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Environment and Equality » Inequality and Poverty

What you'll learn this session

Study time: 30 minutes

Edexcel spec: 2.1.1 (f)

What income inequality, absolute poverty and relative poverty mean
Why governments want to reduce poverty and inequality
How progressive taxation, benefits, education and healthcare redistribute income
How to work out tax on a simple progressive tax system

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Redistribution of income

Redistribution of income is the last of the government's macroeconomic aims in this section. It means moving income from some people to others, so that the gap between rich and poor gets smaller. This content is examined on Paper 2: Macroeconomics and the Global Economy.

Key terms:

Income inequality: the unequal sharing of income between people or households in a country.
Absolute poverty: not having enough income to afford the basic things needed to live, such as food, clean water, clothing and shelter.
Relative poverty: having an income that is much lower than the average income in your own country, so you cannot live as most people do.

Absolute and relative poverty

Relative poverty means being much poorer than most people around you, even if basic needs are met

These two ideas are easy to mix up. The key is what the person is compared with.

🍲 Absolute poverty

The comparison is with a basic standard of living. A family that cannot afford enough food or a safe home is in absolute poverty, wherever they live.

📊 Relative poverty

The comparison is with other people in the same country. A family may have food and a home but still be unable to afford what most people take for granted, such as a school trip for their child.

Because relative poverty depends on the average income, it can exist even in a rich country. Income inequality is different again. It looks at the whole country, not just the poorest. If a few people earn a very large share of all income, inequality is high.

Why reduce poverty and inequality?

Governments try to reduce both for three main reasons.

Meet basic needs: everyone should be able to afford food, water, shelter and clothing. Without these, people become ill or cannot work.
Raise standards of living: people with more income can buy better food, housing and education, so their quality of life rises.
Ethical reasons: many people believe it is simply unfair for some to have so little while others have so much. These are views about right and wrong, not facts.

How governments reduce poverty and inequality

Investing in education gives children from poorer families a better chance of higher earnings later

There are three methods in the spec.

Progressive taxation. A progressive tax takes a larger percentage of income from people with higher incomes than from people with lower incomes. The rich pay a bigger share, so the gap shrinks.
Benefit payments. The government collects tax and pays money to people who need it, for example people without work or on very low incomes. This is redistribution, because money is moved from taxpayers to those with less.
Investment in education and healthcare. Spending on schools, colleges and hospitals helps poorer people gain skills and stay healthy, so they can find better-paid jobs in future. This builds human capital and tackles the cause of low income, not just the effect.

Worked example: a progressive tax

Country Kestor has three tax bands. Tax is only charged on the part of income inside each band.

Part of yearly income	Tax rate
First 10,000 crowns	0%
Next 20,000 crowns (10,001 to 30,000)	20%
Anything above 30,000 crowns	40%

Worked example

Ana earns 20,000 crowns. The first 10,000 is taxed at 0%, so the tax is 0. The next 10,000 is taxed at 20%: 10,000 × 0.20 = 2,000. Total tax = 2,000 crowns. Share of income paid in tax: 2,000 ÷ 20,000 × 100 = 10%.

Ben earns 50,000 crowns. First 10,000: 0. Next 20,000 at 20% = 4,000. The last 20,000 at 40% = 8,000. Total tax = 12,000 crowns. Share of income paid in tax: 12,000 ÷ 50,000 × 100 = 24%.

Ben pays a higher percentage of his income than Ana, so this tax is progressive.

After tax, Ana has 18,000 crowns and Ben has 38,000. Before tax Ben earned 2.5 times as much as Ana. After tax he has about 2.1 times as much (38,000 ÷ 18,000), so the gap has narrowed. That is redistribution at work.

Common mistakes

Charging the top rate on all of a person's income. Each rate only applies to the income inside its own band.
Saying a progressive tax means the rich pay more money. A flat percentage would also do that. Progressive means the rich pay a bigger percentage.
Mixing up absolute and relative poverty. Absolute is about basic needs. Relative is about being far below the national average.
Writing that benefits are free money from nowhere. They are paid for by taxpayers.

Exam-style question

Country Orsa has a progressive tax. The first 5,000 crowns of income is taxed at 0%. Income above 5,000 crowns is taxed at 25%. Yaz earns 25,000 crowns a year. The government also pays benefits to families on low incomes and is building new schools in poor areas.

(a) Define relative poverty. [2 marks]

(b) Calculate the tax Yaz pays. [2 marks]

(d) Evaluate whether reducing inequality should be a government priority. [6 marks]

Model answer

(a) Relative poverty is having an income (1) that is much lower than the average income in the country (1).

(b) Income taxed = 25,000 − 5,000 = 20,000 (1). Tax = 20,000 × 0.25 = 5,000 crowns (1).

(c) Benefit payments give money to low-income families (1), which helps them afford basic needs such as food and housing (1), so fewer families are in poverty (1). An answer about new schools would also score: they give poorer children skills (1) to earn more in future (1) and raise their standard of living (1).

(d) Reducing inequality helps people meet basic needs and raises living standards for the poorest (1), and many people think it is fair (1). Benefits and education can help poor families improve their lives for the long term (1). However, redistribution costs the government money, which has to come from taxes (1), and very high tax rates may make people less keen to work or earn more (1). Overall, it is probably a priority, as long as the tax rates stay low enough to keep people working (1).

Exam tip

For part (b), show each step: the part of income that is taxed, the rate, then the answer. A correct method can earn a mark even if the final number is wrong.

Recap

Income inequality is the unequal sharing of income. Absolute poverty is not affording basic needs. Relative poverty is income far below the national average.
Governments reduce poverty to meet basic needs, raise standards of living and for ethical reasons.
Methods are progressive taxation, benefit payments, and investment in education and healthcare.
A progressive tax takes a bigger percentage of higher incomes. Apply each rate only to the income in its band.

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