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Unequal distribution of income


Markets may result in a very wide distribution of income, such that some individuals may receive no income at all.

Incomes are earned in a market when individuals sell or hire out their factor of production to others.

Factor incomes include:

  • Wages

  • Rents

  • Interest

  • Profits

However, these incomes can vary considerably, and some individuals cannot earn even a moderate income. In a free market it may be difficult for some individuals to earn an income at all, leaving them unable to buy goods and services.

Income distribution in the UK

Who are most likely to have the least income?

Those who are likely to receive less than ‘average incomes’ include:

  1. The unemployed

  2. The underemployed

  3. The sick and disabled

  4. Those with poor qualifications or low skills

  5. The elderly

  6. Those working in the unofficial labour market where pay is below the legal minimum

Remedies

Progressive taxes

Governments can intervene in the labour market by altering personal disposable income via the tax and benefits system. This means employing a progressive tax system. Progressive taxes take proportionately more tax at higher incomes and proportionately less tax at lower incomes.

If this is accompanied by welfare payments to those on lower incomes, any gap between high and low income earners can be reduced.

Income tax in the UK is mildly progressive, because:

  1. Individuals on very low incomes pay no income tax. Everyone can earn up to £6,475 before they pay income tax (2009).

  2. A low tax band of 10% for those earning between £6,475 and just over £9,000.

  3. Middle-income earners pay tax on some of their income at the basic rate - currently 22%.

  4. Those on higher incomes pay tax on some of their income at a higher tax rate, such as 40%.

  5. These tax bands help narrow the income gap between the well paid and poorly paid, or unemployed, and so help reduce inequality.

Regressive taxes

Regressive taxes are those where the tax paid, as a percentage of income, falls the higher the level of income, and hence where the burden of the tax is largely on the poor.

Example of a regressive tax

VAT, currently at 15.%, is a regressive tax as it takes no account of an individual’s income. For example, consider three different drivers, all of whom drive the same distance each year, but each earn a different incomes.

  • Mr Brown earns £10,000 per year

  • Mrs Green earns £50,000

  • Miss Black earns £200,000

If it is assumed that they all drive to work and buy 3000 litres of petrol per year at £1 per litre, of which 15% is VAT, then it can be seen that there is a considerable difference in terms of the proportion of their income that goes to the government in VAT:

  • Mr Brown earns £10,000 per year, and pays 4.5% of his income in petrol taxes

  • Mrs Green earns £50,000, and pays 0.9%, and

  • Miss Black earns £200,000, and pays 0.23%

Welfare benefits

Not all individuals have the opportunity or ability to sell their labour in the labour market. To help provide a basic level of personal income a government may also provide transfer benefits, such as:

  1. Unemployment benefit (Job Seekers Allowance - JSA)

  2. Income support (IS)

  3. Housing benefit

  4. Old age pension

  5. Child benefit

  6. Sick benefit

  7. Disability benefit

  8. Child tax credit and working tax credit.

Many of these individual benefits will be incorpoated into a single universal benefit (uUniversal Credit), introduced in 2013.

More on Universal Benefit....

Criticisms

These benefits may compensate for the failure of labour markets to provide sufficient rewards, but such intervention can be criticised because:

  1. It may create a disincentive effect, which occurs when individuals are discouraged from working hard, because they pay more taxes.

  2. It may create moral hazard, where some individuals may not make an effort to find ways to improve their own position because the state provides insurance against poverty, unemployment and disability.

See also:

National Minimum Wage

Equity

Welfare reforms and universal benefit