Poverty Inability to satisfy minimal consumption needs. Absolute poverty. 1. Define a Poverty line (an income level that is considered minimally sufficient to sustain a family in terms of food, housing, clothing, medical needs,…). There are nationally and internationally determined poverty lines. World Bank: Living on less than $1.25 a day: extreme poverty Living on less than $2 a day: moderate poverty 2. Amount of poverty is the % of a population whose income falls below the poverty line.

Nearly 1.4 billion people in the world live in extreme poverty. 2.6 billion people living in moderate poverty (half the population of developing countries). National poverty lines: In higher income developing countries they are set at a higher income level, so that a larger % of people are considered poor. In lower income countries they are set at a lower income level, so the a smaller % of people are considered poor. MDCs use national poverty lines to determine absolute poverty.

Relative poverty Compares the income of individuals or households in a society with median incomes. (The median is the number that is in the middle of a series of numbers and it is different from the mean). If income were equally distributed, there would be no relative poverty. In general, the more unequal the distribution of income, the greater is the degree of relative poverty. Idea of relative poverty: not being able to afford g&s and a lifestyle that are typical in a society. ‘Typical’ is based on a standard determined by the median income level.

Measuring relative poverty: Specify a % (often 50%) of median income below which there is poverty. If median equals $20 000, any family with annual income below $ is considered poor (in relative terms). But: poverty rates differ among social groups. Older people, children, single-parent households, women,… face higher poverty rates than national averages.

Methods to promote equity 1. Transfer payments. Made by the government to individuals for the purpose of redistributing income away from certain groups and towards other groups. Groups who receive transfer payments include older people, sick people, very poor people, children of poor families, unemployed people,… Referred to as vulnerable groups. Transfer payments include UE benefits, maternity benefits, old age pensions, disability benefits,… They are made possible by taxes.

2. Subsidised or direct provision of merit goods. Gov must ensure that health care and education are affordable for very low income groups. For this reason they offer these services (nearly) free of charge to consumers (subsidised provision). Infrastructure is a merit good that may also require subsidised or direct provision by the gov and is especially important in LDCs. Ex: sanitation, clean water, sewerage. Gov uses tax revenues to provide the good in larger quantities than the market would have provided and at very low or zero prices.

3. Gov intervention in markets. This also changes the distribution of income. Minimum wage legislation Food price ceilings Price floors for farmers 4. Taxation It makes redistribution possible through transfer payments and subsidised provision of merit goods. In itself, it is an important instrument for redistribution, because it can lower income inequalities.

Direct and Indirect Taxation Direct taxes are paid directly to the tax authority by the taxpayer: Personal income taxes: on all forms of income, i.e., wages, rental income, interest, dividends. Most important source of gov tax revenues, especially MDCs. Corporate income taxes: on profits of corporations (firms that have formed a legal body separate from its owners). Wealth taxes: on the ownership of assets, such as wealth taxes and inheritance taxes. These are used to finance a variety of gov. expenditures, in contrast to

Social insurance contributions: paid by workers and their employees. They are used to finance specific expenditures: pensions, social insurance and health care. Also known as ‘earmarked taxation’. Indirect taxes are taxes on spending of goods and services. They are paid by consumers indirectly through the suppliers of the good or service. Sales taxes. In the US: fixed % of the retail price. Some goods are excluded, on the grounds of equity. In the EU: VAT, on the value added by each producer. Different rates for different types of goods and services and exceptions for some goods. Excise taxes. On specific goods and serv: cigarettes, petrol. Split between consumer and firm.

Custom duties (tariffs). On imports of foreign goods. Levied in order to either to raise tax revuenues or to decrease imports. More important in LDCs.

Evaluation of income redistribution According to many economists, there is a trade–off between efficiency and equity. The reason is that gov intervention in markets to achieve equity changes the allocation of resources. Although it is clear that some income redistribution is necessary, there is disagreement on how much is appropriate.

1. Taxes and allocative efficiency. Taxes affect the allocation of resources. When they are used to correct market failures, they are intended to move the economy towards a more efficient allocation of resources. However, when taxes are used for other objectives other than correcting market failures, they change the relative prices of goods and services and f of p, causing allocative inefficiencies. The reason is that in the market system resource allocation is guided by the signal and incentive functions of prices.

a) Income taxes and efficiency in resource markets. ‘High taxes reduce the incentives of the rich to work and save’(proponents of supply-side policies). Negative effects on amount of labour offered and investment (and therefore capital goods formation). b) Indirect taxes, equity and efficiency in product markets. General expenditure taxes are levied on all goods and services at the same percentage, so there is no impact on resource allocation because relative prices do not change. However, these taxes are regressive and lead to a more unequal distribution of income. Different VAT rates are applied to different categories of goods and services, while some goods are exempted in order to make them more affordable to low-income earners. However, the allocation of resources is affected as relative prices change.

Counter-arguments 1. Empirical evidence suggests that tax increases or decreases do not have a very significant effect on labour supplied, saving, investment and capital and hence on output. 2. Progressive income taxes act to reduce short-term fluctuations of economic activity: A less severe recession means that fewer resources are wasted due to UE, and hence a smaller reduction in Y. A less severe inflation means that negative effects of inflation on investment will be less pronounced. Therefore, progressive income taxes may have positive effects on economic performance by making business cycle fluctuations milder.

3. Some economists argue that policies in pursuit of both equity and efficiency may complement each other: High income inequalities mean that some groups live in poverty, and the poor have low levels of education and health, fewer opportunities to work, etc. UE results in lower output produced. Hence, greater income equality could raise these people out of their poverty and increase their opportunities to find employment, therefore contributing to increasing output produced and economic growth.

2. Transfer payments and allocative efficiency. Supporters of supply-side policies argue that UE benefits or other benefits for the poor create disincentives to accept work. The result is an extra burden on the government and higher UE rates for the economy, causing output to be lower than it could be.  Counter-argument: while it is likely that some people may take advantage of such a system of transfer payments, this is necessary to offer protection to vulnerable groups.  Also, UE benefits reduce the effect of short-time fluctuations in economic activity, lessening the severity of recession or inflation (automatic stabilizers).

3. Gov expenditures on merit goods and allocative efficiency. Burden on the gov budget, opportunity costs involved.  Consistent with the achievement of allocative efficiency. 4. Gov intervention in markets and allocative efficiency. Clearly conflicts with resource allocation objectives, leading to allocative inefficiency and a loss of social surplus.