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  • A means-tested benefit is a payment available to people who can demonstrate that their income and capital (their 'means') are below specified limits.
  • The main means-tested benefits in 2013 are (UK):
  • Income Support
  • Income-based Jobseeker's Allowance
  • Income-related Employment and Support Allowance
  • Pension Credit Guarantee Credit
  • Working tax credit
  • Child Tax Credit
  • Universal Credit
  • Housing Benefit

Receipt of these benefits, other than Housing Benefit and tax credits is a passport to other non-cash help such as free school meals, free prescription charges, Legal Aid, cold weather payment. The claimant, their partner and dependent children are covered.

1. Sustained economic growth- here is a concern that economic growth could widen relative poverty because it benefits the highly skilled and wealthy classes more than those at the bottom

2. Reduce Unemployment- Unemployment is a major cause of poverty because the unemployed have little income, relying on state benefits. Unemployment can be reduced through both supply Side and demand side policies 

3. Progressive Taxes- This can be an effective way for reducing relative poverty. However, critics argue higher income taxes create a disincentive to work., leading to less output, However this is disputed by other economists. Higher tax reduces incomes and this may encourage people to work more, to maintain their income.

4. Increasing benefits to the poor -

  • Means tested benefits involve increasing welfare benefits to those on low incomes. For example, universal tax credit or child benefit.

Advantages of means tested benefits:

  • They allow money to be targeted to those who need it most. e.g family tax credit or pension credit.
  • It is cheaper than universal benefits and reduces the burden on the tax payer.

However the problem with using benefits to reduce poverty include:

  • Means tested benefits are often unpopular because people are stigmatised as being poor.
  • Also it may create a disincentive to earn a higher wage, because if you do get a higher paid job you will lose at least some of your benefits and pay more tax. This is known as “the benefit trap” or the “poverty trap”. The poverty trap occurs where people on low incomes are discouraged from working extra hours or getting a higher paid job because any extra income they earn will be taken away in lost benefits and higher taxes. To avoid the poverty trap the government can grade benefits so that there isn’t an immediate cut off point.
  • Some relatively poor may fall just outside the qualifying limit.
  • Also not everyone entitled to means tested benefit will collect them because of ignorance or difficulties in applying.
  • The government used to prefer universal benefits because it avoided the above problem, and people feel if they contribute towards taxes they deserve their benefits regardless of their wealth.

However in recent years, the welfare state has faced increased demands due to demographic factors leading to more calls for means tested benefits.

5. National Minimum Wage - The government could increase the national minimum wage. This is an effective way of increasing the incomes of the low paid, and therefore reducing wage inequality.

However, the problem is that it may cause unemployment because firms may not be able to afford the workers. If it does cause unemployment, poverty could worsen. However, if firms have monopsony power then they will be able to afford higher wages.

A related concept is the Voluntary Living Wage – an attempt to encourage firms to pay higher wages.

6. Benefits in kind. These are important public services which are provided free at the point of use (or subsidised). They mainly involve education and health care. Free education enables those from low income families to gain skills and qualifications which can help lead to better jobs and higher incomes in the future.

7. Universal basic income (UBI) A universal basic income or citizen’s income involves giving every citizen a weekly benefit – regardless of circumstances and income. The idea is to ensure everyone has a minimum income guarantee, but without any disincentives of losing means tested benefits from working more. See more at: Universal basic income (UBI)

Tax policy can play a major role in making the post-tax income distribution less unequal. In addition, tax policy is crucial for raising revenues to finance public expenditure on transfers, health and education that tend to favour low-income households, as well as on growth-enabling infrastructure that can also increase social equity.

The effects of taxation on income distribution needs to be seen in the context of the trade-offs between growth and equity, and this means looking at the overall effects of any reform on the fiscal regime as a whole, and not just at whether individual taxes are progressive or regressive.

This is because the distribution of disposable incomes depends on both taxes and benefits. Raising indirect taxes, for instance, is often regressive where these taxes fall on the consumption of goods and services that make up a larger share of the budgets of poorer than richer households. But the overall impact of a fiscal reform can still be progressive, if these effects are offset by other tax and benefit changes.

Income-related benefits, for example, are a much more efficient way of increasing the disposable income of poorer households than reduced rates of VAT.

Simply raising marginal personal income tax rates on high earners will not necessarily bring in much additional revenue, because of effects on work intensity, career decisions, tax avoidance and other behavioural responses.

Where tax increases are necessary, the most growth-friendly approach would be to reduce tax-induced distortions that harm growth, including closing loopholes, and to raise more revenues from recurrent taxes on residential property, while setting taxes to reduce environmental damage and correct other externalities.

There is also scope to raise taxation of residential property which is relatively lightly taxed in many countries. However, while the better off tend to own the most expensive residential property, there are many middle class owners too, so reform has to be approached cautiously, especially given the bruising many home-owners took from the housing bubble.

Nevertheless, out-of-date values for tax purposes often distort the efficiency of property markets (by discouraging individuals from moving home, thus reducing labour mobility) and many existing property taxes tend to be regressive, i.e. take proportionally more of the income of poorer households. Reform and revaluation could make property taxes both fairer and less distortive.

Good tax administration also matters. New IT systems in use in revenue administrations increasingly include tools such as sophisticated risk engines to identify potential missing revenues. Efforts to curb offshore non-compliance by making the exchange of information among tax authorities more effective have been given a new impetus. Tax evaders, who are often wealthy, have fewer places to hide their money. These initiatives also bolster international efforts by the IMF, OECD, UN and World Bank to help low-income countries to develop more effective tax systems.

Capital gains tax

Capital gains tax can effect economic growth, when the tax rate is high investment will decrease however the opposite will occur when the tax rate is low, the benefit of this is that the government can therefore use capital gains tax to influence behaviour.

Another merit is that this form of taxation does promote equality as it is a tax on the profit made when an asset is sold, people making gains.

A Capital Gains Tax may be regarded as reducing inequality of wealth in much the same way as a progressive income tax system.

Inheritance Tax

One merit of inheritance tax is that it motivates charitable contributions because charitable donations are exempt from the tax and may also reduce the rate of tax that is paid. This motivation would be diminished if inheritance tax was abolished. However some may argue that death isn't the most appropriate time to impose a tax. Another benefit is that this tax is in line with the equity principle where by a person is taxed according to his/her ability to pay

The main aim of this form of taxation is to reduce inequality through the redistribute income and wealth, 

Value added tax

A merit of value added tax is the level of horizontal equality associated, everyone that buys a certain product has to pay the same level of VAT and if a person spends more on those products they pay more VAT, in a way giving people choice.

Another merit is how this type of tax can be used to influence behaviour for example if there was a high VAT on petrol consumption of this in theory would fall, this technique could be used for the greater good of the economy.

However if the VAT was set too high it could just lead to inflation and maybe even a decrease in the standard of living.

Value added tax is also efficient as the cost of collection is minimal because collection takes place automatically when goods/services are bought and sold, Adam smith (1776) suggested that this was a principle of a "good tax". This method of collection also makes tax evasion very difficult.

Negative Income tax

In economics, a negative income tax (NIT) is a progressive income tax system where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. Such a system has been discussed by economists but never fully implemented.

Negative income taxes can implement a basic income or supplement a guaranteed minimum income system.

In a negative income tax system, people earning a certain income level would owe no taxes; those earning more than that would pay a proportion of their income above that level; and those below that level would receive a payment of a proportion of their shortfall, which is the amount their income falls below that level.

A negative income tax is intended to create a single system that would not only pay for government, but would also fulfill the social goal of making sure that there was a minimum level of income for all.

Negative income tax (NIT) would allow claimants to receive income through the simple filing of tax returns rather than through the claiming of welfare benefits, ideally eliminating the need for a complex welfare bureaucracy.

Poverty Trap

The poverty trap is a mechanism which makes it very difficult for people to escape poverty. A poverty trap is created when an economic system requires a significant amount of various forms of capital in order to earn enough to escape poverty. When individuals lack this capital, they may also find it difficult to acquire it, creating a self-reinforcing cycle of poverty.

BREAKING DOWN 'Poverty Trap'

In order to escape the poverty trap:

It is argued that individuals in poverty must be given sufficient aid so that they can acquire the critical mass of capital necessary to raise themselves out of poverty. This theory of poverty helps to explain why certain aid programs which do not provide a high enough level of support may be ineffective at raising individuals from poverty.

If those in poverty do not acquire the critical mass of capital, then they will simply remain dependent on aid indefinitely and regress if aid is ended.

Poverty trap is a spiraling mechanism which forces people to remain poor. It is so binding in itself that it doesn't allow the poor people to escape it. Poverty trap generally happens in developing and under-developing countries, and is caused by a lack of capital and credit to people.

Poverty trap can be broken by planned investments in the economy and providing people the means to earn and be employed. A series of poverty alleviation programs can be enforced to raise individuals out of poverty by providing monetary aid for a period of time.

But if the plan fails, people will become dependent on such programs forever and may even go deeper down in the poverty spiral. However, poorer countries find this to be difficult, leading to the over-exploitation of natural resources and land.

Policies to reduce Poverty Trap

1. Reduce benefits.

If benefits are reduced or abolished, such as income support there is a greater incentive to get a better paid job. However, this may increase relative poverty as the low paid will get lower incomes compared to the rest of the population.It may cause the unemployment trap. It will reduce the gap between unemployment benefits and low paid work.

2. Have a Graded system of Benefits.

This means that if your income increases you still get some benefits. There isn't an immediate cut off point, but, there is still an incentive to work longer hours and get a better paid job.

3. Increase the Income Tax Threshold.

This means that you increase the amount of income that you can earn before you start paying any tax. At the moment, it is around £5,000. Increasing this limit gives a greater incentive to work and earn more.

4. Increased Minimum Wages.

A higher minimum wage helps to make work more attractive. However, if it is too high it might cause a rise in unemployment. However, the increase in the UK minimum wages since '97 has not caused unemployment

5. Family Tax Credits

Graded benefits for those in work. It leads to lower tax bills and is graded to avoid any disincentives of working harder.

6. Make it harder to get sickness and disability to benefits.

It is argued that many people who are on sickness and disability benefits would be able to do some types of jobs. In some cases, sickness benefit has been seen as an alternative to being on unemployment benefit. But, because it is attractive to remain on sickness benefit there is a disincentive to work.

It is a difficult situation, with a conflict between the need to give workers the proper incentives and the importance of avoiding unfair treatment of the low paid.

  • This curve is called the "line of perfect inequality." The Gini coefficient is the ratio of the area between the line of perfect equality and the observed Lorenz curve to the area between the line of perfect equality and the line of perfect inequality. The higher the coefficient, the more unequal the distribution is.

  • On the graph, a straight diagonal line represents perfect equality of wealth distribution; the Lorenz curve lies beneath it, showing the reality of wealth distribution. The difference between the straight line and the curved line is the amount of inequality of wealth distribution, a figure described by the Gini coefficient.
  • The Lorenz curve can be used to show what percentage of a nation's residents possess what percentage of that nation's wealth. For example, it might show that the country's poorest 10% possess 2% of the country's wealth.

  • While the Lorenz curve is most often used to represent economic inequality, it can be used to represent inequality in any system. The further away the curve lines from the baseline, represented by the diagonal, the higher the level of inequality it represents. When related to economics, the Gini coefficient is used the express the inequality with a single figure. The Gini coefficient can be anywhere from 0, representing complete equality, to 1, representing complete inequality.

In an economy with perfect equality, noted by a Gini coefficient of 0, 20% of the population would hold 20% of the wealth. As the percentage of the population in consideration rises, so do the amount of wealth held, with a one for one increase.

In a perfectly inequality curve, the Gini coefficient is 1, and the curve represents 100% of a nation's wealth being held by one single person or entity.

More commonly, Lorenz curves bring out information showing some level of inequality, such as 50% of the population only holding 35% of the wealth. The greater the disparity within a nation, the closer the Gini coefficient will be toward 1.

The Lorenz curve and Gini coefficient are popular in economics because they allow for negative wealth. If a certain portion of the population has negative wealth, the Lorenz curve can move below the x-axis.

Though this can provide valuable information, it should be used in conjunction with other information and models. It cannot demonstrate the cause of the negative wealth, which may be relevant to the overall economic analysis.

The Gini index is a measurement of the income distribution of a country's residents. This number, which ranges between 0 and 1 and is based on residents' net income, helps define the gap between the rich and the poor, with 0 representing perfect equality and 1 representing perfect inequality. It is typically expressed as a percentage, referred to as the Gini coefficient.

BREAKING DOWN 'Gini Index'

The Gini coefficient is an important figure for the analysis of relative poverty within a country or region, but it should not be mistaken for a measurement of wealth. A wealthy country and a poor country can have the same Gini coefficient, as long as they have similar income distributions.

Graphical Representation

The Gini coefficient is often represented graphically as the area between the Lorenz curve and a line of equality. The Lorenz curve is also a graphical representation of income distribution, plotting cumulative income shares relative to cumulative population shares.

For example, the chart would could show that the poorest 80% of the population takes in 50% of total income. The Lorenz curve and Gini coefficient can also be altered to reflect wealth rather than income, though wealth is often more difficult to measure than income.

  • Intergenerational equity is a concept that says that humans 'hold the natural and cultural environment of the Earth in common both with other members of the present generation and with other generations, past and future' (Weiss, 1990, p. 8). It means that we inherit the Earth from previous generations and have an obligation to pass it on in reasonable condition to future generations.

  • The idea behind not reducing the ability of future generations to meet their needs is that, although future generations might gain from economic progress, those gains might be more than offset by environmental deterioration. Most people would acknowledge a moral obligation to future generations, particularly as people who are not yet born can have no say in decisions taken today that may affect them.
  • There are two different ways of looking at the need to ensure that future generations can supply their needs. One is to view the environment in terms of the natural resources or natural capital that is available for wealth creation, and to say that future generations should have the same ability to create wealth as we have. Therefore, future generations will be adequately compensated for any loss of environmental amenity by having alternative sources of wealth creation. This is referred to as 'weak sustainability'.

The government's ESD working groups have argued that, unless substantial change occurs, the present generation may not be able to pass on an equivalent stock of environmental goods to the next generation. This would be due to three factors:

  • Firstly, the rates of loss of animal and plant species, arable land, water quality, tropical forests and cultural heritage are especially serious.

  • Secondly, and perhaps more widely recognised, is the fact that we will not pass on to future generations the ozone layer or global climate system that the current generation inherited.

  • A third factor that contributes overwhelmingly to the anxieties about the first two is the prospective impact of continuing population growth and the environmental consequences if rising standards of material income around the world produce the same sorts of consumption patterns that are characteristic of the currently industrialised countries.

The other way is to view the environment as offering more than just economic potential that cannot be replaced by man-made wealth and to argue that future generations should not inherit a degraded environment, no matter how many extra sources of wealth are available to them. This is referred to as 'strong sustainability'.

Policies to reduce relative poverty

  • There are two major types of poverty:
  • Absolute poverty – when people have insufficient income to afford the basic necessities of life, such as food, rent and clothing.
  • Relative poverty – when people have income significantly less than the average income for society.
  • In a developed country, like the UK, absolute poverty is generally very rare. However, relative poverty is a significant problem.

How does the government use the means tested benefits to redistribute income and wealth?

Progressive Income tax, Inheritance and capital gains tax – How does it redistribute Income and wealth?

Intergenerational Equity

Means Tested Benefits

Lorenz Curve, Gini Coefficient & Measuring Inequality

The Gini Coefficient

  • The Gini coefficient is calculated based on the discrepancy between the diagonal line and the Lorenz curve, dividing that figure by the total of the wealth held within a particular country. This allows multiple economies to be compared to one another when examining wealth distribution among individual nations.

  • Tracking the Gini coefficient can demonstrate wealth trends in particular nations over time.

Gini Coefficient & Lorenz Curve

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