Theme 3, 3.6 Inequality and Redistribution Flashcards

Question

What are microfinance schemes ?

Answer 1

This involves borrowing small amounts of money to fund new enterprises.

Answer 2

People who don't have a suitable credit score for a loan from the bank.

Answer 3

It would encourage them to work harder, become more productive and gain a higher wage rate.

Answer 4

Monopolies have the market power to exploit consumers by charging higher prices, thus increasing profits for big firms but leaving consumers with less income as a result.

Answer 5

By changing inheritance taxes, the upper class keep less of their wealth, thus reducing the inequality gap.

Answer 6

Social unrest

Answer 7

Wealth is a stock of assets, whereas income is money received on a periodic basis.

Answer 8

A mechanism which forces people to remain in poverty.

Answer 9

If income taxes are too high, workers may be demotivated to work longer hours as they know they'll receive the same income once taxes are deducted.

Answer 10

When the tax rate increases as income increases.

Answer 11

Negative income tax is when a worker earns below a certain income level, so instead of paying taxes the government gives them money.

Answer 12

Poverty seems to be a simple concept, but it can have alternative meanings in different contexts. Absolute poverty is concerned with living in conditions which make it hard to survive. The United Nations definition is “a condition characterised by severe deprivation of basic human needs, including food, safe drinking water, sanitation facilities, health, shelter, education and information.” This might seem ponderous, but it is thought provoking. Besides the ‘basic human needs’ which are obvious essentials, it adds education and information as indicators that part of the problem is the inability of the absolute poor to escape the situation they are in. Relative poverty means not being able to participate in a ‘normal’ life by the standards of society. This is a trickier concept, but everyone else having such luxuries as holidays and mobile phones means that the relatively poor are those who are ‘excluded’ because they cannot afford such things. As a rule of thumb, anything below 60% of median income is defined as relative poverty Whilst absolute poverty is rare in the UK, there are people who struggle to meet basic needs. Besides rough sleepers with no home, Shelter estimates that the number of households in temporary accommodation fluctuates around 60,000 from year to year. More than two thirds of these are households with children. There are many families missing meals when they have no money for food and many more with limited diets. The Trussell Trust reports that more than a million three day food packs were distributed from food banks in the 2014-15 financial year. There were 56 UK food banks in 2009 but this grew to 445 in 2014. Food insecurity, uncertainty about having food to eat, has become a widespread problem.

Answer 13

Poverty has dietary implications beyond the obvious limit to spending on food. If, say, power bills are unpaid so supplies are cut off, heating food can become an issue. The psychological impact of poverty is also unhealthy and adds to both physical and mental health problems. People living in the poorest areas have lower life expectancy. A downward spiral to despondency and despair can leave people feeling incapable of changing the situation. Poverty can be particularly difficult for parents struggling to meet the needs of their children. Early chapters of ‘This Boy’, by Alan Johnson, paint a vivid sample picture of poverty in London 50 years ago. UNICEF estimate that globally around 22,000 children a day die from causes related to poverty. Resistance to diseases is stripped away by malnutrition. Children “die quietly in some of the poorest villages on earth, far removed from the scrutiny and the conscience of the world. Being meek and weak in life makes these dying multitudes even more invisible in death” (Globalissues.org). Such situations need not continue indefinitely. Improvement is possible. By one measure, China’s poverty rate fell from 85% to 15.9% in 40 years.

Answer 14

Successive UK governments have sought to tackle and even eradicate child poverty. Until 2015, the 60% of median household income was the accepted benchmark. Minister Ian Duncan Smith described this approach as ‘deeply flawed’ in July, 2015, and announced a change to a range of indicators such as exam results, workless households, family breakdown, debt and drug and alcohol dependency. Precisely how this system will work is not currently clear. This change was announced days after figures using the 60% of median income approach showed an increase in child poverty from 2.3 to 2.5 million and the four UK Children's Commissioners warned that child poverty in Britain was “unacceptably high”. Organisations concerned with child poverty opposed the change. As another approach to relative poverty, The Joseph Rowntree Foundation had developed its MIS (Minimum Income Standard). This surveys what is seen as necessary for a normal UK life and then looks at the income needed to finance it. Besides obvious items such as rent, food and fuel for heating, this includes less essential items such as motoring costs for a family (but not for single people). It also includes an amount for ‘social and cultural participation’. Around £17,000 p.a. meant an individual could reach MIS in 2015, but around £40,000 was needed for a household of two adults and two children. With median gross annual earnings at £28,000 p.a., a household with children and one parent on median earnings would also need a second earner, at least part-time, to reach MIS.

Answer 15

Around 40% of UK households with children fall below MIS incomes. In recent years, pensioners have fared relatively well, though 16% of pensioners still live in relative poverty. The number of workless households has also fallen, but there has been a significant rise in working households with children living in relative poverty (and below MIS). Factors contributing to this include zero hours contracts, the rise in part-time work and the extent to which the pay of unskilled earners has fallen behind.

Answer 16

The World Bank suggests that poverty can be measured by income, consumption, health, education and assets owned. However, it concentrates mainly on income and consumption. Setting a global income level for absolute poverty is difficult and it uses two benchmarks. $1.25 per day is taken as a clear sign of extreme (absolute) poverty. The bank’s estimate is that 1.2 billion people live below this level, around 17% of the global population of 7 billion. $2.50 per day is thought to show significant deprivation and 2.7 billion people are estimated to have incomes below this, almost 40% of population. Such poverty is most common in rural areas in sub-Saharan Africa and parts of Asia, most notably in the Democratic Republic of Congo, Nigeria, Pakistan, Afghanistan, India and parts of China. There is no global standard for relative poverty as this depends on incomes in each country. By definition relative poverty depends on median incomes in each separate country. As one generalisation, there is likely to be more relative poverty where very uneven income distributions leave a large proportion of households well below the median income. Looking at world consumption shares by quintile groups (fifths) gives a ‘champagne glass’ distribution.

Answer 17

Comparisons of living standards between nations often use the Human Development Index (HDI), which combines measures of income per capita, life expectation and years of schooling. The countries which rank lowest on HDI comparisons (in sub-Saharan Africa) also tend to have very extensive poverty. The relevance of HDI is its identification of the way that quality of life depends on more than just income or material well-being. Many of those in the bottom 40% of the ‘champagne glass’ have a level of deprivation in their lives which represents the reality of poverty.

Answer 18

Within the richest societies, there are people living in poverty. The poorest societies have a minority of very rich people. The Lorenz curve gives us a measure of inequality. It plots the share of total incomes held by household groups. The horizontal axis represents percentage groups of households, working progressively from households with lowest incomes on the left to the highest on the right. The vertical axis shows the cumulative percentage of total income held by households. The curve will be fairly flat on the left, because this represents households with least income. The biggest incomes on the right will make that end steep. The orange line on Figure 2 is a typical Lorenz curve. The black line is a theoretical diagonal line showing all households having identical incomes. No country actually has identical incomes for all households. Whilst Lorenz curves normally focus on income, the flow of receipts to households in a time period, the same approach can be used to chart inequality of wealth. In this case we plot wealth at one moment rather than a flow over time. The poorest households have few assets and often net debts, the richest have £ billions of assets. Wealth distribution is more unequal than income distribution.

Answer 19

Two variants of the Lorenz curve are common, one showing ‘market’ incomes before tax and benefits, the second adjusted to take account of what the government does. Some pre-tax income is normally lost to taxes both on income and expenditure. As a general rule, those with the highest incomes pay more, though tax avoidance changes this in some cases. Benefits such as state pensions and child benefit add a supplement to earned income. Normally, the poorest households have a net gain so higher incomes after taxes and benefits than beforehand. Those with highest incomes usually pay more tax than they receive in benefits.

Answer 20

The extent to which taxes and benefits redistribute income varies from country to country. Some countries favour higher taxes and benefits so more redistribution; others try to rely on market incentives, which keeps the two curves on the Lorenz diagram closer together.

Answer 21

Our main numerical indicator of the extent of inequality of income, the Gini coefficient, is based on the information in the Lorenz curve. A theoretical totally even income distribution would produce a straight diagonal line. The more uneven the distribution is, the further the line would bend away from the diagonal. The Gini approach uses this. The space between the diagonal and the Lorenz curve is first measured; next the share of that area in the total space under the diagonal is calculated.

Answer 22

Economic growth is a fairly straightforward concept, often measured as real GDP per person. It can be argued that GDP is not a good measure of growth; unequal income distributions sometimes lift the mean (arithmetic average) above the median income. But GDP per capita is accepted as a reasonable guide to the availability of material goods and services.

Answer 23

Economic development is a broader concept which attempts to take account of wider aspects of well-being for the bulk of a population. Whereas economic growth measures quantity of income, economic development brings in aspects of the quality of life. Attempts to measure the quality of life often use normative judgements and opinions, but there are measurable indicators in areas such as health, education and access to services such as electricity. Specifics such as doctors per thousand people, access to clean water or ownership of phones can also be measured. Some analysts add less specific concepts of personal freedom and justice to their view of development. Economic growth is especially important where there is absolute poverty. Concerns about wider development become more pressing once basic survival needs are met. Those who flee from a war zone, for example, first prioritise finding somewhere safe. As they rebuild their lives, growing attention is likely to be paid to the quality of life.

Answer 24

Since 1990, UN agencies have used the HDI to compare levels of development and to chart progress. The HDI is comparatively easy to calculate; its weakness is that it takes a rather narrow view. It has three equal components: ● Life expectancy at birth is taken as an indicator of health. ● Mean years of schooling for adults and expected years for children measure education. ● Average real income at purchasing power parity indicates the material standard of living. The trend in most countries is for the index to rise gradually over time, reflecting some progress in development. Telling people in Niger that their HDI ranks lowest has little value, though there could be some benefit in identifying which component requires most attention. There is value in identifying countries that have moved up the ranking most rapidly.

Answer 25

Many poorer economies are growing successfully now, in terms of GDP. But economic development actually requires sound government policies, the provision of public services and infrastructure and the rule of law, which can provide trust and security. All of these can, potentially reduce risks. All require government expenditure, so economic growth is extremely important to provide tax revenue that can be used to create good education and health care provision. Many economies achieve significant improvements by using their resources effectively, making good use of foreign aid, being open to FDI and being willing to collaborate at every level. Wars and serious political discord are perhaps the biggest enemies of development and corruption can slow down growth.

Answer 26

In the 1970s, the small Himalayan country of Bhutan introduced measurement of Gross National Happiness (GNH) which it sees as more significant than GDP. The emphasis on human well-being is combined with concern for the environment. Variants on GNH have since appeared. For example, the Happy Planet Index (HPI) multiplies a subjective measure of happiness by life expectancy and then divides this total by the ecological footprint per capita. This footprint measures the amount of land and sea needed to sustain production of the resources used and to absorb waste created. Costa Rica tops this index, along with other countries which are partly helped by needing little energy for heating. Heavy resource users are well down the rankings, with the USA at position 104, for example.

Answer 27

In 1970, the UN set a target: developed countries should spend 0.7% of their national income on aid. Only a handful of countries have consistently met this target. The UK set a legal requirement to meet it in 2015. The poorest economies may have under-exploited natural resources and plentiful supplies of labour, but limited skills, capital equipment and technology. Aid can be used to kick-start investment and capital accumulation, to transfer technology and to improve skills. Overall, aid has been of some value to developing countries, but less than donors and recipients might have hoped. In the period 1975-2000, some developing economies made rapid progress with relatively little aid. These countries were mainly in Asia. In other countries, mainly African, aid seemed to generate little real poverty reduction. An important book, ‘Dead Aid’, by Dambisa Moyo, chronicled reasons why aid might fail to reduce poverty. Reasons vary, for example: ● Aid in the form of loans rather than grants are repayable, often with interest. If aid is spent on unproductive or unsuccessful projects which generate little income, repayments will leave a country worse off than it started. ● Some governments used aid to buy arms; some took aid but could not supervise the projects on which it was spent, or did not spend it in the way intended. ● Some chose prestige projects such as expensive airports where demand for travel was low. ● Some donors pushed technologies which were inappropriate for the local infrastructure and needs of recipients. ● Many of the poorest countries are also highly indebted, with debt and interest payments cutting their capacity to tackle poverty.

Answer 28

In some communities, aid often happened to them rather than with them. The arrival of food supplies in an area of drought, for example, can give the impression that helping yourself by growing food is futile. Local farmers might find that demand and prices for their output drop if people have access to free food. Such situations can create a ‘dependency culture’ with little incentive for people to work at producing food themselves.

Answer 29

Large aid inflows have often been a magnet for corruption. There is limited scope to cream off revenue in a poor country from its very limited tax income. Aid can change this. As an example, ‘It’s Our Turn to Eat’, by Michela Wrong, describes how US aid to finance a better passport system in Kenya went astray. Despite lower priced competition from reputable international firms, ‘Anglo Leasing’ won a $34 million contract for new style passports. Anglo Leasing allegedly had no ability or intention to fulfil the contract and only existed to collect the payment. It is also alleged that some Kenyan government ministers and officials were involved in this deception.

Answer 30

Aid can: -Meet short run emergency needs -Increase capital stock -Improve infrastructure -Promote enterprise -Spread knowledge and technology But might: -Increase debt via loan repayments - Create a dependency culture -Attract corruption -Damage existing local firms - Tough aid terms can create problems

Answer 31

Many NGOs are formed specifically to help developing countries. The emergency relief work of Médicins Sans Frontières and the Red Cross, for example, saves lives and meets immediate needs at times of crisis. This is a valuable short term response for people who suddenly lose their homes and livelihoods. Oxfam and Save the Children similarly help in times of disaster but also target long term development, often working with local communities. Plan International, for example, places a heavy emphasis on education and working with children to promote long term development. Its ‘Because I am a girl’ project has more than 500 local programmes and hopes to develop role models, leaders and heroines for the future.

Answer 32

Aid has helped; the early experiences outlined above have created a learning curve. In 2000, United Nations members adopted eight millennium goals, such as eradicating extreme poverty and hunger and achieving universal primary education, setting an ambitious timetable. Progress has been made, though some targets have been missed. Numbers in extreme poverty halved between 1990 and 2015. At this point the millennium goals were reset with 17 new sustainable development goals. The first goal of these is to end poverty. There is no single way to achieve this goal. The UN has thousands of programmes, some small and some with global ambition. National governments, NGOs and individuals, including those living in poverty, can all make contributions to poverty reduction.

Answer 33

Carefully targeted aid can reduce poverty. Many developments can be facilitated by aid but others may grow without it. Possibilities include: ● WTO negotiations, trade liberalisation and FDI have increased the scope for emerging economies to increase export revenue, as shown by the Chinese experience. The subsidised and protected EU agricultural market could be opened to allow exports from African and other countries. South American farmers could gain from better access to US consumers. In current and future negotiations, developing economies will ask for fewer restrictions on exports of their agricultural and other primary products. Better access to rich markets could reduce poverty. ● Access to electricity for a majority of Africans is still a problem, despite the huge potential for renewables such as solar power. If this limitation is tackled, it will offer a major boost to development. Experience in India has shown how small scale generation projects can speed development. ● Benefits from mobile phones and the internet are already visible. Easier communication makes markets work better and mobile banking helps businesses. ● Crowdsourcing encourages small businesses and can provide an effective route out of poverty. But few financial institutions will lend to new entrepreneurs in developing countries. In Bangladesh, the Grameen Bank brought ‘microfinance’ loans where credit to fund small scale start-up businesses was not previously available. ● Trade barriers have been used by some governments to protect infant industries from overseas competition while they become established. However, Brazil’s protection for its computer industry resulted in higher prices and inferior technology for its computer users. ● Building up the quantity and quality of infrastructure can boost growth and economic development.

Answer 34

Political opinions do offer a range of ways to reduce poverty. Some believe that market forces promote efficiency and create an economic environment in which businesses will flourish and create jobs. Interventionists want much more active involvement on the part of government. Public provision of education and training, often free to consumers, can lift the skills level of workers. Managing the currency exchange rate can keep the price of exports attractively low. Trade barriers can be used to develop infant industries.

Answer 35

Building up the quantity and quality of infrastructure can boost growth and economic develop ment. China’s spectacular development was based on a strongly interventionist approach. However, interventionist policies can fail; they may make it easy for businesses to survive without becoming competitive.

Answer 36

Africa, with its rich natural resources, has become an increasingly important economic partner for China. Chinese FDI in Africa grew from $210 million in 2000 to $3.17 billion in 2011. China uses a blend of aid, direct investment, joint ventures and trade in its dealing with African countries. There is Western criticism of Chinese willingness to work with undemocratic regimes. However, there has been a clear contribution to poverty reduction. There is strong emphasis on infrastructure development, using ‘tied aid’ to favour Chinese construction businesses. One highly visible result is that dirt roads that made transport slow and uncertain have been replaced by properly surfaced roads. One consequence of this is that farmers can now easily reach markets in towns; another is that commuting has become easier. Previously isolated communities have become better integrated into their region. This has contributed to poverty reduction.

Answer 37

Where there is sound government, policies to target poverty reduction are influenced by the attitude to market forces. Where free markets are seen as most likely to promote growth and so increase well-being, promarket policies are more likely to be adopted. These can include trade liberalisation to give firms better access to foreign markets and allow imports into the home market, stimulating efficiency and allowing industries to expand. FDI and joint ventures can bring investment and hopefully growth. Making microfinance available can lead to more start-ups. Where there are wasteful public sector organisations, privatisation may bring better resource use. South Korea successfully followed a broadly market based approach. On the other hand, privatisations can lead to increased prices and have a negative impact on poverty. In practice, many governments use a mixture of intervention and market forces to get the results they want

Answer 38

Market based policies: -Trade liberalisation -FDI and joint ventures -Microfinance -Privatisation Interventionist policies: - Education and training -Infant industry protection - Managed exchange rate -Infrastructure improvement

Answer 39

Good governance can aid poverty reduction; the benefits of growth can be shared when governments promote practical measures, such as extending clean water supplies and educational provision. Corruption can cause funds for poverty reduction to be siphoned off towards individual pockets. Where there is armed conflict, GDP often falls, poverty increases and the poor are the most vulnerable.

Answer 40

If income and wealth are distributed very unequally, the high share of resources going to the wealthy will leave a relatively small share for those with least. The poorest households will live in relative poverty and perhaps absolute poverty. Their relative or absolute deprivation will disadvantage them in material terms. The poorest households fare badly on indicators such as life expectancy, educational attainment and obesity. It might be tempting to think that the converse of this is that households which have most in material terms will score well on all indicators of well-being, but this is not necessarily so.

Answer 41

Wilkinson and Pickett’s work suggests that many aspects of development depend more on the distribution of income and wealth than on GDP. A country with a lower GDP per head and less inequality might be more ‘developed’ than a richer country with greater inequality. Economic growth might not bring greater well-being if it is combined with increasing inequality. The data correlations in the study are statistically significant, despite the efforts of other researchers to question both methodology and findings. What the data cannot do is to point out precise causes of the results shown

Answer 42

The issue of trust is probably significant. Many towns and cities have ‘sink’ areas in which the poorest households are concentrated. Some of the richest households live in ‘gated communities’ from which non-residents are excluded. In these circumstances, social cohesion is likely to be weak. Contact between different groups will be limited, making mutual understanding and respect less probable. A relatively small and privileged elite might have little genuine understanding of others whose circumstances are very different, possibly feeling uneasy about them rather than empathy and trust. Households at the bottom of the scale can see the situation as unfair and might well become alienated, not just from the rich but also from institutions and organisations, such as the police, which maintain the status quo.

Answer 43

Children from the poorest households are likely to be less successful at school for a range of reasons including poorer health, lower expectations and less encouragement to study. When they are old enough to leave school, even low earnings can alleviate poverty a little. Carrying on with full-time education has both the opportunity cost of lost earnings and direct costs which can include tuition fees and repayable loans for living expenses. The prospect of debt from time spent studying is likely to be most daunting to those longing to escape from poverty. This results in long term losses for the individual and for society as part of the potential contribution of many able individuals is lost. Some young people overcome such disadvantages, triumphing over adversity. The combination of growing differences between social groups and falling potential to move away from deprivation might help to explain a shift to a more dysfunctional society. Those who feel trapped in absolute or relative poverty might come to see efforts to improve their situation as futile. At the other end of the scale, preserving personal advantage might seem more important than working towards a more equitable society. It would be an overstatement to see societies with a great deal of inequality as ‘profoundly sick’, but the evidence from Wilkinson and Pickett is that they function less effectively in terms of trust, physical and mental health, obesity, educational attainment, teenage births, violence, imprisonment and social mobility. The most unequal societies face greater problems in some important areas.

Answer 44

In an economy with an unequal distribution of income, there will be large groups of people with low incomes and periodically, many will be unemployed or underemployed. Competitive markets, which are generally good for consumers, require businesses to keep costs down and also to be flexible – adapting readily to change in the market place. Being able to draw on cheap labour can be regarded as advantageous. There are, however, some considerable disadvantages. Poorly paid employees do not necessarily have high productivity.

Answer 45

● People who have been poorly educated are liable to have limited skills and little optimism about their future; their commitment and motivation to work may be weak. ● People on low incomes tend to have more health problems; they may therefore be absent more often due to sickness. ● Fear of losing the limited job and income they have will lead some to be careful. As a generalisation, though, the enthusiasm and productivity of low paid and insecure workers can be low.

Answer 46

Some employers compound this situation by their treatment of employees. In a high staff turnover environment where people are working part-time or for short periods, the return on time and money spent training and developing workers is likely to be low. If employers come to expect that poor performance and productivity are inevitable with such staff, this can colour their attitude and approach. The working relationship can become mutually suspicious and is unlikely to be a happy and productive one. It may be more profitable to train employees properly, to regard them as potential assets and to pay them accordingly

Answer 47

For students zero-hours contracts can be a good way of combining study with earning and they may perform well. For others the insecurity of income is a problem but they see no alternative. Similarly, some of the 8.4 million people working part-time in the UK prefer a part-time job but others are underemployed and want to work full-time. Those on short-term contracts have little job security. From the employer’s perspective, zero hours, part-time work and short-term contracts offer flexibility at low cost, usually at or near the minimum wage.

Answer 48

Some people are trapped in unrewarding jobs with low productivity and pay, while employers are struggling to fill more attractive and better paid jobs. Many people don’t have the education, qualifications and training to move into areas such as engineering and nursing where there are serious staff shortages. The potential these people might have had as children has faded. Some problems with occupational mobility are inevitable. However, it is likely that inequality partly explains why some workers get stuck in unskilled jobs and cannot acquire skills which are in short supply. Lack of timely training can mean that top skilled jobs are done less well by people with less innate potential. This can damage the performance of firms.

Answer 49

If income and expenditure are lower than predicted, there will be less revenue from direct taxes such as income tax and indirect taxes such as VAT. A government that prioritises debt reduction will cut public spending (e.g. on benefits) or raise taxes. Both will cut disposable income, consumption and aggregate demand. At a time of ‘austerity’, there can also be a temptation to reduce public sector investment in infrastructure. In the short run this reduces investment, an injection to the circular flow of money. In the long run it can hold back productivity and growth, for example by congestion and transport delays or by waiting lists for medical treatments. Another of the arguments made by Stiglitz is that the small minority at the top of the income distribution gain power and influence over key decision makers, lobbying to get their views heard. Decisions may reflect their narrow interests, creating market failures affecting the whole community.

Answer 50

An OECD study suggests that increasing inequalities reduce the incentives for the bottom 40% of income earners to invest in their own education and training. Over time, this reduces the human capital of the working population and causes slower economic growth. Number crunching suggested that “rising inequality by three Gini points would drag down economic growth by 0.35% per year for 25 years.” The OECD suggests that the best way to increase the incomes of the poorest 40% is to increase welfare benefits and improve “access to high-quality education, training and health care… Strategies to foster skills development must include improved job-related training and education for the low skilled over their whole working lives.” This would improve the supply of skilled labour, raising incomes for the individuals involved whilst also boosting productivity and growth for the entire economy. Many of the arguments linking greater inequality with slower development and poorer economic performance are theoretical. There are also contrasting theoretical arguments that lower taxes on top earners will improve incentives and so lead to faster growth. It is important to test hypothetical (theoretical) arguments against empirical evidence. The evidence is increasingly clear. The OECD analysis found, for example, a “negative and statistically significant” correlation between income inequality and economic growth.

Answer 51

We can measure flows over a period of time. Rainfall and income are two examples of this. To say that there were four centimetres of rain means very little without a time period. Four centimetres in a day is exceptional in Britain. Four centimetres in a year is more likely in desert regions. Similarly, saying someone has an income of £10 means little without a time period. A Bangladeshi garment worker might earn £10 per week, a top banker or CEO might be paid £10 per minute. In recording floods, we tend to look at the high water mark. We call this a stock measure because it refers to the amount of water at one time, in this case the peak flood level. Wealth is a stock measure of the assets people own at any given time. Whilst it would be hard to survive with no income, there are households with negative wealth because they have more debts than assets. Early in 2016, Oxfam claimed that the richest 62 people in the world had as much wealth as the poorer half of the global population.

Answer 52

Most income is received as earnings, but it can be supplemented by receipt of benefits and services for which there is no direct charge. So most households receive education and medical services from the public sector. Since the recession, record numbers of households have depended on food banks to maintain adequate nourishment.

Answer 53

Earnings can either be counted gross, before any deductions, or net to see ‘take home pay’, which is the amount actually received. Many taxpayers resent the income tax and other deductions which can take net pay well below their gross earnings. Only rarely do they consider the benefit of payments and services which add to their household’s well-being. It can come as a surprise that the average household receives more in benefits and services than it pays in taxes, as shown.

Answer 54

If we divide people into quintile groups according to incomes, the amount paid in direct taxes rises relatively steeply as we move up through income levels. The amount of indirect tax also rises with income but less steeply. Cash benefits are significantly lower for the top two quintile groups but benefits in kind are more evenly distributed.

Answer 55

Original -> (+Cash benefits) -> Gross Income -> (- Direct taxes, National Insurance and local taxes) -> Disposable income -> (- Indirect taxes) -> post-tax income -> (+ Benefits in kind e.g. health and education) -> Final income.

Answer 56

Taxes can be regressive, proportional or progressive, depending on the share of each income they take. Taxes on tobacco are regressive for two reasons. Firstly, there is a higher proportion of smokers in the bottom quintile so more people in that group pay the duty on tobacco. Secondly, if a smoker with £10,000 per year and a smoker on £100,000 a year both pay £1,000 a year in duty, that will take 10% of the lower income but only 1% of the higher income. Some US states have a proportional income tax, but examples of proportional taxation are relatively rare. UK income tax is structured to be progressive. A personal allowance is tax free, so everyone with incomes below this allowance pays no income tax. In the 2016 budget, the personal allowance for the 2017-18 tax year was set at £11,500 for most people. Income between £11,500 and £45,000 is taxed at the standard rate of 20%. Beyond £45,000 the marginal rate is a higher rate of 40%. Earnings above £150,000 have a 45% marginal tax rate. The average rate paid by taxpayers is lower than their marginal rate. For example, an income of £100,000 would have £11,500 tax free, £33,500 at 20% (= £6,700 tax) and £55,000 at 40% (= £22,000). Total tax would be £27,700 so 27.7% of income. This tax is progressive as someone with income at £10,000 pays nothing, someone with £40,000 pays 20% of £28,500 (= £5,700) so 14.25%.

Answer 57

The analysis of income tax above assumes that people make an honest tax declaration. In practice, many people structure their incomes to avoid tax. Wealthy investor Warren Buffet benefits from a lower tax rate on income from investments, like many of the richest. Some years ago, he said his cleaner was paying tax at a higher tax rate than he was. This is because he makes most of his money from capital gains (rising share prices), which are taxed at a lower rate than dividends in the US. He now campaigns for capital gains tax to be levied at a higher rate. But he is a remarkably honest person.

Answer 58

Some individuals on the highest incomes buy specialist help to exploit similar loopholes. Many MNCs also avoid tax in varied ways, often using transfer pricing strategies (see page 62). Some top earners are tax exiles, spending most of the year abroad in order to avoid UK income tax. Most government Budgets include an estimate for extra revenue from clamping down on tax evasion and avoidance, but the extra revenue actually collected is often well below the budget target. Tax avoidance and evasion strategies deliberately seek to reduce the amount of income redistribution that takes place. The loss of tax revenue often leaves governments with insufficient funds to maintain public services and pay benefits to disabled and unemployed people. Few taxpayers consider the detrimental effects this has on people in need.

Answer 59

A household with no income would struggle to survive. Living without wealth is more feasible. Some households live in rented, furnished accommodation. Their assets might amount to little more than some clothes (part worn) and a few other items. Debts could mean that such households have negative wealth overall. At the opposite end of the scale, wealthy households with property, shares and other assets benefit from unearned income from profits and rents, plus increases in asset values that provide capital gains over time. Between these two extremes, many homeowners have acquired wealth from rising house prices. (This capital gain is not taxed because people need a place to live.)

Answer 60

Mortgages slowly bring home-buyers ownership as repayments are made. Their equity (share of ownership) increases faster when house prices rise. Those who have lucrative pension funds have a second source of wealth. The age at which people buy their first house in the UK has been rising recently and the proportion of households renting has risen. Rising house prices and tougher mortgage conditions have increased the deposit needed for a mortgage. Also, many people have heavy student debts to repay, reducing their ability to save for a deposit.

Answer 61

Some taxes on earnings from wealth have been cut, allowing the wealthy to become wealthier. Some wealth is redistributed via inheritance tax, currently on estates above £325,000 for a single person and £650,000 for a married couple. This tax is unpopular with the wealthy and avoidance schemes are common. 2014 ONS data showed the distribution of wealth becoming less even.

Answer 62

At the time of writing, the UK is in a transitional phase to a new ‘universal credit’ system. A complex web of benefit payments, such as job seekers allowance, working families’ tax credits and housing benefit, are to be absorbed into the single universal credit. There are positive claims about simplicity and fairness but also deep suspicions about this reform in different quarters. Further adjustments to the new scheme are likely as it is rolled out. Universal credit is ‘means tested’ so will go to households below set incomes. Some benefits have been paid to all households, (such as state pensions and formerly child benefit,) but now the benefits system mainly targets poverty reduction by helping those most in need. All households benefit from public sector provision, from roads and street lighting to the police and libraries. Education and the Health Service are available for all, though some households prefer to use private sector provision. Low income households depend more heavily on public sector services, which make a useful contribution to their quality of life.

Answer 63

The tax and benefit system is said to risk disincentive effects on both top earners and the low paid. ● Some politicians argue that high marginal tax rates discourage able people from working. However, data on top earners’ responses to rising tax rates do not suggest that they work less. Some people have a target lifestyle. Behavioural economists say that those who want posh cars, private swimming pools and similar luxuries will earn enough to pay for them. If their tax rate rises, they might work harder to get what they want. The evidence on this is mixed. Sweden and Finland have marginal rates around 60% for top earners, yet their economies perform as well as most and the holders of their top jobs don’t noticeably underperform their peers in other countries. On the other hand, a few top global performers such as racing drivers have moved their home base away from the UK to lower tax locations such as Monaco.

Answer 64

● For the lowest earners, there is the risk of a poverty trap. Many benefits are means tested so earning more can cut benefit entitlement whilst also bringing liability to income tax. Combining these two factors could mean that working an extra day for £60 leaves the worker just, say, £20 better off; then extras such as transport to work can add more costs. There will be a temptation not to bother working. In the past the poverty trap meant that some people were actually worse off working than unemployed. The working families’ tax credit ensured that this could not happen. However, benefit cuts currently under discussion could bring a return of the poverty trap if politicians do not take care to maintain incentives. ● Some people build their identity and self-respect through work. Others see a low paid job as a stepping stone to a better future. They may be motivated to work even for very low pay. Many unemployed people are desperate to work. Many job adverts attract hundreds or thousands of applicants. On the other hand, some people do give up trying for work and become voluntarily unemployed. There has never been firm evidence of large numbers in this position. There is also a minority of benefit cheats, who work whilst claiming they have no income. There are complex ethical issues here. It would be wrong to punish the honest unemployed (and their children) by setting benefits too low for anyone to choose voluntary unemployment or bother to cheat the system. The move from the national minimum wage to a higher living wage has at least two advantages. A higher living wage creates an incentive to work; voluntary unemployment becomes less attractive. Higher pay may reduce some households’ need for benefits (and their entitlement). This is expected to reduce public expenditure. At the same time though, some of those who gain extra income from the living wage are second earners in reasonably well-off households. If the higher wage increases unemployment, some households will lose out.