Income Inequality in the United Kingdom - Essay Example

Profs Income Inequality in the United Kingdom Disparity between initial and final income Income in the United Kingdom is subject to a number of forces. Many of these are market side, and indicated in the initial income that someone is able to earn. This amount can range from anywhere from the hundreds or low thousands of pounds to the millions or sometimes even billions of pounds. The table referenced has a much narrower range of incomes, from the low thousands to the mid-ten thousands of pounds annually, representing the quartiles of income in the United Kingdom. Beyond these market forces, however, there are a large range of other forces that have a drastic impact on final income in the United Kingdom. The government causes most of these differences through credits, welfare and taxes. There are four main ways that the government impacts a person or family’s take home income in the United Kingdom: cash benefits, non cash/in kind benefits, direct taxes and indirect taxes. These factors impact different levels of income very differently. Typically (though not always), benefits have an inverse relationship to income (going up as income goes down), while taxes have are directly related to income, rising as income rises. These factors, however, tend to be logarithmic rather than linear, increasing and decreasing at rates disproportional to changes in income. Taxes tend to rise at a greater rate than benefits decrease. For instance, at the lowest quartile of income, a family would earn 1,920 pounds of direct income, but would get in the order of 4.5 thousand pounds of tax benefits, plus around 3.5 thousand pounds of benefits in kind. For the top quartile, with an income of 39,370 pounds, these benefits would drop to the order of one thousand and two thousand pounds respectively. Thus, from the bottom to the top quartile benefits drop to about one quarter of their rate for the bottom quartile. Taxes, however, change at a much more rapid pace. The lowest quartile of tax-payers pays only about 790 pounds of direct taxes, plus indirect taxes in the order of 1,170 pounds. Someone in the top quartile would pay more in the order of 10,000 pounds in direct taxes, plus an additional 5,000 pounds of indirect taxes. This whole system means that for people in the lowest three quartiles, (anywhere up to about 13,000 pounds annually) actually take home more than they make after accounting for benefits and taxes, while people in the top two, making between twenty and forty thousand dollars, take home a lot less. Assessing tax burden is a somewhat complicated question. If one compares only taxes to original income, clearly the poorest pay the greatest taxes – almost as much in taxes as they make. However, once benefits are accounted for, they pay much less, only about one quarter of their income in taxes. The top quartile, when taking everything into account, bears the greatest tax burden, given that they pay both the largest absolute amount and the highest percentage. Furthermore, they benefit less from the taxes they pay than others – they pay taxes that go to supporting people in the lower quartiles. They, however, still retain the higest disposable income by a large margin, and thus their “tax burden” is less burdensome than a much smaller amount would be to a lower income person. Finally, it is interesting that the total percentage of taxes paid does not change drastically from the lowest to the top quartile once benefits are accounted for – each group pays about 1 out of every 4 pounds made to the government. The people in the lowest quartile certainly gain the most from this system. They gain a net of approximately 6,000 pounds, or 300 % of their initial income, when all is said and done. This advantage drops precipitously as income rises: someone making 5,000 pounds annually, despite making more than 3,000 pounds more than the bottom quartile, only takes home approximately 1,000 pounds more at the end of the day. This means that the benefit from the system drops from 300% to under 100%. People in the top two quartiles gain nothing from this system in terms of personal income (though they might gain through reductions in crime, better social conditions in their country and so forth). Overall, this system seems to give very little incentive to increase income, especially for the lowest income earners. The fact that increasing income by 3000 pounds from 2000 to 5000 would only translate into an extra thousand pounds seems to indicate that it would give very little reason to do that extra work. However, this also discounts the fact that when making only in the order of eight to nine thousand pounds annually, an extra thousand pounds could lead to significant gains in terms of quality of life. One must then question whether someone making only 2,000 pounds annually would have the drive or determination to work twice as hard to double their income for only an increase in take home income by about 10 %. This disincentive for extra works also occurs at higher income brackets, as the increasing tax rate continues to take more and more money the more one makes. However, making more money still translates into quite significant gains in take-home disposable pay. In the chart given, the taxes never rise to a point of making work of little value – a tax rate of between twenty five and thirty five percent is not particularly burdensome in historical terms, and still gives quite an incentive to earn the extra money. The returns are diminishing, but not to a particularly harmful point. Overall, this system seems to create the most disincentive for the incredibly poor to move into being simply poor – the gains through work and enterprise for such groups are minimal. However, as mentioned previously, these groups will see the most value for every extra pound, so that might change the degree to which this functions as a true disincentive. Overall, there are two possible interpretations of this in terms of overall effect on the economy. Classical economic theory, along with theories of Austrian and Chicago school economists such as Milton Friedman, would expect this to drive down total production in the economy significantly.1 Simply put, this argument would state that it is unlikely that people would work hard and continue to work harder while their returns are diminishing, which functions at all levels.2 The rich would have less reason to risk and invest their money, as they would see less of it come back to them, while the poor would have very little reason to work harder as they are already given a livable wage regardless of level of work put in, and see relatively little benefit to working more until they begin making much more money (something in an order of magnitude or so) than they originally did. This argument simply states that it makes very little since to increase economic production when one sees very little benefit from that economic production: if everyone’s take home income was more correlated with their initial income, they will always have more of an incentive to work harder and produce more. There are, however, some critics of such thinking. One of the main issues with this is that economic output is not necessarily completely correlated with total amount of money earned in an economy. Spending patterns of the very rich, for instance, are very different from those of the very poor. The very poor are more likely to spend every dime they earn, less likely to use such money to pay down debt or increase savings, things that the rich will tend to do. Such spending can be more productive to an economy than other forms of economic activity. However, the counterargument to this is that the poor invest very little money, as compared to the wealthy, so the people who earn more will tend to produce more economic activity through investment than the poor would create through spending. Finally, there is a question to the degree to which a disincentive will actually create changes in behaviour. Classical economists would argue that any change in income incentives will lead to changes in behavior – that even the smallest change in taxation will cause changes in earning behavior. However, other economists would argue that people tend to earn as much as they are able given certain conditions, and that the disincentive associated with a moderate tax increase with income is not enough to actually stop people making that degree of income from investing or working harder to earn their money. Finally, risk-taking behaviour is incredibly important to a strong economy, and this system ensures that the poor have enough money to take risks (such as seeking more education) in order to improve their lot, turning them into higher wage earners. Both sides of this argument have a great deal of support for their theories, and the truth probably lies somewhere in the middle. The fact is that taxation probably dampens the economy to some degree, but this could possibly be offset by changes in spending behaviour and risk taking among the poor compared to a system where everyone simply keeps every dollar they earn. References Blaug, M. Economic Theory in Retrospect Cambrdige, Cambridge UP, 1985 Sloman. Economics, Pearson, New York 2006. Read More