A LevelEconomicsCambridge (CIE)Revision NotesGovernment Microeconomic InterventionAddressing Income & Wealth InequalityPolicies To Redistribute Income & Wealth

Policies To Redistribute Income & Wealth (Cambridge (CIE) A Level Economics): Revision Note

Exam code: 9708

Steve Vorster

Written by: Steve Vorster

Reviewed by: Lisa Eades

Updated on

The impact of a national minimum wage (NMW)

  • Government's often intervene in the labour market by setting a minimum wage

    • They do this in order to improve equity and avoid the exploitation of workers

  • A minimum wage is a legally imposed wage level that employers must pay their workers

    • It is set above the market rate

      • The minimum wage per hour often varies based on age

Graph showing wage rate versus truck driver quantity, with demand and supply lines intersecting. Includes a minimum wage line above equilibrium wage.
A national minimum wage (NMW1) is imposed above the market wage rate (We) at W1

Diagram analysis

  • The market equilibrium wage and quantity for truck drivers in the the labour market is seen at WeQe

  • The government imposes a national minimum wage (NMW) at W1

  • Incentivised by higher wages, the supply of labour extends from Qe to Qs, leading to higher incomes for more workers

  • Facing higher production costs, the demand for labour by firms contracts from Qe to Qd

  • This means that at a wage rate of W1 there is excess supply of labour and the potential for unemployment equal to QdQs

Evaluating the use of minimum wages

Advantages

Disadvantages

  • Raises wages for low-paid workers → reduces income inequality

  • Higher income levels help to increase consumption in the economy. This improves economics growth and tax revenue for more redistributive policies

  • May incentivise workers to be more productive

  • If demand for labour is inelastic → employment falls by less → more effective

  • Raises the costs of production for firms that may respond by raising the price of goods and services

    If elastic → greater unemployment → less effective

  • If firms are unable to raise their prices, the introduction of a minimum wage may force them to lay off some workers, increasing unemployment and reducing incomes for the lowest paid

  • The NMW may still be set close to the poverty threshold, so it has little impact on inequality

Transfer payments

  • Transfer payments are payments made by the government from tax revenue, where no good or service is exchanged

    • Redistributes income from higher-income taxpayers to lower-income households → reduces income inequality

  • They mainly support groups who may struggle to earn sufficient income through work. These are people who are unable to work or cannot participate fully in the labour market

  • Transfer payments typically involve a redistribution from taxpayers to recipients who require financial support

  • Examples include:

    • state retirement pensions

    • unemployment support payments

    • rent or housing support

    • income support for low-income households

    • family or child support payments

    • disability support

    • Tax credits

Effectiveness of transfer payments

  • The scale and effectiveness of transfer payment systems depend on the size of the government’s tax revenue and the proportion of the population contributing tax

  • In many lower-income economies, there is narrow tax base and a large informal sector

    • Only workers in the formal sector contribute regularly to income tax, meaning social protection schemes cover only a small share of the population

  • Where populations are ageing or unemployment is high, governments may struggle to fund pensions and welfare payments

  • Higher-income economies with broader tax bases are generally better able to finance extensive welfare systems

Advantages

Disadvantages

  • Help to reduce absolute poverty

  • Provide a basic standard of living

  • Promote a more equitable distribution of income.

  • Stabilise the economy during periods of recession by supporting household spending

  • Generous welfare payments may reduce incentives to work (moral hazard) → increases dependency, particularly if the difference between earned income and benefits is small

  • This could lead to higher unemployment and lower overall output, resulting in allocative inefficiency

Examiner Tips and Tricks

Transfer payments improve equity, but may create efficiency trade-offs if work incentives are weakened

Progressive taxation

  • Progressive tax system: as income rises, a larger percentage of income is paid in tax (e.g. UK Income Tax; UK Corporation Tax)

    • This system is built around the idea of marginal tax rates

Case Study

UK progressive tax rates : June 2022

Tax Band

Taxable Income

Tax Rate

Personal Allowance

Up to £12,500

0%

Basic Rate

£12,501 to £50,000

20%

Higher Rate

£50,001 to £150,000

40%

Additional Rate

Over £150,000

45%

Using this system, a salary of £60,000 would attract a tax bill of £11,499.80, calculated as follows:

  • First £12,500 - no tax

  • Next £37,499 at 20% = £7499.80

  • Final £10,001 at 40% = £4,000

Advantages

Disadvantages

  • A progressive tax system is one that applies higher levels of income tax to higher levels of income i.e lower income earners pay a lower tax rate than higher income earners

  • Tax revenue collected is then redistributed to those who need it most

  • Redistribution often starts with the provision of free education and healthcare

  • Higher tax revenue funds public services → improves equality of opportunity

  • Based on ability to pay, improving fairness and social equity

  • May reduce incentives to work, save or invest

  • Risk of tax avoidance or evasion if marginal tax rates are very high

  • Can discourage entrepreneurship and risk-taking

  • Administrative costs can be high due to complexity of the tax system

Inheritance and capital gains tax to reduce wealth inequality

1. Inheritance tax (IHT)

  • Inheritance tax is a tax charged on the transfer of wealth when an individual dies. It is typically paid on estates above a certain threshold

How it reduces wealth inequality

  • Limits the intergenerational transfer of wealth, preventing large fortunes from being passed on unchanged

  • Reduces wealth inequality that arises from inheritance rather than earned income

  • Tax revenue can be used to fund public services or transfer payments that benefit lower-income households

Advantages

Disadvantages

  • Targets wealth inequality (not just income inequality)

  • Encourages wealth to be earned rather than inherited, promoting equality of opportunity

  • Raises government revenue without directly affecting current consumption

  • Can be avoided through tax planning, trusts or gifting assets before death

  • May discourage saving and wealth accumulation

  • Difficult to value non-cash assets such as property or family businesses

  • Politically unpopular and costly to administer

2. Capital gains tax (CGT)

  • Capital gains tax is charged on the profit made from selling assets such as shares, property or businesses

How it reduces wealth inequality

  • Ensures that income earned from assets and investments is taxed, not just wages

  • Reduces the gap between those who earn mainly from labour and those who earn from wealth

  • Slows the accumulation of wealth among high-asset individuals

Advantages

Disadvantages

  • Promotes fairness in the tax system by taxing unearned income

  • Raises government revenue that can be redistributed

  • Discourages speculative investment that may increase asset price bubbles

  • May reduce incentives to invest or take risks

  • Difficult to calculate gains accurately due to inflation and asset valuation

  • Can lead to capital flight if investors move assets to lower-tax countries

  • Tax avoidance is possible through timing the sale of assets

State provision of education and healthcare

  • Education and healthcare are often provided or funded by the state because they are essential services that generate significant social benefits beyond the individual consumer

How state provision reduces inequality

  • Improves equality of opportunity

    • Free or subsidised education allows individuals from low-income households to develop skills and qualifications. This increases their chances of higher-paid employment

  • Reduces income-related barriers to access

    • Without state provision, only higher-income households may be able to afford quality schooling or medical treatment, widening inequality

  • Raises long-term earning potential

    • Improves human capital → increases earning potential → reduces inequality

  • Improves health outcomes

    • Access to healthcare reduces illness and absenteeism, allowing people to work more consistently and productively

  • Supports social mobility

    • When access to education and healthcare is based on need rather than ability to pay, individuals are more able to move up the income distribution

Advantages

Disadvantages

  • Both services are merit goods, meaning they tend to be under-consumed if left to the market

  • They generate positive externalities, such as a healthier workforce and lower crime rates

  • State provision helps correct market failure while improving equity

  • May reduce incentives to invest or take risks

  • Difficult to calculate gains accurately due to inflation and asset valuation

  • Can lead to capital flight if investors move assets to lower-tax countries

  • Tax avoidance is possible through timing the sale of assets

Worked Example

Question

Which policy is most likely to reduce wealth inequality rather than income inequality?

A. Increasing the national minimum wage
B. Increasing transfer payments to unemployed workers
C. Increasing inheritance tax
D. Increasing government spending on educatio

Answer

C. Increasing inheritance tax [1]

Explanation

  • A. Minimum wage
    Raises earnings for low-paid workers → reduces income inequality, not wealth

  • B. Transfer payments
    Redistribute income from taxpayers to recipients → reduces income inequality

  • C. Inheritance tax
    Taxes the transfer of assets → reduces the accumulation of wealth across generations → reduces wealth inequality

  • D. Government spending on education
    Improves skills and earning potential → reduces income inequality over time (equality of opportunity)

State provision mainly improves equality of opportunity, but it does not guarantee equal outcomes

  • Policies such as education improve equality of opportunity

  • Taxes and transfers improve equality of outcome

Unlock more, it's free!

Join the 100,000+ Students that ❤️ Save My Exams

the (exam) results speak for themselves:

I would just like to say a massive thank you for putting together such a brilliant, easy to use website.I really think using this site helped me secure my top gradesin science and maths. You really did save my exams! Thank you.

Beth
IGCSE Student

This website is soooo useful and I can’t ever thank you enough for organising questions by topic like this. Furthermore, the name of the website could not have been more appropriate as it literally did SAVE MY EXAMS!

Fathima
A Level Student

Incredible! SO worth my money, the revision notes have everything I need to know and are so easy to understand. I actually enjoy revising! It makes me feel a lot more confident for my GCSEs in a few months.

Kate
GCSE Student

Absolutely brilliant, both my girls used it for A levels and GCSE. It's saves on paper copies, also beneficial exam questions ranked from easy to hard. It's removed a lot of stress from the exams.

Sameera
Parent

Just to say that your resources are the best I have seen and I have been teaching chemistry at different levels for about 40 years

Mark
Chemistry Teacher

Excellent

Our rating represented in Trustpilot stars
Read more reviews
Previous:Measuring Income & Wealth Inequality
Author
Reviewer
Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

Lisa Eades

Reviewer: Lisa Eades

Expertise: Business Content Creator

Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.