Equity and redistribution of income and wealth

Economics A2 · Government microeconomic intervention. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Equality means everyone receives the same. Equity means fairness, which is a value judgement: a fair distribution need not be an equal one. Efficiency is about the size of total output, while equity is about how it is shared. Policies that raise equity, such as higher taxes on high incomes, may weaken incentives and so reduce efficiency.

Absolute poverty is not having enough income for basic needs. Relative poverty is being poor compared with others in the same country.

The poverty trap arises when a low-income person who earns more pays more tax and loses benefits, so is little better off and has less reason to work more.

Rules to remember

Horizontal equity: people in the same circumstances are treated the same. Vertical equity: people with more ability to pay contribute more.
Absolute poverty: income too low to buy basic needs such as food, clothing and shelter.
Relative poverty: income below a set share of the average, for example below 60% of median income.
Effective marginal tax rate = (extra tax paid + benefits lost) ÷ extra income × 100.
Means-tested benefits: paid only to those with low income. They are targeted and cheaper, but can cause a poverty trap and some people do not claim.
Universal benefits: paid to everyone in a group whatever their income. Simple and no poverty trap, but costly.
Negative income tax: people below a set income receive a payment from the state. Universal basic income: a regular payment to every citizen with no conditions.

Common mistake

Students say economic growth always reduces poverty. If all incomes rise by the same percentage, absolute poverty falls but relative poverty does not change.

Worked example

Under a negative income tax scheme, a household with no earnings receives $6000 a year. The payment is reduced by 40 cents for each $1 the household earns. What is the total income of a household that earns $5000, and at what earnings does the payment reach zero?

Reduction in payment = 0.40 × 5000 = $2000.
Payment received = 6000 − 2000 = $4000.
Total income = 5000 + 4000 = $9000.
Payment is zero when 0.40 × earnings = 6000, so earnings = 6000 ÷ 0.40 = $15 000.

Answer: The household has a total income of $9000, and the payment stops at earnings of $15 000.

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