[2.1.1f] Redistribution of Income

Income Inequality, Poverty and Redistribution

Free markets tend to distribute income unevenly — those with greater skills, capital or inherited wealth earn significantly more than others. Without intervention, income inequality can become extreme. Redistribution of income is a key macroeconomic objective for most governments: ensuring that the benefits of economic activity are more evenly shared across society.

Key Definitions

  • Income inequality refers to the unequal distribution of income among individuals or households in an economy. It is often measured using the Gini coefficient — a number between 0 (perfect equality) and 1 (one person receives all income). High Gini coefficients indicate large gaps between rich and poor.
  • Absolute poverty means living below a fixed minimum standard — unable to afford the basic necessities of life (food, shelter, clean water, healthcare). The World Bank defines extreme absolute poverty as living on less than .15 per person per day (2022 threshold). Absolute poverty has fallen dramatically globally over the past century due to economic growth.
  • Relative poverty means having income significantly below the average or median income in the society in which you live. In many countries, relative poverty is defined as having income below 60% of the national median. Unlike absolute poverty, relative poverty is inherently comparative — someone can be in relative poverty in a rich country whilst living far above absolute poverty thresholds.

Reasons to Reduce Poverty and Inequality

  • Meet basic needs: poverty denies individuals access to the food, shelter, healthcare and education required for a dignified human life. Reducing absolute poverty is the most immediate priority — ensuring all citizens can meet their basic physical needs.
  • Raise standards of living: greater equality of income allows more people to participate in economic life as consumers, improving aggregate demand and overall welfare. Societies with lower inequality tend to have better health outcomes, higher social mobility and stronger educational attainment.
  • Ethical reasons: many people believe that large inequalities are unjust in themselves, regardless of their economic consequences. The idea that a wealthy society should not allow extreme poverty among its citizens reflects widely held moral values about fairness, social solidarity and the equal worth of all individuals.

Government Intervention to Reduce Inequality and Poverty

A progressive tax is one in which the percentage of income paid in tax rises as income increases. Higher earners pay a larger share of their income in tax than lower earners. Income tax in most countries is progressive — basic rate taxpayers pay a lower percentage than higher or additional rate taxpayers.

Progressive taxation compresses the income distribution by taking proportionally more from high earners and using the revenue to fund public services and transfers that disproportionately benefit lower earners. It is contrasted with regressive taxes (e.g. VAT, fuel duty) which take a higher proportion of income from poorer households and with proportional taxes (flat-rate) that take the same percentage from all income levels.

The government redistributes income through transfer payments — cash payments to individuals that do not require economic activity in return. These include:

  • Unemployment benefits — replacing part of lost income for those who lose their jobs
  • State pension — providing retirement income for older citizens
  • Child benefit and tax credits — supplementing the incomes of families with children
  • Housing benefit — helping low-income households afford accommodation
  • Disability benefits — supporting those unable to work due to ill health or disability

Transfer payments redistribute income from those in work (who pay taxes) to those in need, directly reducing absolute poverty and compressing income inequality.

Investment in free or subsidised education gives individuals from all backgrounds the opportunity to develop skills and access higher-earning careers — improving social mobility and reducing the intergenerational transmission of poverty. Without public education, access to good schooling would be determined almost entirely by parents' income, entrenching inequality across generations.

Investment in free or subsidised healthcare ensures that all citizens can maintain their health and remain economically productive regardless of their income. Poor health is both a cause and a consequence of poverty — addressing it directly reduces inequality and its social costs. Universal healthcare also removes the risk of catastrophic healthcare costs pushing households into poverty.

 Key Takeaways

  • Income inequality: unequal distribution of income. Absolute poverty: below a fixed minimum standard. Relative poverty: significantly below the average income in the same society.
  • Governments reduce inequality to meet basic needs, raise living standards and on ethical grounds.
  • Policy tools: progressive taxation (higher earners pay higher %; funds redistribution), benefit payments (direct transfers to those in need) and investment in education and healthcare (improving opportunity and social mobility).
f) Redistribution of income: • definition of income inequality • definition of absolute poverty • definition of relative poverty • reasons to reduce poverty and inequality: o meet basic needs o raise standards of living o ethical reasons. • government intervention to reduce inequality and poverty: o progressive taxation o redistribution through benefit payments o investment in education and healthcare.