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Microeconomic Interventions:
Redistribution
Economic Policy Analysis
Dragana Radicic
dradicic@lincoln.ac.uk
Redistributive policies and optimal taxation
• Redistributive policies
• Government action aimed at obtaining a certain distribution of
income (or wealth) considered to be optimal, i.e. at modifying the
distribution produced by the operation of the market.
• A special case arises when the government selects its criteria
for allocating the tax burden, on which the final distribution of
income and wealth depends.
• An optimal tax maximises social welfare in terms of both
equity and efficiency.
Theories of justice and the principles of
redistribution
• The fundamental principles of equity are horizontal equity and vertical equity.
• Horizontal equity requires that individuals in the same position in all
relevant aspects are treated equally.
• Vertical equity requires that individuals in different positions are treated
differently.
• The productivity principle = everyone has an inviolable natural right to the
product of his labour and capital.
• Any acceptable redistribution policy would be that of voluntary transfers (e.g.
donations).
• A more moderate version
• Government should ensure equal opportunity.
The redistribution principle
• The redistribution principle = differences in ability do not justify distributive
inequalities, and redistribution policies should be used to adjust incomes to meet
the needs of individuals or to allow all persons to achieve some basic
functionings.
• Accepting a simple utilitarian SWF has egalitarian implications:
• Social welfare is maximised when individuals have equal utility.
• Equal utility can be achieved only with equal incomes.
• Thus equal distribution of income maximises social welfare.
• The same result of equal income distribution can be derived from Rawls’ theory
of justice if identical utility functions for the various individuals are assumed.
• According to Sen, we should ensure that individuals have equal capacity to
carry out their functionings.
• If individuals are in the same situation, they should be treated in the same
way.
Redistribution policies
• Budget policy is the primary tool for achieving equity goals.
• Taxes
• Cash transfers
• In-kind transfers
• The effects of budget measures do not primarily depend on the total
volume of expenditures and revenues but rather on their composition
and structure.
• Composition = direct and indirect taxes
• Structure of taxes = proportional, progressive or regressive
Taxation
• The average tax rate is the ratio between the total amount of taxes paid
and the tax base.
• The marginal tax rate is the ratio between the increase in the value of
taxes and the increase in the value of the tax base.
• Proportional taxation: average tax rate = marginal tax rate
• Progressive taxation: marginal tax rate > average tax rate
• Regressive taxation: marginal tax rate > average tax rate
• An income tax can be made progressive in several ways:
• By tax deductions (credits)
• By continuous progressivity
• By tax brackets
Utilitarianism, ability to pay and optimal taxation