Reducing Inequality and the Impact on Incentives to work

Readers Question “Evaluate the argument that further measures to reduce inequality may have adverse consequences for work incentives ”

Measures to reduce inequality include, progressive taxes, means tested benefits and higher minimum wages

1. Higher Income Tax. Increasing the highest rate of income tax from 40% to 50% will make work and overtime less attractive because of the lower renumeration. Here the substitution effect means people will be encouraged to work less and have more leisure time.

However, there is also the income effect. This states that if wages fall (because of higher taxes) people will need to work longer hours to maintain their target income. If you have a target income of £40,000 (large mortgage, school fees e.t.c) then higher taxes actually mean you need to work longer hours. Therefore, it is uncertain whether people will work longer hours or not.

It may depend how much income tax is increased e.g. an increase in basic rate from 22% to 24% is unlikely to have much impact. But, if higher rate was increased to say 70% then disincentives are more likely to occur.

2. Increasing Means tested Benefits. If means tested benefits such as unemployment benefits are increased then people may have less incentive to get a new job but will stay unemployed. Income support could also encourage people to stay in part time work. However, it is possible to arrange the means tested benefit system so that if people work longer hours, they will be better off. e.g. benefits are graded so that as your wage increases you still get some benefits.

3. Increasing Minimum Wage. Higher minimum wage increases income of the low paid. This may actually increase incentives to work because it increases the gap between  a wage and unemployment benefits. The only problem here is that minimum wage may cause lower demand for workers.

See also: Labour Market

Policies to reduce poverty

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