Thursday, 10 November 2011

Comment on the effectiveness of one policy which could be used by a government to reduce income inequality.

One policy that could be used by a government to reduce income inequality is progressive taxation. People with higher incomes would have to pay a higher percentage of their income in taxes and low-income people would have to pay less. On one hand, it could lead to a reduction in income inequalities among people but, on the other hand, its effectiveness could be limited. First of all, high-income people would have an incentive to stop working (or work less) or flee the country. It could also encourage them to avoid paying taxes and keep their money in banks from abroad. Secondly, it depend on the difference between two levels of taxation, because if it is significantly low it will not have a big impact on reducing income inequalities.

Other factors to consider are:
1. wider macroeconomic implications (e.g. discouraging inward investment, fall in tax revenue, therefore, reducing the funds available for welfare benefits)
2. tax as an instrument excludes those who do not pay income tax (students, unemployed, pensioners) who, arguably suffer most from inequality
3. criticism of a fiscal policy as a blunt instrument
4. how progressive should the tax be, data from other countries?

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