Do you agree that
the distribution of income should be made more equal solely through the use of
progressive taxation and transfers? Justify your answer. (25 marks)
Progressive taxation is when the proportion of income tax
increases as income increases thus the marginal rate of tax is greater than the
average rate; this enables a more equal distribution of income. However
criticism could be made for the progressive taxation policy and there are other
policies which may aid in a more equal distribution of income such as the
national minimum wage and government supply-side schemes to improve education
and training
Firstly progressive taxation closes the wealth gap as when
income increases so does the tax rate. For example in the UK the lowest band
with earnings up to £32,000 are taxed at 20% whereas the highest income band
earning over £150,000 are taxed at 45%. Consequently this redistributes income
with more equality and gives the government higher tax revenues, some
transferring in the forms of welfare spending therefore closing the income and
wealth gap. However, it can be argued that it is unfair for the higher income
earners to be taxed harshly only for their income to be distributed to lower
income earners as welfare benefits. This may create disincentives for people to
aim for high income jobs or become entrepreneurs, typically requiring greater
skill and qualifications, as a large quantity of the income will be taxed away;
by extension this will decrease the UK’s competitiveness and wealth compared
with other countries in the long run. Thus it can be considered that
progressive taxation and transfers should not be the sole instrument for a
fairer distribution of income. A system of regressive taxation maybe considered
for example VAT where the tax added on items is fixed (currently at 20%) for
all income earners, though this may be considered unfair to the low income
earners. Progressive and regressive taxation discourages the equity concept
whereby distribution is fair and just as it can be argued that for example a
window cleaner should not be earning as much as a surgeon thus progressive
taxation can be considered as not a fair system. However equity carries a value
judgement as there may be conflicting opinions on what ‘fair’ is.
The National Minimum Wage must also be considered; in the UK the NMW is
currently at £6.31 per hour for those who are aged 21 or over. Higher income
will suggest higher tax revenues and national insurance contributions for the
government. This policy suggests that all workers must be paid a bare minimum
of £6.31 (a substantial increase since the introduction of the national minimum
wage at £3.60 per hour in 1999) and therefore closes the income gap. Additionally
the national minimum wage will further encourage more unemployed workers to
work at the increased going wage rate thus will reduce workers falling into the
unemployment trap (whereby benefits outweighs thus erode any motivation to go
to work). As illustrated in the diagram above, the national minimum wage will
increase wages from ‘W’ to ‘NMW’ however this illustrates there is trade-off between
higher wages and employment, as firms are unwilling to hire more than ‘Q1’ at
the ‘NMW’ wage rate and as more workers are willing to work at the ‘NMW’ rate
results in excess supply as illustrated. Therefore higher wages can only be
achieved at the cost of unemployment (Q2 to Q1). However this will also give firms incentives
to raise the productivity of employees if they must pay the minimum wage. A
high minimum wage can also cause price inflation as it increases the costs to
firms who then may pass on the higher cost in wages to higher prices for
consumers thus results in cost-push inflation.
Government supply-side schemes
promoting education and training may also be considered. For example, the
government may implement training schemes to improve teaching which will lead
to better education and in the long run a more educated population with greater
skills and qualification which will reduce likeliness of different wages
arising from very skilled and unskilled workers thus resulting in a more equal
distribution of income. Other government schemes may also be considered, such
as awareness campaigns illustrating the positive spill overs of merit goods
such as education which will encourage people to work harder, for example in
the long run better education will suggests a more prestigious high status job
in the future which will also benefit the economy and contribute to economic
growth.
Overall progressive taxation can
be considered strong instrument in the fairer distribution of income and wealth.
However this policy does not follow the concept of equity and therefore can be
considered unfair. Furthermore it may cause disincentives for people to work
harder for higher income jobs as a larger percentage will be taxed away thus
will decrease the rate of growth of the economy and therefore weakening the
international competitiveness in the long run. Thus cannot be considered the
sole policy to distribute income more fairly. Other policies such as the
national minimum wage can be considered as it immediately minimises the income
gap in the short run. Furthermore it will encourage unemployed workers to find
work however as the supply of labour increases with the higher wage rate, the
demand of labour from firms will be reduced due to higher costs thus promotes
unemployment. Cost push inflation may also occur if the pressure for higher
wages gets passed onto to the customers by higher prices. Education and
training supply-side reforms may perhaps be the best way to distribute income
more fairly as it gives the opportunity of ‘unskilled workers’ to be trained
thus allows more job opportunities which may enable access to better paid jobs
in the long run resulting in a more equal distribution of income, though it
must be considered that supply-side polices are a long run phenomenon. Overall,
the best solution to a more equal distribution of income may be the combination
of several policies simultaneously.
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