18/08/15
Lesson 1: Chapter 20, Equity in the distribution of income
Learning Objective: I can explain how taxation and government spending affect the distribution of income in an economy.
DA- To what extent do you feel that it is government's obligation to reduce inequality?
Equality vs. Equity
Unequal ownership of the factors of production.
Lorenz Curve and Gini Index:
DA- To what extent do you feel that it is government's obligation to reduce inequality?
Equality vs. Equity
- Equality=Equal, everyone receives equal pay.
- Equity=Fairness, governments attempt to redistribute income to make the distribution more fair.
- Absolute: When people don't earn enough for basic survival. Earning < $1.25 per day (World Bank) is considered absolute poverty.
- Relative: When people are relatively poor in comparison to those around them.
- LEDCs more likely to have people living in absolute poverty vs. MEDCs are in relative poverty.
Unequal ownership of the factors of production.
Lorenz Curve and Gini Index:
Taxation: As you know, there are a variety of taxes but we are looking only at the way in which taxation is used to change the distribution of income.
- Direct taxes-Imposed on people's income/wealth and firms' profits. Employment income and interest on savings and dividends from ownership of shares.
- Indirect (expenditure/consumption) taxes-Vary based on different goods/services, i.e., necessities such as food in a supermarket charged lower tax rate than luxuries (restaurants).
- Progressive taxes-As incomes rise, people pay a higher proportion of this income in taxes. Sometimes low incomes aren't taxed at all.
Based on the progressive tax model, if a person were to earn $15,000, no taxes paid on the first $10,000 and 30% on the next $5,000 so they would $1,500 in taxes, representing an average tax of 10%.
A person earning $30,000 would pay nothing on the first $10,000, 30% on the next $15,000 ($4,500) and 40% on the remaining $5,000 ($2,000) total=$6,500. Represents an average tax of approximately 22%. Activity: Using the tax structure given in table 20.2, calculate the total tax paid and the average tax paid for a person earning: a. $7,000 b. $28,000 c. $14,000 d. $56,000 Regressive taxes: Proportion of income paid in tax falls as income rises. Indirect taxes is an example of a regressive tax. Good source of government revenue and discourage consumption of demerit goods, but can worsen income inequality. Proportional taxes: Income paid in tax is constant for all income levels.
Transfer payments: Governments can use tax revenues to redistribute income and fund public programs, transfer payments, i.e., child support, pensions, unemployment benefits, disability, and subsidies to producers. Government provision of essential goods: Goods and services which have positive externalities of consumption, i.e., health care, education, sanitation, and water supplies. |
HL: Calculate the average tax rate if Luis is making $24,000 and marginal tax rate if his income increases to $30,000.
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Evaluation of redistribution of income policies: Government provision vs. Free market forces
New classical point of view argue against active role of government in redistributing income because it inteferes with market forces and results in inefficiencies. As we know, this view argues that the optimal allocation of resources occurs in free markets and gov. taxation must be kept to a minimum.
- Firms pay insurance/social security, this will encourage firms to hire fewer workers=unemployment.
- High taxes might discourage entrepreneurial activity and even encourage entrepreneurs to lave a country in search of more "favorable" tax climates.
- High taxes have negative effects on overall growth in the economy; lower taxes will encourage economic activity=increase output (GDP).
HW: Article explaining a particular tax system, due Monday.