Policies to Redistribute Income and Wealth
The use of progressive tax is capable of redistributing income because as income increases, the proportion of people’s income paid as tax increases (tax rate). The tax rate decreases as income decreases. Therefore, the rich are proportionally taxed more while the low-income earners pay a lower tax rate. Progressive tax reduces the income of the rich. The more money collected from high-income earners can then be used to pay benefits or provide services for the poor, e.g. education, healthcare, etc.
A regressive tax, on the other hand, does not redistribute income from the rich; rather it takes more from the poor because as income decreases tax rate increases. An example is Value-Added Tax (VAT) or General Sales Tax (GST); VAT or GST is a fixed percentage of the price of the product or a specific amount per unit but it forms a bigger proportion of income as income decreases.
A proportional tax is fair to all as everyone pays the same tax rate irrespective of income level, e.g. corporation tax.
The government can impose an inheritance tax on those who inherit some assets from others in order to redistribute income. Taxes can also be levied on profit made when an asset is sold (capital gains tax).
Figure 1: Global income inequality as measured by Gini Coefficient
Source: International Monetary Fund
The income and substitution effects of taxation
The net effect of increasing tax is determined by the substitution effect and income effect. Because taxes reduce disposable income, people may have to work for more hours to compensate for a reduced income. This is the income effect.
High taxation may encourage people to substitute leisure for work and work less as disposable income has gone down (substitution effect). For a low-income earner, the substitution effect is stronger than the income effect; so tax is not a disincentive to work as they work more even if taxes are going up. A high-income earner, on the other hand, will reduce the hours of work as taxes increase because the income effect is stronger than the substitution effect. This person will, therefore, work less as taxes are increased. High income tax can also lead to relocation to a low-tax country.
Benefits can be in the form of monetary payments or the provision of certain products free of charge or at subsidised prices.
Government makes a direct payment which can be a grant or low-interest loan facility. Some benefits are paid to only those with low income to support their income or help them afford some items, e.g. housing benefits, food vouchers, fuel allowances, etc. These are known means-tested benefits. they are directed to those in need.
Some benefits can be claimed regardless of the income of the recipient. These are called universal benefits, e.g. child benefits, state pensions, unemployment benefits, incapacity allowances and sickness allowances.
These involve the provision of free or subsidised products by the government. These are also known as benefits-in-kind, e.g. healthcare and education. These services are often available to everyone. But they help redistribute income since they form a big percentage of poor people’s income. They help increase the capacity of the poor to earn more income.
Effect of benefits
Benefits may not be claimed because of ignorance, reluctance or inability to meet the stipulated conditions. Reliance on benefits can make people find it difficult to look for jobs, thereby relying on the insufficient benefits they receive from the government (poverty trap).
Benefits require a substantial amount of financial resources on the part of the government especially if it is a universal benefit that has to be paid regardless of income.
The government stipulates a minimum wage through legislation for the benefit of low-paid employees. This can motivate workers to be more productive. However, those who are not employed will not benefit from minimum wage. It is, therefore, a limited solution to the problem of poverty in the country.
A minimum wage may force businesses to cut jobs since it adds to their labor cost unless the rise in productivity outweighs the additional wage costs.
The government can promulgate laws against discrimination so that everyone has equal opportunities to be gainfully employed. Employment, wages and benefits must not be based on gender, religion, age, race, nationality and disability. Personal knowledge and job-related abilities are the primary factors to be considered for offering people jobs.