VII Международная студенческая научная конференция Студенческий научный форум - 2015

Whether one claims that “money is the king”, or “money cannot buy happiness”, one thing remains constant: mankind has been using money for well over two thousand years, and most likely will continue to do so for foreseeable future. And as long as some equivalent of money has been in circulation, there has been an issue of economic inequality between people. Some States have tried to ignore the issue; some have taken quite drastic measures to try to eliminate it. Nowadays, the topic is still relevant. There are vigorous discussions going on constantly concerning whether government should interfere with the problem or not.

Naturally, before considering whether or not governments should take action in the matter of solving income inequality, one first needs to clearly define what income inequality means. According to Investopedia, income inequality is the unequal distribution of household or individual income across the various participants of an economy. Hence, equity can be defined as a state of economy when income is distributed justly and fairly (Sloman, 2013).

Concepts like these are quite abstract, and moreover very subjective. For instance, is income equality simply an equal share of wealth given to each participant of economy, or an equal opportunity to earn that wealth? Moreover, should income equality include social benefits, which add up to well-being of households? Last but not least, which approach should the governments use when defining what kind of distribution is to be considered fair?

Economic theory does not provide certain answers to these questions. That makes the dilemma even harder, since it is challenging to find remedies for vaguely defined issues, to say the least. Nevertheless, majority of the governments in the world still use redistribution of income policies, which comprise a practice designed to level incomes across a society through the transfer of income from wealthier to poorer individuals, either directly or indirectly (Stiglitz, 2000).

When it comes to defining what should be considered a ‘fair’ redistribution of income, there are four most known approaches. Egalitarian approach assumes that just distribution of wealth is when every participant gets an equal share of monetary or other benefits. Probably the most well-known example of this concept in action is Soviet Union barrack-style communism. History taught us that this approach does not work, as it creates major disincentives for workers. Since profits are divided equally between everyone, there is no need to put in more effort or work harder, and in the end, that drastically affects the economy.

Another approach, utilitarian, states that a fair distribution of wealth is such, when public welfare and well-being maximizes. While rawlsian approach would presume the fairest outcome to be the one in which the least favoured participant of the economy benefits. Lastly, market approach considers the natural result of free trade and perfect competition to be the most just.

As was already said above, there is no ‘official’ explanation of what is fair distribution, which would be accepted universally by all countries, nevertheless, majority of the governments implement at least some of income redistribution policies.

The most common practices include various benefits and taxation policies. Benefits can be divided into benefits in kind (or so-called ‘equal opportunity’ benefits), means-tested cash benefits, and finally, universal cash benefits.

Benefits in-kind include free education, free health-care, public parks, public recreational facilities, etc. provided by the government. A good example of benefits in kind would be the educational system of Finland: education is completely free of charge, including the higher levels, and what’s even more impressive, even to foreign citizens. These benefits are very helpful in terms of creating equal opportunities for people of different income. Unfortunately, not all governments are able (or willing) to provide these benefits. For instance, in USA primary and secondary education is free of charge, while higher education is very costly. Furthermore, only a small percentage of college applicants match the requirements for scholarship, and even if they do, it is rarely government-funded.

Moreover, some people argue that benefits in kind should not be available for all stratums, as wealthy people are perfectly able to pay for services they need. Advocates of this suggestion reason that money spent on providing rich with free health care could be better spent on aiding orphans. While this reasoning seems to make some sense, I personally do not agree with such judgement. After all, it starts to appear like in modern world governments are ought to discriminate and rob wealthier households in order to please the poorer ones.

Another type of benefits are universal cash benefits, which are granted regardless of the income, but rather on basis of other criteria. For example, a maternity capital of 430 000 rubles (approximately 86 000 euros) is given to every mother in Russian Federation for each child born after the first one. This money can be used for child’s education, or buying a larger home, etc. Universal cash benefits face the similar criticism as the benefits in kind. Moreover, in majority of the cases universal cash benefits are implemented to impact society in a certain way, i.e. the maternity capital in Russia is aimed at increasing the population. What happens to these benefits once the primarily goal is achieved? Most likely they will be no more, so economically challenged households cannot depend on these as a constant mean of support.

It is important to remember, that the more universal and in-kind benefits there are, the more costly it is to provide them, which in turn, means higher taxes.

On the other hand, there are means-tested cash benefits, which are given to people only if they fall into certain category: i.e. orphans in Russia are given a certain amount of cash each month; unemployed people in Finland are entitled to subsidy from Kela.

Figure 1

However, there are several issues to consider concerning means-rested benfits. First of all, how low or high should the threshold for receiving these benefits be drawn? It might happen that people, who live in utter beggary, do not qualify for the benefits. Second, awareness of these benefits might be relatively low in a country. This means that individuals who need help and qualify for it might not apply for it at all, due to ignorance. Third, means-tested benefits often create a so-called poverty trap, which is based on the concept of tax-plus-lost-benefit. In a nutshell, security benefits provided by the State make people so dependent on them, it becomes practically impossible to escape the poverty, especially if State implements steep progressive taxation. This is due to the fact, that if these people strive and earn more, they move into higher tax brackets and end up having even less disposable income than before. In a situation like this, it becomes easier for economically challenged to give up trying, and just continue receiving benefits. Furthermore, the bigger the means-tested benefits are, in other words, the more they are directed towards the impoverished, the bigger the poverty trap is. Some countries (for example United Kingdom) have tried to ease this problem by implementing a negative income tax (Figure1)

Negative income tax is a combination of taxation and benefits systems. Basically, below a certain threshold, people pay a negative tax and receive a number of means-tested benefits. The more they start to earn, the bigger tax they start to pay and the less benefits they receive, until some day, they start paying a positive tax and receive no means-tested benefits at all.

As for the taxation policies used in the redistribution of income, progressive taxation is the tool some governments use. In simple terms it works like this: the more money an individual earns, the higher the tax, and vice versa. This practice is commonly used in many countries (including Finland and USA). Yet, as J. Sloman (2013) put it: “taxes can reduce the income of the wealthy, but cannot increase the income of the poor.” On top of that, taxes can affect the incentives of the population drastically, and not always in a good manner. The main reason for using progressive income taxation (in redistribution of income context) is to compensate for the fact that many indirect taxes (such as VAT) place a heavier burden on households of smaller income. However, progressive taxation is the cause of income effect and substitution effect. When taxes rise, income effect will cause certain people to work more to fill up the income taken away in taxes. Typically, these will be people with long-term commitments, such as family, children, mortgage, or a big loan, as these people are the ones who cannot afford earning less money. At the same time, other people will be subjects to substitution effect, which will cause them to endure in leisure activities, rather than working, since the opportunity costs of not working has decreased with the tax raise. Some economists claim that this, in turn, causes smaller national output, which as a consequence calls for bigger taxes, and so the vicious circle closes.

It depends on a particular country which effect will prevail (on the rich vs poor ratio, credit loans percentage, etc.)

Meanwhile, certain people advocate for an overall tax cuts. It is true, that to some extent, people would be relieved, especially in countries with high tax rates (such as Finland). Nevertheless, it is a very short-sighted demand, as governments need taxes to operate State transactions and perform its duties.

In theory, means of redistribution of income should help those in need and serve as a jumping –off point into the ‘better life’ for recipients of the help, as we see, each policy has major drawbacks, that affect economy in a harmful way. A relevant question arises: if redistributive policies are so controversial, why governments use them in the first place? After all, equality, like some other economic concepts, is unnatural and non-existent in real life. Moreover, markets fail to resolve the issue of redistribution of income, because they are socially neutral. It means that there is no Pareto optimal solution for the matter: as was said earlier ‘fairness’ is a vague subjective concept.

However, economics is a social science, and although for the sake of theory we assume that a lot of concepts and economic actors are impartial, in reality that is not the case. That is why governments should definitely continue to implement redistributive policies, regardless of the fact that it might mean less effective economy. These policies are aimed primarily at easing the social tension between stratums, not at achieving the utopic state of mankind equality. Redistributing income is never going to solve the problem of inequality, but it is going to allow for a more nourishing social environment to be created.

References

1. John Sloman and Dean Garratt (2013) Essentials of Economics, 6^th ed. Harlow: Pearson.

2. Investopedia. 2014. Income Inequality Definition. [ONLINE] Available at:http://www.investopedia.com/terms/i/income-inequality.asp. [Accessed 20 March 14].

3. What Is Income Redistribution? (with picture). 2014. What Is Income Redistribution? (with picture). [ONLINE] Available at:http://www.wisegeek.org/what-is-income-redistribution.htm. [Accessed 20 March 2014].

4. Stiglitz J.E. , Driffill J., 2000. Economics. 3rd ed. New York: W.W. Norton&Company Inc.

5. PensionFund of Russian Federation. 2014. Maternity Capital 2014. [ONLINE] Available at:http://www.pfrf.ru/family_capital/. [Accessed 21 March 14].

6. Poverty Trap Definition | Poverty Trap Meaning - The Economic Times. [ONLINE] Available at: http://economictimes.indiatimes.com/definition/Poverty-Trap. [Accessed 21March2014]

7. What is poverty trap? definition and meaning. 2014. What is poverty trap? definition and meaning. [ONLINE] Available at:http://www.businessdictionary.com/definition/poverty-trap.html. [Accessed 30 March 2014].

8. Illustration. 2014.. [ONLINE] Available at: http://www.yawningbread.org/arch_2009/pic-1090b.gif. [Accessed 30 March 2014]

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