Line of Equality if everyone earned the same income, 20% of the population would earn 20%
of the income, 40% would earn 40% etc.
Lorenz Curve shows the actual share of income earned by each fifth, from poorest to richest. The further away the curve is from the line of equality, the more unequal the distribution of income.
1. PERCEPTIONS OF FAIRNESS OR EQUITY
If the poor feel the rules and institutions which govern them favour the wealthy and hinder their own efforts to improve their economic and social position they either will stop trying, which is a huge loss of potential, or they will actively seek to overturn the existing order through revolution, which is hugely destructive. While some inequality is motivating (both for the poor to work hard to improve their position and for the wealthy to work hard to maintain their position), too much in-equality (especially that seen as the result of cronyism or corruption) is seen as unfair, which breeds resentment amongst the poor and complacency amongst the rich to the detriment of all.
2. SPILL-OVER EFFECTS OF INEQUALITY
Inequality tends to reduce the quality of life of both the poor and the rich in various ways. It has been found that societies with more inequality have higher crime rates. This causes everyone in so-ciety, rich and poor, to be more fearful. As well, societies with more inequality are also more prone to outbreaks of infectious diseases, as the poor are less likely to have access to preventative medical care and healthy diets. However, as both crime and disease affect the rich as well as the poor it is in the interest of even the rich to address the root cause, which is poverty. As well, poverty can cause people to be under-educated which again has ramifications for the entire society (lower productiv-ity, lower employment, higher social spending). Basically, inequality has some negative spill-over ef-fects (crime, poor health, and lower average levels of education) which governments are wise to try to minimize.
How do we measure inequality? The most common measures of income distribution are the Lorenz curve and the Gini coefficient. The Lorenz curve divides the population up into 5 parts (quintiles), ranked from poorest to richest, and then shows what portion of national income each part receives. It can be shown as follows:
% Income
% of Population Line of Equality
Lorenz Curve
As was mentioned in the introduction, as a market economy does tend to create income inequality, we do expect governments to act to reduce such inequality, often
on the grounds of 'fairness' or equity.
This can become a complicated moral argument (looking after our fellow man), but fundamentally, there are good practical grounds for governments to pursue such a goal. Where gross inequality of mate-rial conditions exists there are often problems with:
Poverty can be measured as well. Absolute poverty occurs when people cannot afford the necessities of life. In developing countries this is often defined as having a per capita income of under $2 per day. Rel-ative poverty, on the other hand, looks at how people are doing in relation to others. RelRel-ative poverty is often determined by comparing a person's income to their country’s median income. For instance, if a person is earning less than 50% of the median income of people in their country, they might be defined as suffering from relative poverty. In wealthy countries, people suffering from relative poverty are likely not poor in absolute terms.
Governments can act to reduce inequality and poverty mainly through fiscal policy. Income taxes are often progressive, meaning that the rich pay a greater percentage of their income in tax than the poor.
This is done through taxing different portions of a person's income at different rates. For instance, a country may allow people to earn $10 000 before they need to pay tax. Then, the 10 001st dollar
through to the 30 000th dollar are taxed at a rate of 15%, the 30 001st through to the 50 000th dollar are taxed at a rate of 25%, and income over $50 000 is taxed at a rate of 35%. Let's compare how this pro-gressive income tax system would affect two people, one earning $40 000 and another earning $100 000.
The Gini coefficient merely expresses the Lorenz curve as a number by dividing the area between the Lorenz curve and the line of equality by the total area of the right triangle between the x-axis and the line of equality. Thus, a higher Gini coefficient indicates greater income inequality.
We can see that the person earning $40 000 pays both a lower marginal rate of income tax (i.e. his 40000th dollar is taxed at a rate of 25%) than the person earning $100 000 (whose 100 000th dollar is taxed at a rate of 35%), and a lower average rate of income tax (13.75% as opposed to 25.5%).
The fairness of progressive income taxes is often justified according to the principle of the ability to pay. However, some countries (notably some of the Baltic States) have flat or proportional income taxes, where all income (above a certain threshold) is taxed at the same rate. Even in this case, though, while marginal tax rates for everyone are the same, the existence of an untaxed initial portion of income will result in average tax rates being progressive. Lastly there are regressive taxes towards which the poor pay a greater percentage of their income than the rich. Fees and fines (as they are a set sum) and
Person earning 40 000 Person earning 100 000
First 10 000 - tax rate 0% 0 0
10 001 - 30 000 - tax rate 15% 3000 (15% * 20K) 3000 (15% * 20K) 30 001 - 50 000 - tax rate 25% 2500 (25% * 10K) 5000 (25% * 20K)
50 000 + - tax rate 35% 0 17 500 (35% * 50K)
Total Income Tax Burden : 5500 25 500
Average Tax rate: (5500/40 000) * 100 = 13.75% (25 500/100 000) * 100 = 25.5%
gressive in nature.
Government spending is also employed to reduce poverty and inequality. Most directly, government transfer paymentssuch as pension supplements, welfare payments, disability allowances and child benefit payments raise the cash income of poor households. Progressive taxation of the rich combined with trans-fer payments to the poor clearly show governments playing the role of "Robin Hood" (i.e. taking from the rich and giving to the poor). Less directly, much government program spending is redistributive in nature.
Free public education and health care, subsidized recreation programs and much else are enjoyed by all, rich and poor, but are paid for mainly by the taxes paid by the rich.