Trying to make an unfair world a
little bit more fair…..
Remember the big 3 economic
questions?

For whom to produce?

 So what decides who receives the majority of income
and output in a market economy? What are the
determining factors?
Selling those factors of
production

Market economy reality

As we all know, there is a huge
disparity among owners of the factors
of production. Some people have
special talents and are highly educated,
some people do not. Many critics of the
market economy use this as an
argument against it….
So what if anything is government to
do?

The Big 4

 Government typically chooses from among four
policies to try and correct the issue of income
redistribution. Can we name them……?
#1--Transfer Payments

The distribution of income from the
haves to the have nots (vulnerable
groups). Let’s all shout out without
raising our hands some examples of
recipients of transfer payments and
types of transfer payments….
Transfers

Recipients
 Old folks
 Sick folks
 Poor folks
 Kids of poor folks
 Unemployed folks
Examples
 Pensions
 Unemployment
benefits
 Housing benefits
 Child allowances
 Maternity benefits and
more….
#2—Subsidized provision of merit goods

Accepting the reality of unequal income
distribution, it would not be surprising to
see many of the less fortunate in society
unable to receive the benefits of certain
merit goods. Merit goods are goods
that……..
Merit Goods

Merit goods have spillover benefits but often
can’t be purchased by poor people.
Considered basic human rights nowadays,
with unequal distribution of income, too
many people would not receive these goods,
thus causing significant problems for society
as a whole.
Government’s role

Government must make sure not only to
provide education and healthcare but to
make them affordable too. Some
governments provide free universal
healthcare and education, while others have
not gone as far…..perhaps they should…
Other subsidized merit goods

 Thank-you government for:
 Clean Water
 Sanitation
 Sewerage
Government’s role

Subsidize merit goods to ensure that the
quantity provided increases
#3—Government intervention in
markets

Government will often intervene in markets
to benefit certain groups. Examples include:
Minimum wage legislation
Price supports for farmers
Subsidies to firms
#4--Taxation

Taxation

Tax revenue allows for the provision of
transfer payments and the subsiding of
merit goods. Tax policies on their own
also allow for redistribution of income,
but decisions must be made….
Everybody hates taxes!

 Yet they allow government to do many important
things, such as:
 Provide public transport
 Provide transfer payments/merit goods
 Correct negative externalities
 Pursue fiscal policy when needed
 And many, many more…
Two types of taxes

Direct taxes

These taxes are paid directly by the consumer
to the government. Examples include:
Personal income tax
Corporate income tax
Wealth tax (on property, inheritances)
Earmarked taxes (to support programs like
unemployment insurance, social security and
healthcare)
Indirect Taxes

These taxes are usually placed on the
supplier or seller of a good/service, but the
consumer will have to incur some incidence
of this tax. There are three main categories
we will discuss……
General Expenditure Taxes (Sales
taxes)

These are taxes on various goods and
services paid at the time of purchase.
In the U.S.A., many states put a fixed
percentage tax on goods purchased.
Other countries use a value added tax, which
taxes each stage of the production process for
the value that is added.
Excise taxes (Sin taxes)

These are taxes placed on goods that the
government wants to discourage
consumption of. The level of incidence of the
tax for the consumer depends on the
elasticity of demand of the consumer for the
particular product.
Tariffs (Customs duties)

These are taxes placed on imported goods.
They serve the purpose of protecting
domestic industries and at the same time
raising revenues. They tend to be much less
a part of government policy in MDCs than
they are in LDCs
The ability to pay principle

Most human beings with a heart can come to
terms with the idea that the more income you
earn the more you should contribute in taxes.
 Unfortunately, the question is more
complicated than should the wealth pay
more, but how much more should they pay?
Tax Flavours

Tax Flavours

Taxes are usually defined as being either:
Proportional
Progressive
Regressive
This depends on the relationship between
income and the fraction of income paid as
tax…sound confusing? It’s not really….
Proportional Tax

As income increases, the fraction of income
paid as taxes remains constant.
Joe makes $10,000 a year and his tax rate is
15%. Warren makes $10,000,000,000,000 a
year, and his tax rate is 15%.
Warren obviously pays more in taxes, but the
tax rate is the same. Seem fair?
Proportional Tax

As income increases, the fraction of income
paid as taxes remains increases.
Joe makes $10,000 a year and his tax rate is
15%. Joel makes $20,000 a year, and his tax
rate is 20%.
Joel earns more therefore pays more in taxes.
This is a mildly progressive tax, a strongly
progressive tax would be higher for Joel.
Seem fair?
Regressive tax

As income increases, the fraction of income
paid as taxes decreases.
Joe makes $10,000 a year and his tax rate is
15%. Bill makes $20,000 a year and his rate is
10%.
Bill still pays a larger dollar amount in this
example than Joe, but his % is lower. Seem
fair?
General Conclusion

The more progressive a tax system is, the
more equal the after-tax distribution of
income will be compared to the pre-tax
distribution of income.
However, this alone does not remove the
controversy surrounding the tax issue
Controversy over taxes

As you can probably guess, people with high
incomes are not happy to see a highly
progressive tax system.
They argue that they worked hard to achieve
what they have, and shouldn’t be forced to
pay a higher rate to support the lower
income classes.
Is this a fair point?
Additional questions to ponder

Do high taxes reduce the incentives of
the rich to work and save?
Additional questions to ponder

Do taxes worsen the allocation of resources
(create allocative efficiency) ?
Do high taxes encourage tax evasion?
Additional questions to ponder

Is there a trade-off between income equality
and efficiency?
If we create more income equality, will
economic growth be sacrificed?
Additional questions to ponder

Might there be a conflict between using taxes
as a fiscal policy tool and as an income
redistribution tool?
Do transfer payments reduce the incentives
of the poor to work and save?