and wealth of different generations of people over time.
- It is concerned with how the income distribution today can affect future generations.

Question 21

Gini coefficient:

Answer 21

a statistical measure of inequality.

• 0 = perfect equality
• 1 = perfect inequality

Question 22

Lorenz Curve

Answer 22

a graphical representation of inequality.

Question 23

Gini coefficient:Equation

Answer 23

Area A / Area A + Area B

Question 24

Government Failure

Answer 24

occurs when government intervention to correct market failure leads to further inefficiencies.

Question 25

Reasons for Government Failure

Answer 25

1) Political self-interest (policies designed to win votes).
2) Policy myopia (short-term thinking instead of long-term thinking).
3) Regulatory capture (decisions that favour producers over consumers).
4) Disincentive effects (e.g. higher tax creating disincentives for the unemployed).
5) Imperfect information (government does have all information about policy impacts)
6) Tax evasion, tax avoidance, smuggling and black markets.
7) When the cost of intervention is greater than the benefits of intervention.
8) Unintended consequences (impacts that were not anticipated in advance).