universal benefits and means-tested benefits

Equity and Redistribution of Income and Wealth (Syllabus 8.2)

Learning Objectives

• Distinguish between equality and equity and explain the equity‑efficiency trade‑off.
• Define absolute and relative poverty.
• Define universal and means‑tested benefits and evaluate their advantages and disadvantages.
• Analyse the poverty trap and calculate the effective marginal tax rate (EMTR) under different scenarios.
• Identify the main policy tools governments use to redistribute income and wealth, including progressive taxation, negative income tax, universal basic income, earned‑income tax credit and universal basic services.

Key Concepts

Concept	Cambridge definition	Relevance to redistribution
Equality	Everyone receives the same amount of resources or opportunities.	Often leads to horizontal equity but ignores differing needs.
Equity	Resources are allocated according to need or merit – “fairness”.	Forms the basis of most welfare policies (e.g., targeting low‑income households).
Horizontal equity	People in similar circumstances should be treated alike.	Ensures that two households with the same income face the same tax or benefit rules.
Vertical equity	People with different abilities to pay should bear different burdens – the richer should pay more.	Justifies progressive taxation and means‑tested benefits.
Equity vs. Efficiency	Equity seeks a fair distribution; efficiency seeks to maximise total output with the least waste.	Targeted (means‑tested) programmes improve allocative efficiency but may create administrative costs and work‑disincentives.
Absolute poverty	Inability to meet basic physical needs (food, shelter, clothing). Measured against a fixed poverty line.	Universal basic services (e.g., free primary education) aim to eradicate absolute poverty.
Relative poverty	Living with an income below a set proportion of the median (commonly 60 % in the UK). Reflects social exclusion.	Means‑tested cash transfers can reduce relative poverty by raising low‑income households’ disposable income.
Poverty trap	A situation where an increase in earnings leads to a loss of benefits that outweighs the gain, creating a high EMTR.	Common in means‑tested schemes; illustrated by the EMTR calculations below.
Administrative error	Incorrect inclusion (over‑inclusion) or exclusion (under‑inclusion) of households from a means‑tested programme.	Can increase poverty (exclusion errors) or waste public money (inclusion errors).

Why Governments Use Welfare Instruments

Both universal and means‑tested benefits serve two core purposes:

1. Reduce poverty (absolute and/or relative) and narrow income‑wealth inequalities.
2. Provide a safety net against adverse economic shocks (e.g., unemployment, illness).

Universal Benefits – Definition, Examples & Evaluation

Definition: A benefit available to all residents (or citizens) irrespective of income, wealth, or employment status.

Typical Examples

• State pension (e.g., UK State Pension)
• Child Benefit
• Free primary education
• National Health Service (NHS) – universal health care
• Public libraries, parks, and public‑transport concessions

Advantages

• Simple administration: No means‑testing, so low bureaucratic cost.
• Low stigma: Everyone receives it, avoiding the “poverty label”.
• Broad political support: Large voter base protects programmes from cuts.
• Positive externalities: Better health and education raise overall productivity.

Disadvantages

• Higher fiscal cost: Benefits are paid to high‑income households that may not need them.
• Potential dead‑weight loss: If the benefit replaces private spending that would have occurred anyway.
• Equity concerns: Uniform provision may be less progressive than targeted schemes.

Means‑Tested Benefits – Definition, Examples & Evaluation

Definition: A benefit provided only to individuals/households whose income and/or assets fall below a pre‑set threshold.

Typical Examples

• Income Support / Universal Credit (UK)
• Housing Benefit / Council Tax Reduction
• Child Tax Credit (means‑tested component)
• Free school meals (means‑tested eligibility)

Advantages

• Targeted spending: Resources go to those with the greatest need.
• Lower overall fiscal cost: High‑income households are excluded.
• Potential to reduce relative poverty: Direct cash transfers raise disposable income for the poorest.

Disadvantages

• Administrative complexity: Income/asset verification, regular reassessments and appeals increase costs.
• Stigma: Only “the poor” receive the benefit, which can lower take‑up.
• Poverty trap: Benefit withdrawal as earnings rise creates a high EMTR, discouraging work.
• Administrative error: Over‑inclusion wastes public money; under‑inclusion leaves needy households in poverty.

Effective Marginal Tax Rate (EMTR) – Illustrative Calculations

EMTR measures the proportion of an extra £1 of earnings that is lost through higher tax and reduced benefits.

Scenario 1 – Moderate withdrawal

• Benefit reduction: £0.30 for every £1 earned above the threshold.
• Statutory income‑tax rate: 20 %.

\[ \text{EMTR} = 0.30 + 0.20 = 0.50\;(50\%) \]

Scenario 2 – Steep withdrawal (classic poverty‑trap case)

• Benefit reduction: £0.70 for every £1 earned above the threshold.
• Statutory income‑tax rate: 20 %.

\[ \text{EMTR} = 0.70 + 0.20 = 0.90\;(90\%) \]

In Scenario 2 a claimant keeps only 10 p of every extra £1 earned, providing a strong disincentive to increase work hours.

Measuring Inequality – Gini Coefficient (Optional Exam Material)

The Gini coefficient summarises the Lorenz curve in a single number (0 = perfect equality, 1 = perfect inequality).

1. Arrange households from poorest to richest and calculate cumulative share of income.
2. Plot cumulative population share (x‑axis) against cumulative income share (y‑axis) – this is the Lorenz curve.
3. Gini = \(\dfrac{A}{A+B}\) where A is the area between the line of perfect equality and the Lorenz curve, and B is the area below the Lorenz curve.

Example (simplified):
Population shares: 0 %, 25 %, 50 %, 75 %, 100 %
Income shares: 0 %, 10 %, 30 %, 60 %, 100 %
Estimated Gini ≈ 0.30, indicating moderate inequality.

Comparative Summary of Universal vs. Means‑Tested Benefits

Criterion	Universal Benefits	Means‑Tested Benefits
Eligibility	All residents (or citizens) regardless of income	Only households below a specified income/wealth threshold
Administrative cost	Low – no means assessment required	High – income/asset verification and periodic reviews
Fiscal cost	Higher – paid to high‑income groups as well	Lower – targeted to low‑income groups
Stigma	Minimal – everyone receives it	Potentially high – only “the poor” receive it
Impact on work incentives	Neutral – benefits do not fall as income rises	Negative if withdrawal rates are steep (poverty trap)
Political sustainability	Strong – broad public support	Vulnerable – cuts justified on cost grounds
Equity vs. efficiency	More equitable in provision but less efficient (higher cost)	More efficient allocation of resources but may reduce perceived equity because of stigma and errors

Policy Options for Redistribution (Beyond Simple Universal/Means‑Tested)

• Progressive taxation – tax rates rise with income; a key vertical‑equity tool that reduces disposable income inequality.
• Negative Income Tax (NIT) – individuals earning below a set level receive a cash supplement instead of paying tax. Combines universality (everyone is in the tax system) with targeting (only low earners receive payments).
• Universal Basic Income (UBI) – regular cash payment to every adult, regardless of income. Removes stigma and simplifies administration but raises fiscal cost.
• Earned Income Tax Credit (EITC) – “in‑work” benefit – refundable tax credit that increases with earnings up to a ceiling, then phases out. Encourages work while providing support.
• Universal Basic Services (UBS) – provision of essential services (health, education, transport, housing) to all, reducing the need for cash transfers.
• Hybrid approaches – many welfare states combine a universal core (e.g., NHS, state pension) with means‑tested cash benefits (e.g., Universal Credit) to balance equity, efficiency and fiscal sustainability.

Equity‑Efficiency Trade‑off – Concise Evaluation

• Targeting (means‑testing) improves allocative efficiency by directing scarce resources to those who need them most, but it raises administrative costs, creates stigma, and can generate a poverty trap (high EMTR).
• Universal provision reduces administrative burden and stigma, enhancing political support, but it is less efficient because high‑income households receive benefits they do not need, increasing fiscal burden.
• Governments must decide which side of the trade‑off best matches their objectives (e.g., reducing absolute poverty vs. limiting public‑sector debt).

Key Take‑aways for the Exam

• Equality = same amount; equity = fairness based on need (horizontal vs. vertical equity).
• Absolute poverty = inability to meet basic needs; relative poverty = income below a set proportion of the median.
• Explain the poverty trap using EMTR – show at least two withdrawal rates (e.g., 30 % and 70 %).
• Compare universal and means‑tested benefits using at least three criteria (cost, stigma, work incentives). Include a brief note on administrative error.
• Identify two redistribution tools beyond the basic dichotomy (e.g., progressive tax, NIT, UBI) and discuss one advantage and one drawback of each.
• When writing essays, explicitly mention the equity‑efficiency trade‑off and justify which approach best meets the government’s stated objectives.