Recommend a policy which the government could introduce that might lead to lower levels of

income/wealth inequality in the economy.

Wealth/income inequality refers to the constant state of the market system where ownership is
highly unusual, some people have more FOPs to sell or more services to offer. The market
distributes wealth unequally.

Direct taxes are taxes on income and wealth, paid directly to the government. Indirect taxes
refer to the tax imposed on spending to buy goods and services. Thus, the Govt can manipulate
the tax system to reduce the income inequality by using progressive taxes which involves a tax
rate that increases (or progresses) as taxable income increases.

Progressive taxes are an important method used to make income distribution more equal. The
more progressive a tax system is, the greater the income distribution achieved. The average tax
rate increases rapidly as income increases.

However, a policy the government could use to fight this is imposing higher progressive taxes.
This reduces the tax burden on the people who can least afford to pay. This allows low-wage
earners to have more money. These further increases consumer confidence which makes it
likely for them to spend more money on essential goods and stimulate the economy in the
process.

Furthermore, higher progressive taxes will allow the government to collect more taxes than flat
taxes or regressive taxes, as the highest percentage of taxes is collected from those with the
highest amounts of income.

Income

A
B

Population
The above graph portrays the after effect of progressive taxes. The Lorenz curve above shows
the shift from B to A thus indicating a decrease in income inequality as progressive taxes
increased. The same depicts an underlying notion that the decrease in income differences
between rich and poor results in extra tax revenues which now can be used to provide merit
goods and transfer payments.

To conclude, the government can use the extra tax revenue to provide merit goods or subsidize
necessities, provide transfer payments and set price controls to support minorities or make
things more affordable. However, this might act as incentive to work less as high tax rates may
discourage workers which can further lead to unemployment too. Reduction in the Indirect taxes
as they are regressive in nature will lessen the burden on the poor. More equal income
distribution helps people with low income acquire human capital, become more employable
leading to more economic growth with time.