Policies to reduce inequality can either be applied ‘downstream’ by redistribution to reduce the effects of inequality, or ‘upstream’ at the source of the inequality to prevent it happening – such as be opening up more opportunities to earn income. Policies can also be used to regulate how specific markets work8.
Improvements in education and skills in order to raise the level of achievement, and enable young people to leave education with a set of key skills will enable them to work in higher value-added, higher paid employment. This could also involve more effective career’s advice9.
Reducing discrimination against particular groups through a combination of legislation, incentives and information, will encourage more social mobility and increase access to the upper-end of the reward system. Schemes to reduce workplace discrimination, and encourage diversity, such as training to reduce unconscious bias against certain groups, will not only encourage movement up the promotional ladder, but will encourage those from disadvantaged backgrounds to enter the labour market.
As will all such policy interventions, there may be considerable time-lags between the implementation of any policy, and possible effects on downstream inequality, especially initiatives involving educational provision.
Increasing the progressiveness of the tax system to ensure that the marginal tax rate is rising will redistribute income from the higher paid to the lower paid. However, the danger is that a high marginal tax rate will have disincentive effect on work and effort. [See the Laffer curve].
Another criticism is that high marginal tax rates may deter inward investment, which may have a negative knock-on effect on efficiency and productivity.
Increasing the level of welfare payments may reduce income inequality. Welfare benefits include direct cash benefits, tax credits, and 'benefits in kind' such as assistance with housing costs. These vary considerable across developed economies. Many countries distinguish between 'family' benefits, which involves payments to those with children to support, and 'social assistance' which can be provided to everyone. Perhaps the most significant criticism of increasing welfare benefits is that it can create moral hazard, and trap individuals into long term welfare dependency.
Setting a minimum wage, or raising its level, will impact on the low paid, while having no direct effect on the higher paid. The main argument against an increase in the minimum wage is that it can create a ripple effect, with wages increasing to maintain differentials. If this happens then any reduction in inequality may only be temporary. [See minimum wage.]
Given that unemployment may be a significant cause of inequality, policies to reduce unemployment should also reduce inequality. Policies might include a mix of fiscal, monetary and supply-side policy. [Read more on unemployment.]
Regulation of the gig economy, to increase worker protection and extend employment rights, has been considered and implemented in several major economies, including the US, the UK and the EU10.
However, as with other types of intervention, governments are wary of over-regulating the gig economy as this might stifle innovation, and drive entrepreneurs to move to countries with looser regulatory regimes.
While incentives play an important role in the efficient operation of market forces, making some income inequality functional, there is clearly a 'tipping point' beyond which it becomes dysfunctional in terms of inefficiency, opportunity cost, and low economic growth. What is clear is that the reward to labour has declined relative to that of capital.
There is also evidence that inequality within a particular group is just as great as between groups. Looking at the labour market provides important clues to the origins of inequality, but perhaps even more important is to go back a step, and look at education, and the education system. While policies can reduce downstream inequality, improving equality of opportunity provides the most effective way of reducing inequality in the long run.
There are two approaches to dealing with poverty. Firstly, understanding its causes and putting in place policies that address these causes, and secondly implementing policies that support the poor through transfer payments. For example, reducing unemployment is attempting to tackle the cause of poverty, while providing income support deals with the symptoms of poverty.
Economic growth and development is seen as central to the reduction of extreme poverty in both developed and developing countries. Economic growth generates wide-ranging benefits in terms of job creation, industrialisation, the emergence of new industries and services, increasing saving and enabling capital accumulation.
However, growth alone cannot reduce poverty levels. Other, more targeted measures may include:
The use of progressive taxation to redistribute tax from the relatively well off to the less well off is widely used in most countries. This means that the poorest pay no direct income tax as a result of a tax free allowance, or receive some form of tax credit.
Welfare benefits may be in cash payments, or in kind (such as housing support, support to buy food, such as the food stamps scheme in the US, and free school meals. Benefits can be targeted for specific situations - such as pensions, and disability benefits - or more general benefits, such as 'universal' benefits, such as the UK's universal credit.
While this does not necessarily provide a solution to poverty it can provide a safety-net to prevent extreme poverty.
However, the use of benefits can be criticised in that it does not get to the root cause of poverty. While it may prevent extreme poverty and destitution in the short run, critics argue that it can create welfare dependency and trap individuals into long-term poverty by creating moral hazard.
A negative income tax is an attempt to integrate the tax and benefits system into a single system.
An agreed minimum income level sets the line above which individuals pay income tax, and below which they receive a 'negative' income tax as a payment to them. For example, with a negative tax rate of 50%, individuals earning less than the minimum income level would receive 50% of the difference. Taking the US dollar as our benchmark currency, if the monthly minimum income is set at $2000, and an individual earns $1500, they would receive 50% of the difference [$250].
Those who favour this approach [originally attributed to US economist, Milton Friedman) point to three possible benefits.
A universal basic income is a direct payment to individuals irrespective of their current level of income. For example, in Finland, a small scale trial was launched in 2017 giving all individuals in the trial 560 euros a month payment, which was roughly equivalent to unemployment benefit in Finland. However, researchers monitoring the scheme argued that other benefits should not be reduced, and that UBI should be seen as a supplement to existing benefits. [6]
Many countries have experimented with trials on UBI, but none have implemented a system which replaces their existing tax and benefits system.
A minimum wage may help take the employed out of poverty as well as provide an incentive for individuals to look for work. However, in the developing world, only around 50% of workers are covered by minimum wage legislation. [4]
In many countries the national minimum wage is not indexed to inflation, and hence may not have kept pace with inflation [5]. In the USA, inflation has eroded the real value of the minimum wage and would have to be increased significantly to return it to its 1968 level. Read more
In conclusion, there is a range of possible policies which can reduce poverty. Most systems involve an income-support safety-net together with schemes to tackle poverty at its root cause, with education, training and employment seen as the most effective long-term solutions in both the developed and developing world.
[1] World Bank https://www.worldbank.org/en/news/press-release/2020/10/07/covid-19-to-add-as-many-as-150-million-extreme-poor-by-2021
[2] Based on The European Commission's definition of poverty published in Joint Report on Social Inclusion 2004.
[3] Ethical Trade Report - https://www.ethicaltrade.org/blog/top-10-worst-countries-workers-rights
[4] WOL.iza.com https://wol.iza.org/articles/does-increasing-the-minimum-wage-reduce-poverty-in-developing-countries/long
[5] The ILO - https://www.ilo.org/global/topics/wages/minimum-wages/setting-adjusting/WCMS_439254/lang--en/index.html
[6] OECD Report as link in a CNBC News Report.
1. BIS Working Papers No 654 World changes in inequality: an overview of facts, causes, consequences and policies by François Bourguignon Monetary and Economic Department August 2017)
2. An Anatomy of Economic Inequality in the UK - Report of the National Equality Panel 2010
3. Netflix facts - https://interestingengineering.com/the-fascinating-history-of-netflix.
4. Trapeznikova, I. Measuring income inequality. IZA World of Labor 2019: 462 doi: 10.15185/izawol.462
5 Euronews report - https://www.euronews.com/2019/08/23/uk-inequality-how-the-gig-economy-is-reshaping-workers-rights
6. Keeley, Brian (2015), “Why is income inequality rising?”, in Income Inequality: The Gap between Rich and Poor, OECD Publishing, Paris. DOI: https://doi.org/10.1787/9789264246010-5-en
7. BIS Working Papers No 654 - World changes in inequality: an overview of facts, causes, consequences and policies by François Bourguignon Monetary and Economic Department August 2017
8. BIS Working Papers No 654 - World changes in inequality: an overview of facts, causes, consequences and policies by François Bourguignon Monetary and Economic Department August 2017
9. Good work - The Taylor Review of Modern Working Practices, July 2017, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/627671/good-work-taylor-review-modern-working-practices-rg.pdf
10. Fortune - https://fortune.com/2021/02/24/gig-economy-europe-worker-rights-eu/
11. Trade Union Report 2015 - https://www.tuc.org.uk/sites/default/files/1%20WERS%20lit%20review%20new%20format%20%20RS_0.pdf
12. As reported in Fast Company - https://www.fastcompany.com/90307854/400-million-and-counting-inside-netflixs-arms-race-for-tv-showrunners