IMF (2015) "Fiscal policy is the primary tool for governments to affect income distribution"

Income inequality
Skewed distribution, large gap between rich and relatively poorer households
Measured by 

• Palma Ratio: Income of top 10% divided by income of bottom 40%
• Gini coefficient: Coefficient ranges from zero to one (perfect inequality)

Show contextual awareness 

• Low income inequality in countries such as Sweden, Finland, Slovenia (all have Gini of less than 0.3 and a Palma Ratio of less than 1)
• UK income inequality has been declining in recent years (Gini for final income of 0.34)
• Much higher in countries such as South Africa, China, USA

Remember! Analyse first and then evaluate!

Analyse how fiscal policy can reduce income inequality

(1) Increase in level of means-tested welfare benefits such as income support / housing benefit - targets help on those families in relative poverty in greatest need

Evaluation: Increased complexity and cost of running welfare, risk of poverty trap from withdrawal of income-related benefits, risk of more families gaming the system; doesn’t address root causes of inequality such as low pay / skills gaps

(2) Increase the marginal rate of income tax for top earners e.g. from 45% to 50% - designed to make the tax system more progressive.

Evaluation: Higher top rate taxes might lead to increased tax avoidance, tax evasion, a possible brain drain of highly skilled people. Risk of lower total tax revenues (tax rates beyond the optimal point in a Laffer Curve diagram). Lower revenue affects ability of government to provide public and merit goods

(3) Introduce a progressive consumption tax e.g. higher rates of VAT on luxury products / lower VAT on essential items (e.g. energy)

Evaluation: Who decides what is a luxury product? VAT is already zero on much household spending.

(4) Increase in the income tax free allowance e.g. from £11,600 to £13,000 - this is designed to improve work incentives because people start paying income tax at higher incomes. Government could also increase the level at which people start to pay national insurance contributions.

Evaluation: Helps people in lower-paid jobs but many of the relatively poor are not in work e.g. structurally unemployed, retired, suffering from chronic illnesses. Lifting the income tax free allowance is also expensive - would it be made available to all?

Further evaluation of the question

Focus on the stem word alone

Introduce some alternatives into the discussion:

1. A higher national minimum wage / + widespread adoption of a more generous living wage
2. Supply-side policies to improve occupational mobility of labour / address skills gaps which keep people out of work
3. Address the chronic shortage of and high price of housing which impedes geographical mobility of labour 
4. Policies to introduce competition into markets to increase contestability and lower real prices e.g. helping to lower energy bills
5. A more ambitious regional  and industrial policy to address long-term inequalities in employment and income in depressed regions/localities

Finish off the essay with a final reasoned comment 

e.g. There are some powerful forces (such as globalisation) driving income and wealth inequality in many societies, to what extent can fiscal policy alone reverse these factors? Strategies to increase employment in higher-skilled, emerging industries might be the most effective long term strategy?

High levels of government debt and common use of fiscal austerity may have made redistribution a lower priority for many governments.

In-kind benefits, such as education spending and better quality of and access to health care can also affect the inequality of market incomes in the long run.

Suggestion for wider reading: https://www.imf.org/external/n...