Discuss whether govt policy which aims to make the distribution of income more equal, should be based on higher welfare benefits, higher rates of income tax or upon some other strategy. (30)
Welfare benefits include; job seekers allowance, income support, child benefit and pensions. The biggest cause of poverty is unemployment therefore increasing JSA would increase equality of distribution. However, there is a risk that higher benefits may increase voluntary unemployment. This is because income from benefits may become as much as the income from a job, therefore, there may be a disincentive to take a job, this may increase unemployment and not help to reduce inequality. However, this depends how much benefits were increased and the level of wages. A minimum wage would help alleviate this problem because it increases wages.
Income support or family credit involves giving top up benefits to those on low wages; this will help reduce income inequality. However, it will be quite expensive for the govt and may encourage firms to pay low wages because the govt will top up the wages.
Higher pensions would help reduce inequality amongst pensioners; however, it would be very expensive to increase the universal state pension; especially because there are increasing numbers of OAPs in the UK. Therefore, it may be more effective to target pensions to those who need it most, i.e. use means tested benefits. This could involve an extension of the govt minimum income guarantee for pensioners. The only problem of this is that it may discourage workers from saving for a private pension, because, they will not then get as much from the govt.
A progressive tax takes a higher % of income from the rich. E.g. the top band of income tax takes 40% of incomes over £27,000. If the govt increased the top rate this would cause a reduction income inequality as only the well off would pay the tax also the revenue could be spent on increasing benefits to those on low incomes. However, this would cause problems because higher taxes may discourage people from working harder. Therefore, higher rate of income tax may cause lower AS and not increase revenue for the govt. However, the extent of this depends upon the income and substitution effect. For example, some people need to maintain a certain level of income, therefore, if taxes increase the income effect means that they need to work harder to earn more.
Other policies could include the Minimum wage, this increase the wages of those on low pay. However, it may cause unemployment if the labour market is competitive. Also, it will not help the poorest on unemployment benefits. But, if labour markets are monopsonistic then a min wage will not cause unemployment. Also a min wage could increase labour productivity and incentives to get a job. Empirical evidence suggests a min wages does not cause unemployment.
To conclude, it may be possible to reduce income inequality by increasing income tax rates and means tested benefits such as income support. However, there is a danger that if they are increase too much they may cause disincentive within the economy, this is something the govt will have to be careful about. A min wage also appears to be a useful policy. However, some people may question whether the govt needs to be concerned with reducing poverty, they argue inequality is important for certain incentives and people who work hard should be entitled to it.
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