distribution of income and wealth Flashcards
Income:
Income: a flow of money to a factor of production, usually labour.
Wealth:
Wealth: a stock of valuable assets such as property or shares.
Factors leading to an unequal distribution of income
Differences in skills, qualifications and work experience. Individuals with skills, qualifications and work experience that are in high demand will tend
to earn more than those lacking in these.
* Differences in wealth. Wealthier individuals and households tend to earn more income from their holdings of assets in the form of dividends and
interest.
* Impact of the state. A free market economic system would provide fewer welfare benefits than a command economic system.
Factors leading to an unequal distribution of wealth
- Differences in income. Higher earners are more able to save money and earn interest and so increase their wealth.
- Inheritance. Property and other valuable assets can be passed down from one generation of wealthy families to the next.
- Marriage. Wealthy people tend to marry other wealthy people, leading to a concentration of wealth among a relatively small number of families.
- Property. Wealth can generate wealth for those who own valuable assets such as property if the income earned from rental is saved or used to purchase
further valuable assets.
Equality versus equity
Equality means that income and wealth are shared out equally between all members of society whereas equity is the notion of fairness. Under the notion of equity it may be seen by some societies as fair that income and wealth are unequally shared out between different people. This may be justified if some work longer or harder than others, or have sacrificed earnings in order to complete further or higher education, or taken a business risk as an entrepreneur.
The Gini Coefficient
The Gini Coefficient is a statistical measure of the degree of inequality. It is the ratio of the area between the 45 degree line and the Lorenz Curve divided by the total area below the 45 degree line.
* The higher the value, the more inequality exists.
* Perfect equality gives a Gini Coefficient of 0.
* Perfect inequality gives a Gini Coefficient of 1.
Possible costs of income and wealth inequality
- Social tensions: significant inequality in the distribution of income and wealth may fuel social tensions, as poorer members of society come to resent richer members of society. This may lead to friction, crime and rioting.
- The creation of an ‘underclass’: with a relatively low standard of living and little obvious chance of bettering their position via ‘social mobility’, there may be a significant segment of society that comes to be reliant on welfare benefits.
Possible benefits of income and wealth inequality
- Incentive effects: the existence of high earners and the ‘super rich’ suggests the possibility of many people being able to earn high salaries or profits through hard work, innovation or setting up businesses as entrepreneurs. Free market capitalists would argue that these incentive effects help to generate economic growth, making average incomes higher. Without these incentives, economic activity may be lower.
- ‘Trickle-down’: free market economists would argue that the economic benefits of having relatively high earners can trickle down to all sectors of society, since high earners and the very wealthy tend to be business owners who therefore create employment opportunities. Furthermore, they may also pay higher taxes, which can be redistributed to raise the living standards of the relatively poor. In addition, their taxes can be used to fund merit goods such as healthcare and education, free at the point of consumption for all members of society.
Trickle-down:
Trickle-down: a free market view that poorer members of society will benefit from high earners and the relatively wealthy, e.g. through job opportunities and helping to fund merit goods.
Relative poverty:
Relative poverty: when some people in society are worse off than others, e.g. earning less than 60% of a country’s median income.
Absolute poverty:
Absolute poverty: when some people can’t afford the basic necessities to sustain life, e.g. food, shelter and warmth.
Causes of poverty
- Relatively low wages: workers with relatively low skills, with few, if any relevant qualifications, will find themselves either in low-paid jobs or unable
to secure work. - Unemployment: individuals who are reliant on unemployment benefits tend to have incomes significantly lower than those in work.
- Regressive taxation: increases in the numbers and rates of regressive taxes since the 1980s have placed a higher burden on the poorest members of
society. - Old age: welfare benefits and the state pension are still the major sources of income for older members of society, and these have not grown in line with
average earnings over the last 20 years. - Imperfect information: some people are unaware of their eligibility to claim certain welfare benefits.
Effects of poverty
- Greater demands on the welfare system: people in poverty are more likely to be eligible to claim welfare benefits and not earn incomes high enough to
pay income tax, so will impose a greater cost on the government than those on higher incomes. - Poor educational attainment: people from poorer backgrounds tend to perform less well at all levels of education, meaning they are less likely to go on
to further and higher education. This in turn means that they will have a lower MRP than those with higher levels of attainment, meaning they tend to
earn relatively low wages. - Poor health: those in poverty tend to suffer from poorer health, both physical and mental, and more incidence of chronic illness, which may further
hamper their ability to maintain paid employment. This puts further strain on the nation’s resources.
Policies to influence the distribution of income and wealth and to alleviate poverty
- Progressive taxes: this means making higher earners pay a larger percentage of their income in taxation, such as the introduction of the 45% highest tax rate in the UK in 2013, reduced quickly from 50%. Raising the tax-free threshold, so that the low-paid do not pay tax until they earn a certain amount, e.g. £11,000, is also an example of making income tax more progressive.
- National Minimum Wage: this is a legal minimum wage designed to prevent employers from exploiting those in relatively low-skilled occupations by paying low wages.
- Welfare benefits: these can be ‘means-tested’ in order to target those in greatest need, i.e. those on the lowest incomes.
- Education and training: raising standards of education and training will help to increase the marginal revenue productivity of the labour force, reducing
occupational immobility and enhancing employability. - Reducing unemployment: unemployment can be tackled by specific policies depending upon whether the unemployment is due to a lack of aggregate
demand or supply-side problems. - Promoting ‘trickle-down’: policies to promote economic growth will, in theory, raise average incomes while also creating more opportunities for
entrepreneurship. Those members of society who benefit most from these opportunities can contribute to raising the living standards of poorer people by creating jobs and paying higher taxes to fund merit goods such as state education and the NHS.
The economic consequences of policies to alleviate poverty
Progressive taxes: critics of highly progressive taxes argue that they can create disincentives to work, leading to voluntary unemployment, slower economic growth and reduced income tax revenues overall for the government. In addition, they may create disincentives to invest and be entrepreneurial if they relate to corporation tax on business profits or income taxes on the self-employed. Furthermore, high taxes may encourage a ‘brain drain’ as high earners move overseas to relatively low-tax countries.
- National Minimum Wage: some critics argue that if the NMW is set too high it could lead to increased unemployment. Also, increasing the NMW will not benefit those already unemployed.
- Welfare benefits: increasing benefits may increase the replacement ratio and reduce incentives to work. Means-testing benefits is arguably better than providing universal benefits, but may cost more to check and administer. The government has sought to offer various tax credits as an alternative, increasing the disposable income of low-paid working households.
- Education and training: an individual may take a long time to feel the positive impacts of education and training in terms of increased employability. Many courses are expensive — a problem if the individual has to pay for the courses themselves. Furthermore, some courses may not be appropriate for current job vacancies and therefore may not lead to increased employment prospects.
- Reducing unemployment: expansionary fiscal and monetary policies have time lags before their full effects are felt and may also lead to demand-pull inflation, depending on the extent of supply-side inflexibilities.
- Promoting ‘trickle-down’: critics of trickle-down argue that while it sounds promising in theory, in reality it doesn’t really work. This may be because the highest earners in society can afford the best tax accountants to help them exploit loopholes in the system in order to minimise the tax they pay.
