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Inequality and the

Redistribution of Income
Inequality and the Redistribution of Income

Inequality and Poverty


INEQUALITY AND POVERTY

■ Types of inequality
✜ size distribution of income
✜ functional distribution of income

✜ distribution of income by recipient


✜ distribution of wealth

✜ poverty: absolute and relative


■ Measuring the size distribution of
income
✜ Lorenz curves
Lorenz curve
100

80
national income (cumulative)
Percentage share of

Line of complete
equality
60

40

20

O
O 20 40 60 80 100
Percentage of population
Lorenz curve
100

80
national income (cumulative)
Percentage share of

Line of complete
equality
60

40

20 Lorenz curve

O
O 20 40 60 80 100
Percentage of population
INEQUALITY AND POVERTY

■ Types of inequality
✜ size distribution of income
✜ functional distribution of income
✜ distribution of income by recipient
✜ distribution of wealth
✜ poverty: absolute and relative

■ Measuring the size distribution of


income
✜ Lorenz curves
✜ Gini coefficients
Lorenz curve and Gini coefficient
100

Gini coefficient = A / (A + B)
80
national income (cumulative)
Percentage share of

Line of complete
equality
60

A
40
B
20 Lorenz curve

O
O 20 40 60 80 100
Percentage of population
Lorenz curve: UK households’ pre-tax incomes: 2000/1
100

80
national income (cumulative)
Percentage share of

60

40

x
24.6
20 Lorenz curve

O
O 20 40 5 60 80 100
0
Percentage of population
Lorenz curves for two countries with the same Gini coefficient
100

80
national income (cumulative)

Area X = area Y
Percentage share of

60 Y

40

Country B

20
X
Country A
O
O 20 40 60 80 100
Percentage of population
INEQUALITY AND POVERTY

■ Types of inequality
✜ size distribution of income
✜ functional distribution of income
✜ distribution of income by recipient
✜ distribution of wealth
✜ poverty: absolute and relative
■ Measuring the size distribution of income
✜ Lorenz curves
✜ Gini coefficients
✜ ratios of shares of quantile groups
Ratio of income shares of bottom 40% to top 20%
of households (after taxes and benefits)
INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
Size distribution of UK income by
quintile group of households: 2000/1

Bottom
20%
Next 20%
2%
7%
Middle
20%
15%
Top 51%
20%

25%

Next 20%

Income before
taxes and benefits
Size distribution of UK income by
quintile group of households: 2000/1

Bottom Bottom
20% 20%
Next 20% Top
2% 6%
7%
20% Next 20%
11%
Middle
20%
15% 45%
Top 51%
20% 16%

Middle
20%
25%
22%
Next 20%

Next 20%

Income before Income after


taxes and benefits taxes and benefits
Percentage shares of income before and after tax
by decile group of households: 2000/1

30
26.8
25
% of income

20
In c o m e b e fo r e ta
15.7
15 12.9
11.1
10 9.0
7.6
6.0
4.7
5

0 Source: Economic Trends (ONS, April 2002)


Percentage shares of income before and after tax
by decile group of households: 2000/1

30
26.825.8
25
In c o m e b e fo r e ta
% of income

20 In c o m e a fte r ta x
15.715.2
15 12.912.6
11.110.9
10 9.0 9.1
7.6 7.8
6.0 6.3
4.7 5.2
5

0 Source: Economic Trends (ONS, April 2002)


INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
Sources of UK household income as a
percentage of gross household income
Wages and salaries Income from self employment Investment income

Pensions, annuities Social security benefits Other

1%
2% 10%
4%

6%

77%

1975
Source: Family Spending (ONS, 2002)
Sources of UK household income as a
percentage of gross household income
Wages and salaries Income from self employment Investment income

Pensions, annuities Social security benefits Other

1% 1%
2% 10%
12%
4%
7%
6%
4%

9%
77% 67%

1975 2000/1
Source: Family Spending (ONS, 2002)
INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
✦ by occupation
Average gross weekly earnings of UK
full-time adult male employees: 2001
INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
✦ by occupation

✜ inequality by person/household type


INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
✦ by occupation

✜ inequality by person/household type


✦ household composition
Weekly income for different types of UK households:
2000/1
£700

£600 Gross income

£500

£400

£300

£200

One adult One adult, two or One man, one woman Two adults, four
£100 (not retired) more children (not retired) or more children
Source: Family spending (ONS,2002)
Weekly income for different types of UK households:
2000/1
£700

Gross income
£600
Disposable income

£500

£400

£300

£200

One adult One adult, two or One man, one woman Two adults, four
£100 (not retired) more children (not retired) or more children
Source: Family spending (ONS,2002)
INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
✦ by occupation

✜ inequality by person/household type


✦ household composition
✦ sex
Average gross weekly earnings of
UK full-time adult female employees: 2001

Medical practitioners

Financial managers

Personnel managers

Secondary teachers

Police officers

Nurses

Secretaries

Clerks

Sales assistants
Average gross weekly earnings of
UK full-time adult employees: 2001

Financial managers

Medical practioners

Personnel managers

Secondary teachers

Nurses
Women's
Factory lineworkers
Men's ear
Clerks

Sales assistants
INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
✦ by occupation

✜ inequality by person/household type


✦ household composition
✦ sex
✦ ethnic group
INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
✦ by occupation

✜ inequality by person/household type


✦ household composition
✦ sex
✦ ethnic group
✦ location
Gross weekly household income:
Selected UK regions: 2000/1
£650

£600

£550

£500

£450
West Midlands

UK (average)
£400

South-East
North-East
N. Ireland

Scotland

London
£350

£300

Source: Family spending (ONS,2002)


INEQUALITY AND POVERTY

■ Distribution in the UK
✜ size distribution
✜ functional
✦ by source
✦ by occupation

✜ inequality by person/household type


✦ household composition
✦ sex
✦ ethnic group
✦ location

✜ distribution of wealth
Composition of UK wealth
Stocks and shares Notes, coin and deposits with banks, etc.
Dwellings (net of
Tenancy rights Other fixed assets
mortgage debt)

Life assurance and pension funds Other financial assets (net of liabilities)

15%
– 6%
26%

23%

23%
12%
7%

1971
Composition of UK wealth
Stocks and shares Notes, coin and deposits with banks, etc.
Dwellings (net of
Tenancy rights Other fixed assets
mortgage debt)

Life assurance and pension funds Other financial assets (net of liabilities)
1%

15%
– 6% 16%
26%
35%

23% 14%

23% 5%
12% 26% 3%
7%

1971 2000
INEQUALITY AND POVERTY

■ The causes of inequality


✜ inequality of wealth
✜ differences in workers’
✦ ability;qualifications
✦ attitudes
✦ hours worked
✦ economic power
✦ qualifications
✜ differences in demand for goods
✜ differences in household composition
✜ discrimination
✜ degree of government support
✜ unemployment
■ Government attitudes towards inequality
Inequality and the Redistribution of Income

Taxes and Benefits


TAXES AND BENEFITS

■ Role of taxes and benefits


✜ redistribution of income
✜ achievement of social efficiency
✜ macroeconomic management
■ Requirements of a good tax system
■ Types of tax
✜ direct taxes
✜ indirect taxes
Balance of taxation in different countries
TAXES AND BENEFITS

■ Taxes and the redistribution of income


✜ progressive taxes
✜ regressive taxes
(including lump-sum taxes)
✜ proportional taxes
Different types of tax: (a) total tax paid
Progressive

Regressive
Total tax paid (T)

Proportional

Lump-sum

O
Total income (Y)
Different types of tax: (b) average tax paid
Progressive
Average tax paid (T/Y)

Proportional

Regressive

Lump-sum

O
Total income (Y)
TAXES AND BENEFITS

■ Taxes and the redistribution of income


✜ progressive taxes
✜ regressive taxes
(including lump-sum taxes)
✜ proportional taxes
■ UK taxes and the redistribution of
incomes
✜ direct taxes
UK marginal income tax and
national insurance rates: 2002/3
UK marginal income tax and
national insurance rates: 2002/3
UK marginal income tax and
national insurance rates: 2002/3
UK average income tax plus
national insurance rates: 2002/3
UK average and marginal rates of income tax for
a single person: 2002/3

Marginal
rate
40
Tax rate (%)

22

10

O 4615 6535 34 515


(= 4615 + 29 900)
Individual’s pre-tax income (£)
UK average and marginal rates of income tax for
a single person: 2002/3

Marginal
rate
40
Tax rate (%)

22
Average
rate

10

O 4615 6535 34 515


(= 4615 + 29 900)
Individual’s pre-tax income (£)
UK average and marginal rates of
income tax plus NIC: 2002/3

Marginal
rate
40
Tax rate (%)

32

22
20

O 4535 6415 29 900 33 935


Individual’s pre-tax annual income (£)
UK average and marginal rates of
income tax plus NIC: 2002/3

Marginal
rate
40
Tax rate (%)

32

22 Average
20 rate

O 4615 6535 30 420 34 515


Individual’s pre-tax annual income (£)
TAXES AND BENEFITS

■ Taxes and the redistribution of income


✜ progressive taxes
✜ regressive taxes
(including lump-sum taxes)
✜ proportional taxes
■ UK taxes and the redistribution of
incomes
✜ direct taxes
✜ indirect taxes
TAXES AND BENEFITS

■ Problems in using taxes to redistribute


incomes
✜ problems in achieving redistribution
✦ how to help the very poor
✦ tax evasion and avoidance
✦ undesired incidence of taxation
Incidence of an income tax: elastic supply of labour
Wage rate

W1

D
O Q1
Quantity of labour
Incidence of an income tax: elastic supply of labour

S + tax
Wage rate

W1

D
O Q1
Quantity of labour
Incidence of an income tax: elastic supply of labour

S + tax
Wage rate

S
W2
W1

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: elastic supply of labour

S + tax
Wage rate

S
W2
W1
W2 - tax

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: elastic supply of labour

S + tax
Wage rate

S
W2
W1
W2 - tax A

A: worker share of tax

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: elastic supply of labour

S + tax
Wage rate

S
W2
B
W1 B: employer share of tax
W2 - tax A

A: worker share of tax

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: inelastic supply of labour

S
Wage rate

W1

D
O Q1
Quantity of labour
Incidence of an income tax: inelastic supply of labour
S + tax
S
Wage rate

W2
W1

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: inelastic supply of labour
S + tax
S
Wage rate

W2
W1
W2 - tax

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: inelastic supply of labour
S + tax
S
Wage rate

W2
W1
A A: worker share of tax
W2 - tax

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: inelastic supply of labour
S + tax
S
Wage rate

B: employer share of tax


W2
B
W1
A A: worker share of tax
W2 - tax

D
O Q2 Q1
Quantity of labour
Incidence of an income tax: elastic supply Incidence
of labour of an income tax: inelastic supply
S + tax
S
S + tax
Wage rate

Wage rate
W2 B: employer share o
B W2
W1 B
A B: employer share of tax W1
W2 - tax A A: worker share of
W2 - tax
A: worker share of tax

D D
O Q2 Q1 O Q2 Q1
Quantity of labour Quantity of labour
TAXES AND BENEFITS

■ Problems in using taxes to redistribute


incomes
✜ problems in achieving redistribution
✦ how to help the very poor
✦ tax evasion and avoidance
✦ undesired incidence of taxation
✜ economic costs of redistribution
TAXES AND BENEFITS

■ Problems in using taxes to redistribute


incomes
✜ problems in achieving redistribution
✦ how to help the very poor
✦ tax evasion and avoidance
✦ undesired incidence of taxation
✜ economic costs of redistribution
✦ distortionary effects of taxes
TAXES AND BENEFITS

■ Problems in using taxes to redistribute


incomes
✜ problems in achieving redistribution
✦ how to help the very poor
✦ tax evasion and avoidance
✦ undesired incidence of taxation
✜ economic costs of redistribution
✦ distortionary effects of taxes
✦ deadweight welfare loss of taxes
Indirect tax applied to good X
£

P1

D
O Q1
Quantity
Indirect tax applied to good X
£

S + tax

S
P2 Tax
P1

D
O Q2 Q1
Quantity
Indirect tax applied to good X
£

S + tax

S (=MC)
P2
P1
P2 - tax

D
O Q2 Q1
Quantity
Indirect tax applied to good X
£

S + tax

C
S (=MC)
P2
B A
P1
P2 - tax

D
O Q2 Q1
Quantity
Indirect tax applied to good X
£

S + tax

C
S (=MC)
P2
B A
P1
P2 - tax E D
F

D
O Q2 Q1
Quantity
TAXES AND BENEFITS

■ Problems in using taxes to redistribute


incomes
✜ problems in achieving redistribution
✦ how to help the very poor
✦ tax evasion and avoidance
✦ undesired incidence of taxation
✜ economic costs of redistribution
✦ distortionary effects of taxes
✦ deadweight welfare loss of taxes
✦ disincentives
Total tax revenue A Laffer curve

0 100
Average tax rate (%)
A Laffer curve

R max.
Total tax revenue

0 t1 100
Average tax rate (%)
TAXES AND BENEFITS

■ Taxation and incentives


✜ income and substitution effects of higher
taxes
✜ different effects on different types of people
✜ different types of tax increase
✦ raising the higher rates of tax
✦ raising the basic rate
✦ reducing tax allowances

■ The effects of tax cuts


Tax cuts and incentives
(a) The position with
no income tax
Ymax
Daily income

Budget
line
O Lmax
Leisure (hours)
Tax cuts and incentives
(a) The position with
no income tax
Ymax
Daily income

I3
I2
Budget
line I1
O Lmax
Leisure (hours)
Tax cuts and incentives
(a) The position with
no income tax
Ymax
Daily income

Y*

I3
I2
Budget
line I1
O L* Lmax
Leisure (hours)
Tax cuts and incentives
(b) The position
with income tax
Ymax
Daily income

Y2

I4
Y1 I3
I2
I1
O Lmax
Leisure (hours)
Tax cuts and incentives
(b) The position
with income tax
Ymax
Daily income

Y2

b
Y**
I4
Y1 I3
I2
I1
O L** Lmax
Leisure (hours)
Tax cuts and incentives
(b) The position
with income tax
Ymax
Daily income

Y2
a

b
Y**
I4
Y1 I3
I2
I1
O L* L** Lmax
Leisure (hours)
Tax cuts and incentives
(c) Cut in the basic
rate of tax
Daily income

Leisure (hours)
Tax cuts and incentives
(c) Cut in the basic
rate of tax
Daily income

r
Person
W

O L W1
Leisure (hours)
Tax cuts and incentives
(c) Cut in the basic
rate of tax
Daily income

r
Person
W

O L W2 L W1
Leisure (hours)
Tax cuts and incentives
(c) Cut in the basic
rate of tax
Daily income

r
Person
q W

Person X

O L W2 L W1 LX
Leisure (hours)
Tax cuts and incentives
(d) Increase in the
tax threshold
Daily income

Leisure (hours)
Tax cuts and incentives
(d) Increase in the
tax threshold
Daily income

O L1

Leisure (hours)
Tax cuts and incentives
(d) Increase in the
tax threshold
Daily income

O L1 L2

Leisure (hours)
TAXES AND BENEFITS

■ Cash benefits
✜ means-tested benefits
✜ universal benefits

■ Benefits in kind
■ Benefits and the redistribution of
income
Social protection benefits in various
European countries: (a) €per head
8000

7000 1999

6000
Euro per head

5000

4000

3000

2000

1000

0
Source: Eurostat, 2002
Social protection benefits in various
European countries: (b) % of GDP
35
1990
30
1999
25
% of GDP

20

15

10

0
Source: Eurostat, 2002
TAXES AND BENEFITS

■ The problem of the poverty trap


✜ an argument for universal benefits
✜ problems with universal benefits

■ The negative income tax system


✜ how it would work
A negative income tax system
A negative income tax system
A negative income tax system
A negative income tax system
TAXES AND BENEFITS

■ The problem of the poverty trap


✜ an argument for universal benefits

✜ problems with universal benefits

■ The negative income tax system


✜ how it would work

✜ advantages and disadvantages