1.7.3 Government policies to alleviate poverty and to influence the distribution of income and wealth (A-level only)

Redistribution Aims at a Fairer Spread of Income and Wealth

1. Redistribution aims to reduce poverty and inequality and to achieve a fairer distribution.
2. Governments use several policy tools to do this.
3. Each changes the distribution of income or wealth in a different way.

Tax, Transfers, a Wage Floor and State Provision Redistribute

1. Progressive taxation takes a larger share from higher earners.
2. Transfer payments move money to those on low incomes.
3. A minimum or living wage and state provision of health and education also help.

Each Policy Shifts the Distribution in a Different Way

1. Progressive tax narrows the gap in post-tax income.
2. Transfers and a wage floor lift incomes at the bottom.
3. State provision raises the real living standards of the poorest.

UK Application: Redistribution in Practice

1. UK income tax is progressive, with marginal rates of $20\%$, $40\%$ and $45\%$ applied to successive income bands and administered by HMRC.
2. The National Living Wage sets a wage floor for adult workers, rising each April to lift pay at the bottom of the labour market.
3. Universal Credit combines several means-tested benefits into a single transfer payment for low-income and unemployed households.
4. Together, taxes and benefits are estimated to reduce the UK's income Gini coefficient from around $0.5$ before taxes and benefits to around $0.35$ afterwards.

Redistribution Faces an Equity and Efficiency Trade-off

1. Redistributive policies face a tension between equity and efficiency.
2. Progressive taxes and generous benefits reduce inequality.
3. But they can blunt incentives to work, save and take risks.

High Taxes and Generous Benefits Are Where the Costs Come From

1. High taxes can encourage tax avoidance or emigration of high earners.
2. Generous benefits can weaken the incentive to work.
3. The Laffer curve shows that very high tax rates can even reduce revenue.

Worked Example: Illustrating the Laffer Curve

1. Suppose £100\pounds 100£100 billion of income is taxed at $45\%$, raising 45%×£100bn=£45bn45\% \times \pounds 100\text{bn} = \pounds 45\text{bn}45%×£100bn=£45bn in revenue.
2. The government raises the rate to $60\%$, but avoidance, reduced hours and emigration shrink the taxable income to £70\pounds 70£70 billion.
3. Revenue at the new rate is 60%×£70bn=£42bn60\% \times \pounds 70\text{bn} = \pounds 42\text{bn}60%×£70bn=£42bn, which is less than the original £45bn\pounds 45\text{bn}£45bn despite the higher rate.

The Right Level of Redistribution Depends on How Large Incentive Effects Are

1. Too little redistribution leaves poverty and can harm cohesion and growth.
2. Too much can blunt incentives and shrink the tax base.
3. The right level depends on how large these incentive effects really are.
4. On balance, some redistribution is justified on both equity and efficiency grounds, but pushed too far it becomes self-defeating, so governments face a genuine trade-off.

Weigh the Fall in Inequality Against the Cost to Incentives