Revise Addressing income and wealth inequality for Cambridge 9708 (3.3)

Governments intervene to address income and wealth inequality primarily on the grounds of equity, or fairness. While a pure market economy may achieve allocative efficiency, it can result in a distribution of income and wealth that is considered socially and ethically unacceptable. High levels of inequality can lead to social unrest, reduced social mobility, and market failures, as those with low incomes have limited opportunities and purchasing power. The government's goal is not perfect equality, but to achieve a more equitable distribution. This involves a normative judgement about the desirable level of inequality. Key tools for measuring inequality, such as the Lorenz curve and the Gini coefficient, help policymakers to assess the scale of the issue and the impact of their interventions.

Progressive taxation is a cornerstone of fiscal policy aimed at redistributing income. Under this system, the marginal rate of tax increases as income rises. This means that higher earners not only pay more tax in absolute terms, but they also pay a larger percentage of their income in tax. This is based on the principle of 'ability to pay'. By taking a proportionally larger amount from the rich than the poor, the government reduces disposable income differentials, thereby making the post-tax distribution of income more equal. This is visibly represented by the post-tax Lorenz curve moving closer to the line of perfect equality, resulting in a lower Gini coefficient. However, a key evaluation point is the potential for high marginal tax rates to create disincentive effects on work and investment.

Transfer payments are payments made by the government to individuals, for which no good or service is provided in return. They are the primary method of redistributing the revenue raised from taxation. These can be categorised as means-tested benefits, which are targeted at individuals with low income and wealth (e.g., Jobseeker's Allowance, housing benefit), and universal benefits, which are available to everyone in a certain category regardless of income (e.g., state pensions, child benefit). By directly increasing the income of the poorest households, transfer payments are highly effective at reducing absolute poverty and narrowing the income gap. However, critics argue that means-tested benefits can create a 'poverty trap', where individuals are disincentivised from seeking work as their benefits would be withdrawn.

While income inequality is a flow concept, wealth inequality is a stock concept and is typically much more pronounced. Policies to address wealth inequality are often more difficult to implement politically. These include inheritance taxes, capital gains taxes, and annual wealth taxes. By taxing the transfer or holding of significant assets, these policies aim to prevent the concentration of wealth across generations. Furthermore, governments use other policies to tackle the root causes of inequality. The provision of merit goods like education and healthcare, free at the point of use, aims to improve equality of opportunity. A national minimum wage can also raise the incomes of the lowest-paid workers. These supply-side measures aim for a more equitable pre-distribution of income over the long term.