Discuss policies to help reduce income inequality in the UK (25 marks)
Income inequality is the extent to which the distribution of income is skewed between
households and there are many policies which can reduce this. One type of policy to help
reduce this would be taxation policies, including making progressive tax systems more
progressive. By making the progressive tax systems more progressive, either by taxing the rich
more heavily by raising the top rate taxes, or by raising the tax free allowance of the low end. By
raising the tax free allowance, the poor benefit the most since they are now able to keep most of
their income or more. By raising the top rate taxes on the rich, the government will collect more
tax revenue from the rich that can be used to redistribute and provide to the poor in terms of
higher benefits or spending on education services which are poor in areas. Also could reduce
regressive taxes which take a greater proportion of income from the poor which burden them
more than the rich such as VAT. This increases the amount of income the poor keep which can
be spent on increasing their living standards.
However in evaluation, by making progressive tax systems more progressive, e.g. raising the
top rate tax on the rich, this may distort incentives to work meaning that the government may
receive less tax revenues. This concept is illustrated by the laffer curve which clearly shows that
as tax rates rise past a certain point, the tax revenue falls due to a fall in the incentive to work.
This is because if you're rich then the incentive to work reduces since most of it will be lost to
tax, and also a substitution effect away from work to leisure as their target incomes are already
met. Also there is a hit to government finances since VAT is reduced which is significant since
VAT generated £225bn in 2021-22 meaning that potential rises in taxes in the future may occur
which harms intergenerational equity.
Another policy to reduce income inequality within the UK would be Increasing benefits (transfer
payments) which are payments made by the government to economic agents where there is no
exchange of goods and services at all. Raising benefits such as means tested benefits which
are benefits to those who desperately need them but are removed when living conditions
improve, for example job seekers. In 2023 JSA increased to £84.80 a week, which illustrates
this clearly. Or universal benefits can be increased which are available to all regardless of
condition and don't have to be taken away when something is met. By increasing benefits, we
increase the incomes of the poor, meaning that they have more to spend on their living
standards and less stress from paying bills. This can also help children gain a better education
meaning that benefits have long term impacts for the population as they can boost their
productivity and earn higher wages in the future, reducing income inequality.
However one significant limitation would be increasing means tested benefits could create a
poverty trap. If someone is on means tested benefits and they know they will be taken away
when their incomes rise to a certain level, then the incentive to increase incomes and find work
is reduced. This will lead to an even greater strain on public finances since the population rely
on these benefits to live and this is not what the government should promote. This concept is a
form of moral hazard as the government bears the cost of the individual's actions. Also if the
benefits are universal then they may go to people who do not really need them, increasing
Income inequality is the extent to which the distribution of income is skewed between
households and there are many policies which can reduce this. One type of policy to help
reduce this would be taxation policies, including making progressive tax systems more
progressive. By making the progressive tax systems more progressive, either by taxing the rich
more heavily by raising the top rate taxes, or by raising the tax free allowance of the low end. By
raising the tax free allowance, the poor benefit the most since they are now able to keep most of
their income or more. By raising the top rate taxes on the rich, the government will collect more
tax revenue from the rich that can be used to redistribute and provide to the poor in terms of
higher benefits or spending on education services which are poor in areas. Also could reduce
regressive taxes which take a greater proportion of income from the poor which burden them
more than the rich such as VAT. This increases the amount of income the poor keep which can
be spent on increasing their living standards.
However in evaluation, by making progressive tax systems more progressive, e.g. raising the
top rate tax on the rich, this may distort incentives to work meaning that the government may
receive less tax revenues. This concept is illustrated by the laffer curve which clearly shows that
as tax rates rise past a certain point, the tax revenue falls due to a fall in the incentive to work.
This is because if you're rich then the incentive to work reduces since most of it will be lost to
tax, and also a substitution effect away from work to leisure as their target incomes are already
met. Also there is a hit to government finances since VAT is reduced which is significant since
VAT generated £225bn in 2021-22 meaning that potential rises in taxes in the future may occur
which harms intergenerational equity.
Another policy to reduce income inequality within the UK would be Increasing benefits (transfer
payments) which are payments made by the government to economic agents where there is no
exchange of goods and services at all. Raising benefits such as means tested benefits which
are benefits to those who desperately need them but are removed when living conditions
improve, for example job seekers. In 2023 JSA increased to £84.80 a week, which illustrates
this clearly. Or universal benefits can be increased which are available to all regardless of
condition and don't have to be taken away when something is met. By increasing benefits, we
increase the incomes of the poor, meaning that they have more to spend on their living
standards and less stress from paying bills. This can also help children gain a better education
meaning that benefits have long term impacts for the population as they can boost their
productivity and earn higher wages in the future, reducing income inequality.
However one significant limitation would be increasing means tested benefits could create a
poverty trap. If someone is on means tested benefits and they know they will be taken away
when their incomes rise to a certain level, then the incentive to increase incomes and find work
is reduced. This will lead to an even greater strain on public finances since the population rely
on these benefits to live and this is not what the government should promote. This concept is a
form of moral hazard as the government bears the cost of the individual's actions. Also if the
benefits are universal then they may go to people who do not really need them, increasing
