Government Intervention to Redistribute Income (Edexcel IGCSE Economics)

Revision Note

Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

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

4-3-2-progressive-tax
  • 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

4-3-2-regressive-tax
  • 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 several calculations

    • 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%

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%

0

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

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

Examiner Tips and Tricks

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

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Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

Jenna Quinn

Author: Jenna Quinn

Expertise: Head of New Subjects

Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.