Equity – fairness in the distribution of economic outcomes.
Equality – uniformity of outcomes; everyone receives the same amount.
3.2 Types of Equity
Horizontal equity: individuals with the same ability to pay should face the same tax burden.
Vertical equity: those with higher ability to pay should contribute a larger proportion (progressivity).
3.3 Equity vs. Efficiency Trade‑off (AO‑3)
Policies that improve equity (e.g., high progressive taxes) can create distortions that reduce allocative efficiency by altering labour‑supply or investment decisions. The balance of these effects is a central evaluation point in exam questions.
3.4 Poverty
Absolute poverty – income below a subsistence threshold needed for basic food, shelter and clothing.
Relative poverty – income far below the median/average of a society, indicating exclusion from a normal standard of living.
3.5 Measuring Inequality
Two standard tools used in data‑response questions:
Gini coefficient:
$$G=\frac{\sum_{i=1}^{n}\sum_{j=1}^{n}|y_i-y_j|}{2n^{2}\bar{y}}$$
Use when asked to discuss the degree of inequality.
Lorenz curve – graphical representation of cumulative income share.
4. Why Governments Intervene (AO‑1 & AO‑2)
Market outcomes can produce high poverty and excessive inequality (high Gini).
Unequal income distribution can erode social cohesion and increase crime.
Low‑income groups may under‑invest in human capital (education, health) – a market failure.
Externalities, public‑good provision and information asymmetry also justify intervention.
5. Policy Instruments for Redistribution (AO‑2)
5.1 Progressive Direct Taxes
Marginal‑rate schedule (example):
$$
T(y)=\begin{cases}
t_{1}y & 0\le y\le y_{1}\\[4pt]
t_{1}y_{1}+t_{2}(y-y_{1}) & y_{1}When to use: exam questions asking for the impact of tax progressivity on income distribution or on labour supply.
Directly targets poverty; lower fiscal cost than universal schemes
Stigma; high administrative burden; “poverty‑trap” (welfare cliff)
Universal Public Services
Free provision of health, education, transport, etc.
Entire population (indirect benefit to low‑income)
Improves equality of opportunity; no stigma
Requires large public spending; risk of over‑use
Universal Basic Income (UBI)
Flat, unconditional cash payment to everyone
All residents
Eliminates stigma and welfare cliffs; simple once set up
Potentially high fiscal cost; may reduce work incentives if benefit is generous
Negative Income Tax (NIT)
Tax credit that phases out as income rises
Households earning below the threshold $T$
Combines tax‑system simplicity with targeted support; reduces poverty‑trap
Requires careful calibration of $k$ and $T$; political resistance to “negative” taxes
7. Detailed Evaluation of the Negative Income Tax (AO‑3)
Efficiency
Gradual phase‑out creates a marginal benefit rate $k$ (e.g., 0.5) rather than a sudden loss of benefits, encouraging labour‑market participation.
Compared with a sharp means‑test, the NIT reduces the “effective marginal tax rate” for low‑income workers.
Equity
Horizontal equity – same $k$ for all households below $T$.
Vertical equity – benefit declines as income rises, preserving progressivity.
Administrative Simplicity
Integrated with the existing income‑tax return; no separate benefit‑agency system.
Lower transaction costs than multiple means‑tested programmes.
Fiscal Impact
Cost = $k\sum_{i}(T-y_i)$ for all qualifying households. A high $k$ or a high $T$ raises the fiscal burden, requiring either higher taxes on high earners or re‑allocation from other spending.
Revenue‑neutral designs can set $k$ and $T$ so that the NIT is funded by the progressive tax schedule.
Political Feasibility
Public perception that the state is “paying people not to work” can generate opposition.
Framing the NIT as a “tax credit” rather than a “negative tax” often improves acceptability.
Macroeconomic Effects (AD/AS)
Financing the NIT through higher taxes on high earners shifts the AD curve left (reduced disposable income for the rich).
The transfer to low‑income households raises their consumption, shifting AD right. The net effect depends on the marginal propensity to consume (MPC) of each group.
In the short run, a well‑calibrated NIT can increase aggregate demand without creating large inflationary pressure.
Government‑Failure Risks
Calibration error – setting $k$ or $T$ too high/low leads to either excessive fiscal cost or insufficient poverty reduction.
Targeting errors – inclusion (payments to ineligible households) or exclusion (eligible households missed) if income data are inaccurate.
Political manipulation – frequent changes to $k$ or $T$ can create uncertainty for households.
Interaction with other policies – overlap with existing benefits may cause double‑payment or “benefit cliffs”.
8. Illustrative Numerical Example (with AD/AS note)
Assume a threshold $T = £20{,}000$ and benefit rate $k = 0.5$.
Household earns £12,000:
$$S = 0.5\,(20{,}000-12{,}000)=£4{,}000,$$
Net income = £16,000.
Household earns £18,000:
$$S = 0.5\,(20{,}000-18{,}000)=£1{,}000,$$
Net income = £19,000.
Marginal benefit = £0.50 for each extra £1 earned – a much lower effective marginal tax rate than a traditional means‑tested benefit with a sharp cut‑off.
AD/AS implication: The £4,000 supplement raises low‑income consumption, shifting AD right. If the NIT is funded by a 5 % increase in the top‑rate income tax, high‑earner disposable income falls, shifting AD left. The overall shift depends on the relative size of the two groups and their MPCs.
9. Government‑Failure Considerations (AO‑2)
Administrative costs – complex means‑testing can be expensive and error‑prone.
Targeting errors – inclusion (non‑eligible receive) and exclusion (eligible miss out).
Welfare‑cliff effects – sharp loss of benefits creates disincentives to increase earnings.
Tax avoidance/evasion – high marginal rates may encourage legal avoidance schemes or illegal evasion.
Political economy – interest groups may lobby for exemptions, undermining equity.
10. Assessment‑Objective Checklist (AO‑1 – AO‑3)
AO
What to Look For in These Notes
AO‑1 (Knowledge)
Clear definitions, key formulas (Gini, tax schedule, NIT), concise descriptions of all AS & A‑Level topics.
AO‑2 (Application/Analysis)
When‑to‑use notes (e.g., Gini for inequality questions, NIT formula for data‑response), AD/AS impact analysis, calculation steps in the numerical example.
AO‑3 (Evaluation)
Balanced pros/cons tables, detailed NIT evaluation, discussion of equity vs efficiency, government‑failure risks, political feasibility.
Governments intervene to correct market failures, reduce poverty (absolute & relative) and promote social cohesion.
Key redistribution tools: progressive taxes, indirect taxes with exemptions, means‑tested transfers, universal public services, UBI and the Negative Income Tax.
Each instrument involves trade‑offs among equity, efficiency, administrative simplicity, fiscal cost and political acceptability.
The Negative Income Tax offers a promising mix of efficiency and equity but requires careful calibration and strong political communication.
Suggested diagram: Lorenz curves before and after a progressive tax and a Negative Income Tax, illustrating the movement toward a more equitable income distribution.
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