Welcome to Poverty & Policy: Fixing Inequality!

Hello Economists! This chapter is incredibly important because it moves us from simply measuring inequality (like using the Gini coefficient) to actively discussing what governments actually do about it. Think of yourself as an economic doctor: you've diagnosed the illness (poverty and inequality), and now you need to understand the treatments (government policies).

These notes break down the main tools governments use to redistribute income and wealth, assess their effectiveness, and help you understand the tricky moral and political debates surrounding them.

Section 1: Fiscal Policies for Income Redistribution

The most direct way a government influences the distribution of income is through its budget: taxing certain groups and spending that money on others. This is often called using the fiscal mechanism for redistribution.

1.1 Taxation Policies (Taking from the wealthy)

Governments use different types of taxes, but the goal of redistribution often relies on Progressive Taxation.

  • Definition: A progressive tax system means the proportion of income paid in tax increases as income rises.
    (Example: Income Tax. If you earn $10,000, you might pay 10%. If you earn $100,000, you might pay 30%.)
  • Impact on Distribution: This directly reduces the disposable income gap between the rich and the poor, making the distribution of income more equal (lowering the Gini coefficient).
  • Contrast: A Regressive Tax (like Value Added Tax or Sales Tax) takes a larger percentage of income from the poor than the rich. While not used for redistribution, governments may lower regressive taxes to help the poorest alleviate poverty, though this is rare.

Quick Review: Progressive Tax Trick

If the tax rate progresses (goes up) as income goes up, it’s progressive! This is the primary tool for reducing income inequality.

1.2 Transfer Payments (Giving to the poor)

Transfer Payments are benefits paid to individuals, usually low-income households, for which no good or service is directly provided in return. These are vital for alleviating absolute poverty (the inability to afford basic necessities).

  • Types of Transfers:
    • Means-Tested Benefits: Payments that only go to individuals/families whose income/wealth is below a certain level. (Example: Unemployment benefits, Housing support.) These are highly targeted at poverty.
    • Universal Benefits: Payments made to everyone regardless of income. (Example: State pensions, some child benefits.) These are less effective at *targeting* poverty but avoid issues of stigma and complex paperwork.
  • How they Alleviate Poverty: They act as a crucial safety net, ensuring that even those without earned income have basic purchasing power, increasing their real disposable income.
Did you know?

Transfer payments fund a lot of consumption! By boosting the spending power of the poorest, they can also act as an automatic stabiliser during recessions, preventing aggregate demand from falling too sharply.

Section 2: Policies Targeting Labour Markets and Opportunity

Poverty is often caused by low earnings or lack of access to good jobs. Governments use market interventions and supply-side policies to influence the opportunities available.

2.1 Minimum Wage Laws

A National Minimum Wage (NMW) is a price floor set above the equilibrium wage in the low-skill labour market.

  • Mechanism: Directly raises the income of the lowest-paid workers, helping to move workers out of relative poverty and absolute poverty.
  • Consequence/Trade-off: While it helps those who remain employed, setting the minimum wage too high can lead to job losses (a surplus of labour/unemployment), as firms cut costs or substitute labour with capital.

2.2 Investing in Human Capital (Supply-Side Policies)

These policies address the root causes of low earnings by boosting productivity and skill levels, improving the long-term distribution of income.

  • Education and Training: Government spending on schools, vocational training, and further education increases the human capital of the workforce. This allows individuals to secure higher-skilled, better-paid jobs, naturally increasing their income.
  • Healthcare and Infrastructure: A healthy population is a productive one. Investment in healthcare reduces sick days and increases longevity. Better transport infrastructure (roads, broadband) improves factor mobility and access to jobs.

Key Takeaway for Sections 1 & 2

Fiscal policies (Tax and Transfers) are quick fixes for income inequality and absolute poverty. Supply-side policies (Education/NMW) are slower, but tackle the structural causes of low earnings and boost the potential future income of the poor.

Section 3: Policies Targeting Wealth Distribution

Remember the difference between income (a flow, like monthly salary) and wealth (a stock, like assets accumulated). Wealth is often much more unequally distributed than income.

3.1 Wealth and Inheritance Taxes

The greatest source of wealth inequality is often inherited wealth.

  • Inheritance Tax (or Estate Tax): A tax levied on the value of assets transferred from a deceased person to their heirs.
    • Goal: Breaks the cycle of intergenerational wealth inequality, allowing more equality of opportunity for those born into poorer families.
  • Property/Land Taxes: Taxes on the value of property owned.
    • Goal: These are typically progressive as wealthier individuals own more valuable property, helping to reduce disparities in wealth holdings.

Common Consequence to Evaluate

Heavy wealth taxes can be highly unpopular and lead to tax avoidance or tax emigration (wealthy people moving assets or themselves overseas). This reduces the tax base and limits the government's ability to fund redistribution.

Section 4: Consequences, Trade-offs, and Perspectives (The Evaluation!)

When evaluating policies, you must consider the economic consequences and the moral and political perspectives involved (as required by the syllabus).

4.1 Economic Consequences and the Efficiency vs. Equity Trade-off

Redistribution often creates a fundamental tension: governments aim for greater equity (fairness) but risk reducing economic efficiency (getting the maximum output from resources).

1. Disincentives to Work and Invest (The Leakage)

  • For the High Earners (Tax): Very high marginal tax rates on income or wealth can reduce the incentive for entrepreneurs to work hard, take risks, or invest, leading to lower economic growth. (If the government takes 70% of any extra money I earn, why bother working overtime?)
  • For the Low Earners (Benefits): If the benefits received are withdrawn too quickly as a person earns more income, they face a high effective marginal tax rate. This is known as the poverty trap and discourages them from leaving welfare and entering low-paid jobs.

2. Cost and Administration

  • Policies like means-tested benefits require large government bureaucracy to assess eligibility, which incurs high administrative costs. Sometimes, the cost of running the policy outweighs the benefit received.

4.2 Moral and Political Perspectives

Don't worry if this seems tricky at first—this requires using your judgment! Remember: whether a distribution is considered 'fair' is a value judgment.

The debate hinges on the distinction between equality and equity:

Equality: Everyone receives the exact same amount (equal outcomes).
Equity: Everyone has fair access to resources and opportunity (fair process).

Arguments for Redistribution (Moral Case):

  • Social Justice: Many argue that in a moral society, basic needs (housing, healthcare, food) are a right, not a privilege, and the market often fails to provide these fairly.
  • Reducing Market Failure: Extreme inequality itself is a form of market failure (Syllabus 3.1.5.6). Redistribution corrects this misallocation by ensuring resources are directed towards essential goods and services consumed by the poor.

Arguments Against Excessive Redistribution (Political Case):

  • Deserved Income: Some political views hold that individuals have a right to the wealth they earn through hard work and enterprise, and high taxation is akin to theft.
  • Meritocracy: Excessive government intervention might undermine a meritocracy—a society where success is determined by merit and effort, not state handouts. Policies might create dependency.

Evaluation Summary: The Big Policy Question

The best approach usually involves a mixed strategy:


1. Use Progressive Taxes/Transfers to immediately tackle absolute poverty and provide a safety net (short-run).
2. Focus long-term investment on Education and Skills (human capital) to increase earning power and promote equality of opportunity, which is often seen as more politically equitable than aiming for equality of outcome.

Always conclude your analysis by weighing up the policy's effectiveness in reducing inequality against its potential negative impacts on economic efficiency and incentives.