4.1.7 The distribution of income and wealth: poverty and inequality Flashcards
Define income.
- Flow of money a person / Hh receives in a given period of time.
- Flow concept - measured over given period of time.
Define wealth.
- Value of everything a person or Hh owns at a particular point in time.
- Stock concept - measured at given point in time - assets constitute wealth.
Define assets.
- Anything with market value that can also generate income - bought + sold
- Examples: pensions, gov bonds, gold.
Define equality.
- Equal distribution of income
- When everyone has exactly the same (e.g. same income)
Define equity.
Equity: fairness (i.e. fairness in distribution of income)
• Horizontal Equity: equal treatment of equals (i.e 2 individuals earning same income being taxed exactly the same)
• Vertical Equity: higher earners taxed more - those on lower incomes pay lowest tax (progressive / proportionate taxes).
Explain the difference between income + wealth.
- Income is flow of money going into FoP (e.g. flow concept, monthly salary / W, rental income from property, interest from S, dividends)
- Wealth is current value of a stock of assets owned by someone/society (e.g. stock concept, ownership of property, S in bank account, ownership of shares in business, money held in pension schemes).
Explain the income distribution in the UK.
- Since 1980, share of income earned by top 1% in UK has been rising.
- 2015: top 1% received 13% of all income in UK- almost double figure for Belgium (7%), Sweden (8%), + Norway (8%).
- For whole world, top 1% earns 20% of total income.
Define the lorenz curve.
- Graphical representation of income / wealth distribution- helps see level of income inequality for a given country.
Explain the lorenz curve as a measure of inequality.
• 45 degree line is line of perfect equality-everyone would have same income.
• Lorenz Curve shows cumulative share of income for diff sections of population (e.g. 20% of Hh have 5% share of income)
• Lorenz curve compared with line of perfect equality to show scale of income inequality in country.
• Larger the gap- greater degree of inequality.
Define the gini coefficient.
- Takes visual representation from lorenz curve + turns it into numerical form.
- Measures distance between lorenz curve + line of perfect equality then divides it by total area beneath line of perfect equality.
• If income distribution was perfectly equal, Gini Coefficient would be 0 (A + B would be same as A)
• Closer to 1, higher degree of inequality (e.g. 0.41 more unequal than 0.25)
• More than 0.4 highly unequal, lower than 0.3- relatively equal
Explain the UK’s gini coefficient.
- UK Gini Coefficient for gross income is 0.4 (highly unequal)
- UK Gini Coefficient for disposable income was 0.33 in 2016- similar to early 2000s (pre financial crisis)
- Pandemic + cost for living crisis made inequality worse.
- UK 4th most unequal income distribution in Europe.
State + explain the causes of income inequality.
- Wage + Salary Differentials: Differences in W + salaries for different occupations- significant part of income inequality. In UK- gap between W of those at bottom + top has widened over last 15 years. Public sector workers- real pay cuts over last 15 years.
- Unearned Income: People with assets have unearned income (e.g. rent, profit, interest)- gives more sources of income- largely determined by distribution of wealth, more unequal wealth distribution the more unequal income distribution.
- Relative Returns To Factors Of Production: Across world, returns to capital (unearned incomes) have grown at a faster rate than W (return to labour)- contributing to growing income inequality in UK + across the world.
- Globalisation: international trade + competition led to firms seeking lower C- led to falling W across many industries- reduces incomes / limits growth of incomes of workers across world.
- Tax + Benefit System: income inequality depends on how progressive tax system is + how redistributive benefit system is. UK tax system is progressive overall, but has become less progressive- increases in indirect taxes + reductions in higher income tax rates- taxes on capital gains lower than on earned income. Welfare cuts due to free market supply side policies + austerity also contributed to growing inequality in UK.
State + explain the causes of wealth inequality.
Wealth inequality linked to income inequality- more income someone has, more ability to accumulate wealth.
* Private Pensions: makes up significant proportion of wealth. Have been largely inaccessible to those on low incomes.
* Inheritance: wealth leads to more unearned income + more wealth accumulation.
* Capital Gains: land + property values increased over time. Wealthy own more land + property so benefit from increased value of assets.
* Wealth Taxation: low compared to income tax- enabling wealthy to keep hold of wealth + pass it on.
State + explain the consequences of inequality.
- Less equal distribution of income + wealth will lead to increased poverty - more people live below poverty line leading to less fair + inclusive society.
- Income redistributed back to higher earners with increased S + wealth.
- Ownership of assets leads to higher income- leading to even greater inequality in future (link between income + wealth).
- Capitalism can exacerbate levels of inequality as capitalist owns means of production- especially an issue when returns to FoP (i.e. land + capital) grow at faster rate than W levels.
- However, may be increased I as returns for entrepreneurs improve (e.g. lower tax rates which can lead to higher economic growth).
Evaluate whether the government should intervene to deal with inequality.
Yes:
* Creates a fairer society + improves allocation of resources.
* Prevents problems created by inequality (e.g. poverty, crime, social unrest, asset bubbles, persistent low growth, e.t.c.)
But:
* Inequality creates incentives to work hard (keep the reward)
* Inequality creates I + growth + makes everyone better off- trickle down theory- although not as prevalent as it once was (e.g. in 1980s)- people now I in shares, second properties, e.t.c.
Define absolute poverty.
- Incomes below threshold to access most basic, life sustaining goods / services (e.g. food + water) (world bank defines those living in absolute poverty as those living on less than $2 per day).
• Depends not only on income but also on access to services (e.g. health)
• Generally confined to developing countries.
Define relative poverty.
- Incomes below given average / median in society
- Individuals or Hh are poor in comparison to rest of population.
- In UK, poverty line is 60% of median income.
- Depends on level of median income in country.
• Generally in developed countries.
State + explain the causes of absolute poverty in the UK.
• Housing Poverty: homelessness.
• Food Poverty: people reporting insufficient income to buy food (i.e. using food banks). Growing issue in UK- Trussell Trust Network (covers 60% of food banks), reported increase in three-day food parcels provided from 61,000 in 2010/11 to 1,583,000 in 2018/19.
• Health Poverty: people under consuming health care (e.g. not able to afford to go to dentist / optician).
State + explain the causes of relative poverty in UK.
- Low Incomes + Income Inequality: main cause. Therefore, causes of relative poverty links to causes of income + wealth inequality- W + low W growth (W insufficient to cover C of living), growth of insecure employment + unemployment, lack of assets / wealth + unearned income (Hh vulnerable to shocks + can be easily pushed to poverty), + T + benefit system (especially those reliant on benefits / welfare payments).
- Low Wages: low W earners are relatively poor- W are main source of income for most Hh- low W impacts these groups. SL is elastic in low paid industries, leading to low WR. Trends in UK L market (e.g. zero hour contracts, globalisation, reduction in trade unionism, e.t.c.) have all had impact of keeping W low. NMW introduced in 1998 to help alleviate- firms in London have signed up to a ‘living W’. increases in NMW have been shown to improve incomes + reduce poverty in lowest paid W groups.
- Low Savings + Debt: if people never have spare income, they’re unable to save + build wealth- puts them at greater risk of economic shocks, as they have less financial security + wealth (e.g. pandemic severely affected low-income earners who’ve been more likely to be furloughed / unemployed. Unable to survive on 80% of their normal W + have no S to support them. Any changes in C of essential goods such as energy + food can cause these groups to fall into poverty. Most vulnerable to debt- borrow to survive but struggling to pay off debt.
- Reliance On Welfare Payments (Benefits): more likely to be on low incomes + be in poverty. Affected by inflation eroding real value of welfare payments- doesn’t always increase in line with inflation. Unemployment benefits generally lower than incomes from employment- unemployed relatively poor. Rising inflation erodes real value of unemployment benefits (current issue). Long-term unemployment can lead to absolute poverty (e.g. food poverty + homelessness). System introduced benefit freeze till 2020- benefits not adjusted for inflation- left claimants facing falling real income. 2 child benefit cap- families having another child wont see benefits raise- contributes to child poverty.
- Old Age Pensioners: reliance on state pension means living on very low income. Linked to inflation through triple lock but fallen behind level of real earnings. Rising inflation erodes value of pensions (current issue). Significant variation in income + poverty levels within older age groups- those with private pensions significantly better off.
State + explain the impact of poverty + inequality on households.
• Unable to afford necessity goods / services: (e.g. foods, shelter, clothing, e.t.c.).
• Lower standard of living.
• Restricted access to healthcare: leads to poor health- unable to work- increases days away from work.
• Restricted access to education / training: less educated- lower MRPL (i.e. in poorer areas, there’s less incentive to remain in education- due to financial pressures, social pressures, lack off family support, e.t.c)- leads to low paid work- low income- low saving- limited opportunity to progress- lower pensions in future- less security- higher risk of debt. Cycle of poverty- if you’re born in poverty, likely to remain in poverty (Hysteresis effects- long-term impact- once you’re unemployed, likely to remain unemployed).
State + explain the impact of poverty + inequality on society / community.
• Lower economic welfare.
• Social unrest.
• Higher crime rates.
State + explain the impact of poverty + inequality on the economy.
• Less consumer spending in economy: leads to lower demand in economy- less demand for L (L as derived D)- creates cyclical unemployment.
• Budget Deficit: gov has to spend more on state welfare benefits, may have to I in education / training, to create incentives for poorer individuals to become part of L force / become educated- gov may be spending more than they are receiving through taxation revenue (i.e. leads to structural budget deficit- apparent in UK).
• More Low Paid Work: lower D for goods- reduces sales- higher CoP. Also leads to less taxation revenue- deficit + debt.
• Low Productivity: individuals having low skills- leads to low productivity + decrease in LR economic growth- LR productive potential decreases. Impacts competitiveness- firms have to bring in workers from other countries to fill skill gaps, hire capital to replace unproductive L- leads to higher CoP- decreases competitiveness.
Explain the laffer curve.
- By increasing taxes (i.e. income tax) - tax rev collected can increase - extra tax rev can be used to help redistribute income + wealth, help fund essential public services, e.t.c.
- However, increase taxes beyond efficient tax rate (T) - amount of tax collected by gov will start to decrease
State + explain why there’ll be a reduction in tax revenue, put forward by the laffer curve.
1) Disincentives To Work Harder / Be Entrepreneurial: very high income tax on rich will disincentivise working hard + being entrepreneurial - workers may in fact substitute work for leisure - if they deem working harder is pointless considering how much income is being taxed.
2) Emigration: if income taxes are really high + lower in other economies - incentivises highly skilled workers to leave country + to emigrate to other countries - highly skilled emigration. Furthermore, individuals choosing to emigrate are likely the main tax payers - see large decrease in tax rev collected.
3) Tax Evasion / Tax Avoidance: higher tax rates - promotes tax evasion / avoidance - reduces overall tax rev collected by gov. Promoting illegal activity (tax evasion) - however tax avoidance not illegal - still reduces amount of tax rev collected by gov.
State + explain the policies to reduce inequality + poverty.
- Tax + Benefit System: progressive taxes + redistribution of income through welfare benefits. Through taxing rich more heavily, raising tax rates on those in highest income tax bracket, or raising income tax free allowance on lower end - benefits poor - keep more of income they’re earning. But by raising tax rates on rich - idea is that gov will collect more tax rev from rich + redistribute to poor (i.e. through higher welfare benefits). However, Laffer would argue incentives are distorted - amount of tax may end up being less. Can reduce regressive taxes (e.g. alcohol duty, fuel duty, VAT, e.t.c) - reduces burden on poor + increases amount of income they can keep + spending. Reducing regressive taxes hits gov finances - if gov takes big fiscal hit - may mean austerity policies going forward.
- Provision Of Goods + Services By Gov: provision of services that means Hh don’t have to spend their own income on them (e.g. health care, child care, youth centres / OAP centres, free school meals, e.t.c.)
- National Minimum Wage (NMW) / Living Wage: raises incomes of lowest paid workers. Alternatively wage cap could be used to restrict top W earners. Min W above competitive outcomes - helps those on lower W - access greater living standards. For min W - can reduce employment - particularly youth.
- Provision Of Education + Training: raises productivity + MRPL of workers, increases skills, increases potential W + reduces likelihood of unemployment.
- Reducing Unemployment: getting people back into work reduces reliance on welfare benefits, opportunity for higher incomes. Benefit cuts, back to work schemes (market based supply-side policies).
- Maximum Prices (Price Caps): sets maximum prices for essential goods, makes them more affordable, reduces poverty. Topical at moment due to cost of living crisis (e.g. energy price caps, potential for rent caps to make housing more affordable). Max W to control how much W can increase beyond certain level (e.g. capping bonuses). If max W - reduces incentive to be productive.
Evaluate the policies used to reduce inequality + poverty.
- Incentives: perverse incentives that some policies may impose
- State Of Gov Finances: a lot of policies are costly - whether gov can actually afford them given state of gov finances.
- Equity Vs. Efficiency: policies are all fair - but are they efficient? Consider distortion incentives of many policies - inefficiency in terms of what end outcomes might be. Min / max W distorts efficient L market outcomes - leads to significant inefficiency depending on level of caps / min W.
- Normative Judgements: gov intervention in L markets is normative consideration - is that really the best reason for intervening - would it lead to best outcome? Risk of inefficiency is even greater when normative judgements are made.
- Gov Failure: Consider whether gov needs to intervene - is gap between rich + poor so big it requires intervention or is level of inequality acceptable? Then gov doesn’t need to intervene + risk potential of gov failure.
- Is Inequality Always Bad: bad enough to require intervention.
Define universal basic income (UBI).
Universal Basic Income (UBI): welfare policy that guarantees a monthly income to everyone in population regardless of current income, employment or other factors.
Explain universal basic income (UBI) as a policy to reduce inequality.
• Covers basic needs of individuals receiving basic income (e.g. food, accommodation, e.t.c.)
• Unconditional - everyone receives it , regardless of income, unemployment , e.t.c.
• Funded Through Taxation / Borrowing.
• Could replace existing benefits system (e.g. means tested, UC) - replaced with UBI.
• Trialled by variety of countries in small scale.
State + explain the pros of universal basic income (UBI) as a policy to reduce inequality.
- Support Those Out Of Work: unemployed in times of wide spread unemployment + economically inactive (those unable to work) - support living standards, keep lid on inequality, reduce risks of poverty ,allows unemployed to take time when finding job that’s suitable for them.
- Overcome Problems With Means Tested Benefits: major issues with means-tested benefits - lots of administration involved, checks that need to consistently take place - timely, requires people to be employed - expensive. For individuals looking to receive them - burdens them - stressful - ever month filing paperwork, uncertainty whether you’ll receive benefit or not - UBI solves this - no checks involved, everyone receives this.
- Always Incentive To Work With UBI: no incentive to work with means-tested benefits - as you start working, can be taken away, as incomes rise - massive marginal income tax rate for individuals coming off means tested benefits - major disincentive to work - don’t have that problem with UBI - keep monthly income regardless of employment status + income.
- Everyone Eligible: particularly those not in work received highest benefits. Those in work but not receiving a high income - income top up can help cover basic needs (e.g. part-time workers, self-employed, e.t.c.) - helps reduce inequality + allows those roles to persist in economy - flexible L market good for economy.
- Support Socially Beneficial Activity: looking after children, sick relatives, e.t.c. Left to FM - sending kids to nursery too expensive, carer to look after sick too expensive. UBI that covers basic needs can take away financial burdens + allows people to look after children, sick, e.t.c.
- Can Support Entrepreneurship: allows for S to accumulate + allow people to afford to start their own businesses - takes pressure away from making profit quickly - can take time. Entrepreneurship also good for economy - many macro positive impacts.
State + explain the cons of universal basic income (UBI as a policy to reduce inequality.
- Can Encourage Laziness / Living Off Benefits: acts as disincentive to work - bad for economy.
- Can Reduce Labour Market Flexibility: by reducing occupational + geographical mobility of L - people may now lack incentive to upskill themselves to fill vacancies in economy. People may also now be less willing to move to take job vacancies that exist.
- High Cost + Poorly Targeted: even if replaces existing benefit system - massively expensive + lots of people that receive benefit wont need it at all - negative impact on gov finances (i.e. increases in national debt, burden on future generations) - real concern.
- Inflation Concerns: lots of money circulating economy - likely to be quite inflationary.
Define wealth taxation.
Wealth Taxation: tax on individual’s net worth / assets, rather than their income (e.g. savings, property, financial assets minus debts)
* Can be progressive + set at varying thresholds.
* Common policy against Europe, but many countries that don’t have wealth tax.
State + explain the pros of wealth taxation as a policy to reduce inequality.
- Big Revenue Earner For Gov: wealth drastically increased in past 40 years - globalisation played huge role in this - opening up financial markets, advancements in tech, rising population (higher property + land P) - greater accumulation of S - lots of income going into wealth - increasing asset P. Rev can be used to run down budget deficits / reduce national debts / improve sustainability of gov finances - especially if in a bad way.
- Reduce Wealth / Income Inequality: if rev generated is used to fund health / education, or directly to fund benefits - linked to lower income inequality - overcome issues associated with rising inequality.
- Can Target Windfalls: unexpected rise in asset P (e.g. share P go up as businesses make good decisions on how they run their businesses - running it more efficiently - making own I decisions - leading to higher profitability + share P) - good way to increase asset P. But asset P can also rise through non-productive reasons (e.g. property P can rise because of strict gov legislation, lack of S - scarcity, e.t.c.). Wealth taxes that target windfalls can promote equity, but also means an efficient allocation of funds.
- Can Promote Efficient Re-Allocation Of Wealth: away from low yielding unproductive assets towards higher yielding, more productive assets. If wealth tax is there, people will look to I in assets which are less burdened by taxes - seek most high yielding assets where wealth tax doesn’t have as great of an effect (e.g. savings in bank account to shares where rate of return is much greater) - can fund business growth, business I - contributes to growth + unemployment in economy.
State + explain the cons of wealth taxation as a policy to reduce inequality.
- Discourages Investment, Income Generating Activity + Growth: if wealth tax is set too high - can promote poor incentives. Discourage income generating activity - by taxing wealth highly, discourage income generating activity that becomes wealth later - bad for economic growth.
- Risk Of Emigration: Laffer concerns - highly wealthy leaving country + emigrating to where wealth tax doesn’t exist.
- Tax Loopholes: risk of wealthy finding loopholes in tax system - look to evade / advocate paying tax - limit tax revenue generated to gov by wealth tax.
- Administrative Challenge: of taxing the right assets + valuing assets - if done poorly can reduce effectiveness of policy.
Evaluate wealth taxation as a policy to reduce inequality.
- Rate: higher the rate, more likely to get trade offs.
- Assets Chosen: well designed wealth tax will target less productive assets over more productive assets + will target windfalls more than productive increases in asset P. Very hard to design in reality - change of getting things wrong + trade offs occurring very likely.
- Enforcement: strong enforcement if tax is going to be effective overall + bring in benefits.
