Inequality, poverty and redistribution
Key terms
Define each term.
Multiple choice
Circle the correct answer.
A country's economy grows and every household's real income doubles. What happens to poverty?
Which measure tackles a cause of poverty rather than relieving its symptoms?
Worked problems
Show your working.
Testing whether a tax system is progressive. In a country, a worker earning $20,000 pays $2,000 in total tax, while one earning $80,000 pays $20,000. A third earning $200,000 pays $44,000. Calculate the average tax rate for each and classify the system across the whole range.
Answers
Absolute poverty: A situation in which a person's income is insufficient to afford the basic necessities of life, such as food, clean water, shelter, clothing and healthcare.
B. Doubling every income lifts households above a fixed subsistence threshold, so absolute poverty falls. But every income doubles including the median, so the proportion of households below any given fraction of the median is exactly as before. Relative poverty depends on the shape of the distribution, not its level.
B. Training raises earning capacity so that recipients can command higher wages, which addresses the cause. The other three raise the incomes of poor households, which relieves hardship but leaves the underlying position unchanged if the support is withdrawn. Both kinds of policy are needed, and saying so is the evaluative point.
Step 1. Calculate the average rate for the lowest earner. Average tax rate = (tax paid / income) x 100 = (2,000 / 20,000) x 100 = 10%.
Step 2. Calculate it for the middle earner. (20,000 / 80,000) x 100 = 25%.
Step 3. Calculate it for the highest earner. (44,000 / 200,000) x 100 = 22%.
Step 4. Classify each section of the range. From $20,000 to $80,000 the average rate rises from 10% to 25%, so the system is progressive over that range. From $80,000 to $200,000 it falls from 25% to 22%, so it is regressive over that range.
Step 5. Interpret the pattern. The system redistributes from middle earners towards the poor but not from the very rich. That pattern typically arises where high earners receive income as capital gains or dividends taxed at lower rates than wages, or where reliefs and allowances are available only to those with substantial assets. A headline top rate of tax therefore tells you very little about how progressive a system actually is.
Always calculate the proportion, never compare the amounts. The highest earner pays much the largest sum in absolute terms and the smallest but one as a share of income, and it is the share that determines whether a tax is progressive.