Government Intervention to Redistribute Income | Edexcel IGCSE Economics Revision Notes 2017 (2024)

Revision Note

Methods to Redistribute Income

Government intervention aims to reduce inequality and poverty through:
- Progressive taxation
- Using benefit payments to increase income of the poorest households
- Investing in education and healthcare
Some countries have a stronger focus on the redistribution of income than others
- E.g Nordic countries like Norway and Sweden focus on taxing higher income earners, providing benefits payments and investing into education and healthcare, leading to lower inequality and poverty
The aim of governments is not to have an equal distribution of income but rather a more fair or equitable distribution of income
A blend of policies is the most effective way to tackle poverty and inequality

Progressive Taxation

Tax systems can be classified as progressive or regressive
A progressive tax system redistributes income from those with higher income to those with lower income
- As income rises, a larger percentage of income is paid in tax (called the marginal tax rate)
Most countries have a mix of progressive (direct taxation) and regressive (indirect taxation) taxes in place
The benefits of a good progressive tax system are sometimes lost to society because the high number of regressive (indirect) taxes worsens income inequality
- E.g High VAT rate

An explanation of tax systems

System	Explanation
Progressive	As income rises, a larger percentage of income is paid in tax In the diagram, when personal income rises from Y₁ to Y2, the tax rate rises from TR₁ to TR₂
Regressive	As income rises, a smaller percentage of income is paid in tax In the diagram, when personal income rises from Y₁ to Y2, the tax rate falls from TR₁ to TR₂ All indirect taxes are regressive In the USA, Federal income tax is progressive but almost all State taxes are regressive (the bottom 20% of income earners pay as much as 6x the percentage of their income as the top 20%)

System

Explanation

Progressive

As income rises, a larger percentage of income is paid in tax
In the diagram, when personal income rises from Y₁ to Y2, the tax rate rises from TR₁ to TR₂

Regressive

As income rises, a smaller percentage of income is paid in tax
In the diagram, when personal income rises from Y₁ to Y2, the tax rate falls from TR₁ to TR₂
All indirect taxes are regressive
In the USA, Federal income tax is progressive but almost all State taxes are regressive (the bottom 20% of income earners pay as much as 6x the percentage of their income as the top 20%)

Progressive tax systems are built around the idea of marginal tax rates
- The calculation of an individual's personal income tax requires severalcalculations
- Using this system, a salary of £60,000 would attract a tax bill of £11,500, calculated as follows:

Calculating a tax bill using the UK progressive tax rates from 2022

Tax Band	Taxable Income	Tax Rate	Tax Paid on £60,000
Personal Allowance	Up to £12,500	0%
Basic Rate	£12,500 to £50,000	20%	£37, 500 at 20% = £7,500
Higher Rate	£50,00 to £150,000	40%	£10,000 at 40% = £4,000
Additional Rate	Over £150,000	45%
Total Tax Paid on £60,000			£7,500 + £4,000 = £11,500

Once the tax revenue is received by the government, redistribution often starts with the provision of free education and healthcare
Many governments use tax revenues to provide multiple levels of financial support to poor households, including disability payments, heating subsidies, travel subsidies, etc

An evaluation of progressive taxes

Advantage	Disadvantage
Reduces income inequality Higher earners pay a larger percentage of their income, which can help reduce the gap between rich and poor Increases revenue for public services Can generate more revenue for essential public services like education, healthcare, and infrastructure Fairness perception People with higher incomes have a greater ability to pay, so progressive taxes are often seen as fairer	Potential disincentive to work High taxes on higher incomes may discourage people from working harder or longer Complexity and compliance costs Progressive tax systems can be complicated and expensive to administer Tax avoidance and evasion High-income individuals may seek to exploit loopholes or move their money to lower-tax jurisdictions, reducing the effectiveness of the tax system Impact on investment Progressive taxes on capital gains and dividends can deter investment, which might slow economic growth and innovation

Worked Example

The table below shows rates of taxation for country X

Income ($ per year)	Rate of Income Tax
1–10,000	5%
10,001–18,000	10%
18,001–35,000	20%
35,001 and over	30%

This is an example of what type of taxation system?

A. Sales tax
B. Corporation tax
C. Progressive tax
D. Indirect tax

Answer: C. Progressive tax
The table shows that as income rises, a larger percentage of income is paid in tax

A is incorrect as sales tax is one specific figure e.g. 20%

B is incorrect, as corporation tax is one specific figure, e.g. 17%

D is incorrect as an indirect tax is one specific figure, e.g.VAT of 20%

Benefit Payments

Benefit payments are usually given to the poorest and most vulnerable in society
- They include unemployment and disability payments, pension payments, heating discounts, public transport subsidies, child benefits, etc
- E.g In Denmark, social welfare is high compared to other countries. Income is transferred to low income households through unemployment benefits and housing assistance

An evaluation of benefit payments

Advantages	Disadvantages
Benefit payments reduce inequality and poverty by directly transferring income to households with low incomes Benefit payments enable households with low incomes to afford basic necessities such as food and shelter. This reduces poverty Child benefit payments can empower mothers to re-enter the workforce	High levels of benefit payments can act as a disincentive to work E.g Some European countries with high social welfare payments may be less motivated to actively seek employment Many families may become dependent on benefit payments There is a high opportunity cost of spending on benefit payments Benefit payments may be perceived as unfair by households that do not qualify for such assistance The need to pay benefits may create a high burden of taxation on the working population

Advantages

Disadvantages

Benefit payments reduce inequality and poverty by directly transferring income to households with low incomes
Benefit payments enable households with low incomes to afford basic necessities such as food and shelter. This reduces poverty
Child benefit payments can empower mothers to re-enter the workforce

High levels of benefit payments can act as a disincentive to work
- E.g Some European countries with high social welfare payments may be less motivated to actively seek employment
Many families may become dependent on benefit payments
There is a high opportunity cost of spending on benefit payments
Benefit payments may be perceived as unfair by households that do not qualify for such assistance
The need to pay benefits may create a high burden of taxation on the working population

Investment in Education and Healthcare

Investing in education and healthcare is a supply-side policy
- It increases the potential output of the country (shifts the production possibility frontier outwards)
- Education helps to reduce inequality and poverty by providing individuals with the necessary skills and knowledge to access better employment opportunities
- Healthcare leads to a healthier workforce that is more productive

An evaluation of investment in education and healthcare

Advantages	Disadvantages
Higher levels of education and healthcare contribute to increased human capital and greater productivity This leads to higher output and, as a result, higher levels of income Higher levels of education facilitate greater occupational mobility By acquiring skills needed for jobs, individuals can break the poverty cycle and contribute to economic growth	There is a high cost and an opportunity cost of spending on education and health care There is a time lag involved between investing in education and healthcare and seeing the future benefits A blend of policies (investment in education and benefit payments) may be the most effective way to tackle poverty and inequality

Exam Tip

In paper 2, you will often be asked to evaluate how progressive taxes, benefit payments or investment in education and healthcare will impact inequality or poverty in a given scenario.

Make sure you have a balanced argument and consider the impact on multiple stakeholders (high- and low-income households, producers and government). Also, consider that a blend of policies may be the most effective way to tackle poverty and inequality