Policy: What Can Be Done?

Reducing inequality and poverty, and promoting equity, are important

macroeconomic objec-tives. The widening income gap between the rich and poor
has highlighted the need to understand the causes of relative inequality and
poverty, and to construct suitable policies to reduce poverty and narrow the
income gap.
The Principles of Horizontal and Vertical Equity

Policy towards inequality and poverty is influenced by the desire to achieve

both horizontal and vertical equity. Horizontal equity means that, as a guideline
for tax and benefits policy, individuals in the same financial circumstances have
the same fundamental ability to pay taxes, and, therefore, should be taxed at the
same rate.
The principle of vertical equity suggests that, when individuals are in
different circumstances and have different abilities to pay, they should not
be taxed at the same rate.
Governments can intervene to promote equity, and reduce inequality and
poverty, through the tax and benefits system. This means employing
a progressive tax and benefits system which takes proportionately more tax from
those on higher levels of income, and redistributes welfare benefits to those on
lower incomes.
Stages of Redistribution
Original income can be adjusted in a number of ways to either increase or
decrease post-tax income.

Cash benefits
Cash benefits are designed to help those on low or zero original income,
and include contributory and non-contributory benefits.
1. Contributory benefits, such as pensions and job-seekers’ allowance, are
those where individuals or employers make a contribution into the National
Insurance Fund.
2. Non-contributory benefits, such as housing benefit, income support,
career’s benefit and child support, do not require a previous contribution to
have been made. Generally, there are tests to see if individuals actually
need these benefits, called means tests, though child benefit is not means
tested and is a universal benefit available to all families with children..

Government policies to reduce poverty or to encourage economic equality,

if carried to extremes, can injure incentives for economic output. The poverty
trap, for example, defines a situation where guaranteeing a certain level of
income can eliminate or reduce the incentive to work. An extremely high degree
of redistribution, with very high taxes on the rich, would be likely to discourage
work and entrepreneurship. 
This view of the tradeoff between economic output and equality may be too
pessimistic. For example, the policy of providing free public education has an
element of redistribution, since the value of the public schooling received by
children of low-income families is clearly higher than what low-income families
pay in taxes. A well-educated population, however, is also an enormously
powerful factor in providing the skilled workers of tomorrow and helping the
economy to grow and expand. In this case, equality and economic growth may
complement each other.
O Moreover, policies to diminish inequality and soften the hardship of poverty
may sustain political support for a market economy. After all, if society does
not make some effort toward reducing inequality and poverty, the alternative
might be that people would rebel against market forces. Citizens might seek
economic security by demanding that their legislators pass laws forbidding
employers from ever laying off workers or reducing wages, or laws that would
impose price floors and price ceilings and shut off international trade.