Income distribution and redistribution

Trying to make an unfair world a little bit more fair…..

Remember the big 3 economic

questions?

So what decides who receives the majority of

income and output in a market economy? What are the determining factors?

For whom to produce?

Selling those factors of production

As we all know, there is a huge

disparity among owners of the factors of production. Some

people have special talents and are highly educated, some people do not. Many critics of the market economy use this as an argument

against it….

Market economy reality

So what if anything is government to do?

Government typically chooses from among

four policies to try and correct the issue of income redistribution. Can we name

them……?

The Big 4

The distribution of income from

the haves to the have nots (vulnerable groups). Let’s all shout out without raising our

hands some examples of recipients of transfer payments

and types of transfer payments….

#1--Transfer Payments

Transfers

Recipients

Old folks Sick folks Poor folks Kids of poor folks Unemployed folks

Examples

Pensions Unemployment

benefits Housing benefits Child allowances Maternity benefits

and more….

Accepting the reality of unequal

income distribution, it would not be surprising to see many of the less

fortunate in society unable to receive the benefits of certain merit

goods. Merit goods are goods that……..

#2—Subsidized provision of merit goods

Merit goods have spillover benefits but

often can’t be purchased by poor people.

Considered basic human rights nowadays, with unequal distribution of

income, too many people would not receive these goods, thus causing

significant problems for society as a whole.

Merit Goods

Government must make sure not only to provide education and healthcare but

to make them affordable too. Some governments provide free universal

healthcare and education, while others have not gone as far…..perhaps they

should…

Government’s role

Thank-you government for:

Clean Water Sanitation Sewerage

Other subsidized merit goods

Subsidize merit goods to ensure that

the quantity provided increases

Government’s role

Government will often intervene in

markets to benefit certain groups. Examples include:

Minimum wage legislation Price supports for farmers

Subsidies to firms

#3—Government intervention in markets

#4--Taxation

Tax revenue allows for the

provision of transfer payments and the subsiding of merit goods. Tax policies on their own also allow for

redistribution of income, but decisions must be made….

Taxation

Yet they allow government to do many

important things, such as: Provide public transport

Provide transfer payments/merit goods Correct negative externalities

Pursue fiscal policy when needed And many, many more…

Everybody hates taxes!

Two types of taxes

These taxes are paid directly by the consumer to the government. Examples

include: Personal income tax Corporate income tax

Wealth tax (on property, inheritances) Earmarked taxes (to support programs like

unemployment insurance, social security and healthcare)

Direct taxes

These taxes are usually placed on the

supplier or seller of a good/service, but the consumer will have to incur some incidence of this tax. There are three main categories we will discuss……

Indirect Taxes

These are taxes on various goods and

services paid at the time of purchase. In the U.S.A., many states put a fixed

percentage tax on goods purchased. Other countries use a value added tax,

which taxes each stage of the production process for the value that is

added.

General Expenditure Taxes (Sales taxes)

These are taxes placed on goods that

the government wants to discourage consumption of. The level of incidence of the tax for the consumer depends on

the elasticity of demand of the consumer for the particular product.

Excise taxes (Sin taxes)

These are taxes placed on imported

goods. They serve the purpose of protecting domestic industries and at the same time raising revenues. They

tend to be much less a part of government policy in MDCs than they

are in LDCs

Tariffs (Customs duties)

Most human beings with a heart can

come to terms with the idea that the more income you earn the more you

should contribute in taxes. Unfortunately, the question is more complicated than should the wealth pay

more, but how much more should they pay?

The ability to pay principle

Tax Flavours

Taxes are usually defined as being either:

Proportional Progressive Regressive

This depends on the relationship between income and the fraction of income paid as

tax…sound confusing? It’s not really….

Tax Flavours

As income increases, the fraction of income paid as taxes remains constant. Joe makes $10,000 a year and his tax

rate is 15%. Warren makes $10,000,000,000,000 a year, and his

tax rate is 15%. Warren obviously pays more in taxes, but the tax rate is the same. Seem fair?

Proportional Tax

As income increases, the fraction of income paid as taxes remains increases.

Joe makes $10,000 a year and his tax rate is 15%. Joel makes $20,000 a year, and

his tax rate is 20%. Joel earns more therefore pays more in

taxes. This is a mildly progressive tax, a strongly progressive tax would be higher

for Joel. Seem fair?

Proportional Tax

As income increases, the fraction of

income paid as taxes decreases. Joe makes $10,000 a year and his tax

rate is 15%. Bill makes $20,000 a year and his rate is 10%.

Bill still pays a larger dollar amount in this example than Joe, but his % is

lower. Seem fair?

Regressive tax

The more progressive a tax system is, the more equal the after-tax distribution of income will be compared to the pre-

tax distribution of income. However, this alone does not remove

the controversy surrounding the tax issue

General Conclusion

As you can probably guess, people with

high incomes are not happy to see a highly progressive tax system.

They argue that they worked hard to achieve what they have, and shouldn’t

be forced to pay a higher rate to support the lower income classes.

Is this a fair point?

Controversy over taxes

Do high taxes reduce the

incentives of the rich to work and save?

Additional questions to ponder

Do taxes worsen the allocation of

resources (create allocative efficiency) ?

Do high taxes encourage tax evasion?

Additional questions to ponder

Is there a trade-off between income

equality and efficiency?

If we create more income equality, will economic growth be sacrificed?

Additional questions to ponder

Might there be a conflict between using

taxes as a fiscal policy tool and as an income redistribution tool?

Do transfer payments reduce the incentives of the poor to work and

save?

Additional questions to ponder