The macroeconomic aims of government: redistribution of income

Government Macro‑economic Aims (Syllabus 4.1)

4.1.1 The Five (or Six) Main Aims of Government Intervention

Aim	Why it matters (one‑sentence description)	Key indicator(s)
Economic growth	Increases the nation’s output and improves living standards over the long term.	Real GDP growth rate (percentage change in real GDP)
Full employment	Ensures most people who want a job can find one, reducing poverty and social problems.	Unemployment rate (percentage of labour force not working)
Low inflation	Maintains the purchasing power of money and protects savings.	Consumer Price Index (CPI) inflation rate
Balance‑of‑payments stability	Prevents large deficits or surpluses that could cause exchange‑rate volatility and external debt problems.	Current‑account balance as % of GDP; exchange‑rate movements
Redistribution of income	Reduces excessive inequality and promotes social cohesion.	Gini coefficient; Lorenz curve; poverty rates
Environmental sustainability* (optional in some specifications)	Protects natural resources for future generations while supporting economic activity.	Carbon‑dioxide emissions per capita; share of renewable energy; “green” GNI

*Only required where the specification includes an environmental aim.

4.1.2 Conflicts Between Aims (Evaluation)

Conflict	Why it occurs	Typical policy response (to try to balance the aims)
Growth vs. Low inflation	Rapid demand‑pull growth can push prices up.	Combine fiscal stimulus with monetary restraint; use supply‑side measures to increase output without raising demand.
Full employment vs. Low inflation	Very low unemployment may raise wages, feeding cost‑push inflation (Phillips curve).	Targeted training and productivity‑enhancing policies rather than large wage‑boosting subsidies.
Growth vs. Environmental sustainability	Industrial expansion often raises pollution and resource use.	Introduce green taxes (e.g., carbon tax) or subsidies for clean technology; set environmental standards.
Redistribution vs. Efficiency (Growth)	High marginal tax rates and generous benefits can reduce work incentives and investment.	Design progressive taxes with moderate rates; use means‑tested benefits; pair taxes with incentives for work.
Balance‑of‑payments vs. Domestic demand	Stimulating domestic demand can increase imports, widening the current‑account deficit.	Couple demand‑stimulating measures with export‑support policies (e.g., export credit, trade promotion).
Growth vs. Redistribution	Heavy taxation to fund redistribution may lower disposable income and discourage investment, slowing growth.	Use a balanced tax mix (progressive income tax, moderate indirect taxes) and target transfers to minimise work‑disincentives.

Fiscal Policy – The Main Tool for Redistribution (Syllabus 4.2)

4.2 Definition of Fiscal Policy

Fiscal policy is the use of government taxation and public spending to influence the macro‑economic objectives listed above, especially growth, employment, inflation and income distribution.

4.2.1 Government Budget: Deficit, Surplus and Balance

Budget Balance = Government Revenue – Government Spending

• Surplus: Revenue > Spending (e.g., £150 bn revenue – £120 bn spending = £30 bn surplus).
• Deficit: Spending > Revenue (e.g., £180 bn spending – £150 bn revenue = £30 bn deficit).
• Persistent deficits increase public debt, which may limit future spending or require higher taxes.

4.2.2 Why the Government Spends

• Public services – education, health, policing, defence.
• Infrastructure – roads, rail, broadband, energy networks.
• Welfare & social security – state pensions, unemployment benefit, child benefit.
• Subsidies & transfers – housing assistance, fuel rebates, agricultural support.
• Environmental programmes – renewable‑energy incentives, flood‑defence, carbon‑tax rebates.

4.2.3 Key Instruments for Income Redistribution

1. Taxation

Taxes can be structured to shift income from higher‑earning households to lower‑earning households.

Tax type	Definition	Effect on income distribution
Progressive tax	Rate rises as taxable income rises.	Reduces inequality – higher earners pay a larger share of their income.
Regressive tax	Effective rate falls as income rises (e.g., sales tax, VAT).	Can increase inequality – low‑income households spend a larger proportion of income.
Proportional (flat) tax	Same rate for all income levels.	Neutral for relative distribution; absolute burden is higher for low earners.

2. Direct Transfers (Cash Benefits)

Payments made straight to individuals or households without a direct service exchange.

• Unemployment benefit
• Child benefit
• State pension
• Universal Credit / means‑tested welfare

3. Indirect Transfers (Subsidies)

Government assistance that lowers the price of essential goods and services.

• Housing benefit or rent vouchers
• Fuel, electricity or water rebates
• School‑meal vouchers or free school meals

4. Public Services

Free or low‑cost provision of services that benefit low‑income groups.

• State‑funded education (primary, secondary, university loans)
• National Health Service (NHS) – free at point of use
• Public‑transport concessions for students and pensioners

4.2.4 Measuring the Impact of Redistribution

• Gini coefficient – 0 = perfect equality, 1 = perfect inequality.
  Example: a fall from 0.45 to 0.38 after a tax‑and‑benefit reform signals reduced inequality.
• Lorenz curve – plots cumulative share of income against cumulative share of population.
  Shift of the curve towards the 45° line indicates a more equal distribution.
• Other useful measures: poverty head‑count ratio; income quintile share ratio.

4.2.5 Potential Trade‑offs (Evaluation)

• Equity vs. Efficiency: High marginal tax rates may discourage work or investment, lowering overall output.
• Budget constraints: Expanding welfare programmes must be financed by higher taxes or borrowing, which can raise public debt.
• Incentive effects: Generous benefits may create a “welfare trap” where the marginal gain from work is small.
• Administrative costs: Means‑testing and monitoring increase government expenditure.
• Regressive impact of indirect taxes: VAT on basic goods can be regressive; exemptions or reduced rates for essentials can mitigate this.

4.2.6 Worked Example: Progressive Income‑Tax Calculation

Assume a three‑band system (all figures in £):

\[ \text{Tax Payable}= \begin{cases} 0 & \text{if } Y \le 10{,}000\\[4pt] 0.10\,(Y-10{,}000) & \text{if } 10{,}000 < Y \le 30{,}000\\[4pt] 2{,}000 + 0.20\,(Y-30{,}000) & \text{if } Y > 30{,}000 \end{cases} \]

Example calculations:

• Person A earns £8 000 → Tax = £0 (tax‑free band).
• Person B earns £25 000 → Tax = 0.10 × (25 000 − 10 000) = £1 500.
• Person C earns £50 000 → Tax = £2 000 + 0.20 × (50 000 − 30 000) = £2 000 + £4 000 = £6 000.

Average tax rates: A = 0 %, B = 6 %, C = 12 %. The system is clearly progressive.

4.2.7 Diagram Suggestions for Classroom Use

• Lorenz curve before and after redistribution – show the curve moving closer to the line of equality.
• Tax‑band diagram – illustrate how marginal tax rates increase with income.
• Budget‑balance flow chart – revenue → taxes, spending → services, surplus/deficit arrow.
• Current‑account diagram – illustrate a surplus, deficit and the effect of export‑support measures.
• Supply‑and‑demand diagram with a carbon tax – show shift in marginal cost curve.

Summary (Key Points to Remember)

• Governments intervene to achieve several macro‑economic aims; redistribution of income is one of them.
• Each aim has a standard indicator: real GDP growth, unemployment rate, CPI inflation, current‑account balance, Gini coefficient, and (where required) environmental metrics.
• Fiscal policy – taxes + spending – is the primary tool for redistribution.
• Progressive taxes, direct cash transfers, subsidies, and publicly provided services all shift resources toward lower‑income households.
• The impact of redistribution is measured with the Gini coefficient, Lorenz curve, and poverty rates.
• Every redistribution measure involves trade‑offs, especially between equity and efficiency, and between social goals and fiscal sustainability.
• Policy makers must balance conflicts (e.g., growth vs. redistribution, growth vs. environmental sustainability) by using a mix of fiscal, monetary and structural measures.