Economics: Equality & Equity (Chapter 16)

Tax

A fee charged by a gov't on a person's income, property, or consumption of goods and services.

Equations

(In a progressive tax system, each successively higher tax rate is only charged on the income in excess of that already paid on the previous level.) Marginal rate of taxation (MRT) = Δt/ΔYg Average rate of taxation (ART) = t/Yg [at a particular income level] APC = C / Y APS = S/Y MPC = ΔC / ΔY MPS = ΔS / ΔY Yd = C + S Yd - C = S

Benefits of market economy

-Encourages innovation w/ property rights -Good at resource allocation (where no market failure) -Achieves increase in total output and average standards of living through pursuit of self-interest and profits in f.o.p. Overall quite efficient.

Effects of progressive taxation

-Makes society more equal (and thus pushes lorenz curve line closer to that of perfect equality) (provided this income is redistributed) ->Used to provide goods, services and transfer payments to those whose incomes would otherwise be much lower ->Thus this equity leads to greater equality as shown by Lorenz curves (Sweden vs. Mexico, for example)

Disadvantages of market economy

-Susceptible to market failures; requires gov't intervention often -Unequal distribution of income; extreme in many circumstances where left unregulated

Causes of poverty

1) Low incomes: cannot buy basic necessities 2) Unemployment: unless extensive social safety nets, lack of income means cannot buy basic necessities 3) Lack of human capital: no education, healthcare and skills = less productive, and will produce and consume at a reduced level of income (therefore cannot buy basic necessities)

Consequences of poverty

1) Physical (disease, etc.) 2) Psychological (stress, depression, etc.) 3) Social (domestic abuse, civil unrest, potential violent struggle, etc.) 4) Cultural (social and economic exclusion, etc.) Economic growth will be lower than it needs to be, as the poorest can't contribute much to national output; an equitable distribution of income is therefore necessary to some degree - benefits outweigh costs.

Other means to promote equality

1) Transfer payments (from rich -> poor) 2) Government provision of merit and public goods (that produce spillover benefits and thus are under-provided for) ->Increases human capital and turns poverty trap into prosperity cycle [potentially] [gains society as a whole due to a more productive workforce] *Corruption affects ability to promote equity!*

Transfer payments from gov't

1) Unemployment benefits (keep AD afloat also) 2) Social security benefits 3) Nutritional subsidies 4) Higher education grants & subsidies 5) Welfare benefits

The Laffer curve

A graph the supports the supply-side view that at certain levels, a nation's total tax receipts are maximized (due to incentives to work). At an income of zero, there is no income to tax, and at a tax rate of 100%, nobody would bother working. What level precisely is this maximized, however? (Criticism)

Lorenz curve

A graphical representation of a country's income distriubution, with the % of income found on the y-axis and the % of a population with that % of income found on the x-axis.

Equality

A term that describes smaller disparities amongst a nation's households in maintainable living standards and the distribution of income and wealth across the population of a nation. Not achievable in a market economy due to the incentive schemes in place.

[Essay] Distinguish between progressive, regressive and proportional taxation, providing examples of each.

ANSWER

[Essay] Evaluate the effectiveness of a progressive income tax at bringing about a more equal distribution of a nation's income.

ANSWER

[Essay] In what ways might a more equal distribution of income contribute to greater economic growth?

ANSWER

[Essay] Justify the claim that poverty's consequences make its elimination the most important objective of economic policy.

ANSWER

[Essay] To what extent does greater growth lead to greater income equality?

ANSWER

[Essay] Using a Lorenz curve diagram and examples, distinguish between a country with a high level of income equality and one with a low level of income equality.

ANSWER

Gini index

An economic indicator of the level of income distribution in a nation from 0-100, where neither 100 (perfect inequality) nor 0 (perfect equality, as political connections or corrupt or ownership of essential resources) are achievable. Tells nothing of average incomes, only relative incomes of those within a nation.

Proportional tax

One for which the % remains the same/constant as income increases. The burden of tax is the same on all (rich still pay more in terms of raw numbers). Examples rare, but some payroll taxes.

Evaluation of a progressive taxation system

Disadvantages: -Creates a disincentive to work (punishes productivity) -Can be complex and difficult for nations to implement (particularly in poorer nations where much of the economy is 'underground') -Laffer curve evidence (but where are we on the Laffer curve); beyond certain levels tax revenue decreases from disincentive to work Advantages: -Is usually only 'marginal' (next dollar/currency unit you earn) -Effective means of income distribution -As economic growth will be lower than it needs to be, because the poorest can't contribute much to national output, an equitable distribution of income is therefore necessary to some degree - benefits outweigh costs

Equity

Fairness in economics; providing a level playing field for a "fair shot" at economic success, and promotes distribution. An achievable goal in a market economy. Progressive taxing, for example. Role of Gov't required. Reduces inequality, reduces poverty, and increases productivity (also achieve macroeconomic objective). Don't punish innovation and productivity and hard work too heavily with tax though.

Progressive tax

One for which the % paid increases as income increases; those with a greater ability to pay tax should bear a larger burden. Is the most equitable type of tax a gov't collects (in terms of the redistribution of income). Aligns with most of macroeconomic objectives.

Regressive tax

One that decreases in % as income increases. A larger burden on those with low incomes as must pay a greater % (in proportion to their income, the value paid by the rich is still most often greater). Most indirect taxes are regressive (in proportion to income).

Tax graphs

See notebook.

Indirect tax

Taxes paid by households through an intermediary (such as retail stores) who then pay the gov't. Sales, excise, and ad valorem are all examples of this. Can be legally avoided by not consuming a particular product or service. Burden born determined by PED and PES of product or service. In most cases, such taxes are regressive - this is as those with lower income spend a greater amount (as a proportion) on consumption, and therefore (as a proportion) are taxed higher (even though quantitatively the rich consume more, they have a higher ability to pay these taxes, and thus bear less of a burden).

Direct tax

Taxes paid directly to the gov't by those on whom they are imposed. Income and wealth, for example. Are not legally avoided, and burden is entirely on the households paying them. In most developed nations, such taxes are progressive.

Relative poverty

The condition experienced by those in a country whose incomes are considerably lower than those with higher incomes/higher income groups in the same country. (Rich and poor countries) Best reduced through policies aimed at redistribution of income are enacted (at a national level).

Absolute poverty

The condition experienced by those who cannot afford to buy or acquire basic necessities for a healthy and safe existence. Reduced best through economic development. (Increase in average wages changes absolute poverty but not necessarily relative poverty)

Efficiency

The highest output per unit of input.

The economic tradeoff between efficiency and equality

The incentive scheme provided in market economies means that, as a result, inequality will result; this does, however, allow for greater efficiency. Command economies are very good at distributing the wealth across the nation's population, leading to equality, however at the expense of efficiency due to the lack of incentives (i.e.: profits for entrepreneurs). "The unequal sharing of wealth vs. the equal sharing of poverty." Equity can still be promoted, however.

Gini coefficient

The ratio of the area above a country's Lorenz curve and below the line of equality to the toal area below the line of equality (requires derivation to fully calculate). Used to quantify the degree of income inequality in a nation. = A / (A + B) Higher = greater inequality