Distribution of Income & Wealth

Distribution of Income & Wealth

The distribution of income (flow of earnings over a period) and wealth (stock of assets at a point in time) is a major concern for economists, policymakers, and society. Understanding the causes and consequences of inequality, and evaluating policies to address it, is essential at A-Level.

Defining Income and Wealth

Income

A flow of money received over a given period, including:

• Earned income: wages and salaries from employment
• Unearned income: rent, dividends, interest, profits
• Transfer payments: benefits, pensions, tax credits (not from productive activity)

Wealth

A stock of assets owned at a point in time:

• Marketable wealth: property, shares, savings, art, pensions that can be sold
• Non-marketable wealth: state pension entitlements, some occupational pensions

Key distinction: income is a flow (like water through a pipe); wealth is a stock (like water in a tank). They are related — income can be saved to build wealth, and wealth generates income (interest, rent, dividends).

Measuring Inequality

The Lorenz Curve

A graphical representation of income (or wealth) distribution:

• The diagonal line represents perfect equality (each 10% of the population earns 10% of income)
• The Lorenz curve bows below the diagonal — the further from the diagonal, the greater the inequality
• The area between the diagonal and the Lorenz curve indicates the degree of inequality

The Gini Coefficient

Gini = Area between the diagonal and the Lorenz curve ÷ Total area below the diagonal

Gini Value	Interpretation
0	Perfect equality
1	Perfect inequality (one person has all income)
UK ~0.35	Moderate inequality
Nordics ~0.25	Lower inequality
South Africa ~0.63	High inequality

Limitations of the Gini:

• A single number hides where inequality occurs (top vs bottom)
• Different distributions can produce the same Gini
• Does not account for non-monetary factors (public services, quality of life)
• Pre-tax vs post-tax Gini can differ significantly

Other Measures

• Decile/quintile ratios: compare income shares (e.g., top 20% vs bottom 20%)
• Palma ratio: income share of top 10% divided by bottom 40%
• Absolute vs relative poverty: absolute = below a fixed threshold; relative = below a proportion of median income (UK: 60% of median)

Causes of Income Inequality

Labour Market Factors

• Skills and education: human capital theory (Becker) — higher skills → higher productivity → higher wages
• Occupation and industry: finance and tech pay more than retail and care
• Discrimination: gender, ethnicity, age, disability (Becker's taste model; statistical discrimination)
• Monopsony power: employers suppress wages below MRP
• Trade union decline: reduced bargaining power for low/middle earners since 1980s
• Globalisation: increased demand for skilled workers, reduced demand for unskilled (Stolper-Samuelson)
• Technology: automation displaces routine jobs, raises demand for high-skill roles (skill-biased technological change)

Wealth-Related Factors

• Inheritance: wealth passed between generations perpetuates inequality
• Property ownership: house price inflation benefits owners, excludes renters
• Returns on capital vs labour: Piketty (2014) — r > g (return on capital exceeds economic growth), so wealth concentrates over time
• Access to financial markets: wealthier individuals invest in higher-return assets

Government Policy

• Tax progressivity: more progressive taxation reduces post-tax inequality
• Benefit levels: universal credit, state pension, housing benefit
• Public services: NHS, state education ("social wage")
• Minimum wage: raises floor of earnings

Consequences of Inequality

Economic

• Reduced aggregate demand: high inequality may reduce AD if lower earners have higher MPC
• Lower growth: IMF/OECD research suggests excessive inequality reduces growth (excludes talent, reduces investment in human capital)
• Incentive effects: some inequality is necessary to provide incentives to work, invest, and innovate (free-market view)
• Health and social costs: Wilkinson & Pickett (2009, The Spirit Level) — more unequal countries have worse health, higher crime, lower trust

Social

• Reduced social mobility: children from poor backgrounds have fewer opportunities
• Political instability: extreme inequality can lead to social unrest
• Erosion of social cohesion: "us and them" divisions

Policies to Redistribute Income and Wealth

Progressive Taxation

• Higher earners pay a larger proportion of income in tax
• UK income tax: 20% basic, 40% higher, 45% additional rate
• Evaluation: may reduce incentive to work/invest at high marginal rates (Laffer curve — beyond the revenue-maximising rate, higher taxes reduce revenue); avoidance and evasion; capital flight; but evidence on disincentive effects is mixed

Transfer Payments

• Means-tested benefits (Universal Credit), universal benefits (state pension, child benefit)
• Evaluation: reduce poverty directly; but means-testing creates poverty traps (high effective marginal tax rates as benefits are withdrawn); universal benefits avoid poverty traps but are expensive; dependency culture debate

Minimum Wage

• Raises earnings for the lowest-paid
• Evaluation: effective in monopsonistic markets; may cause unemployment in competitive markets (see labour market notes)

Education and Training

• Supply-side approach: increase human capital to raise productivity and earning potential
• Widening participation, apprenticeships, adult retraining
• Evaluation: long-term solution but slow to take effect; quality of education matters as much as access; may not help those already in the labour market

Wealth Taxes

• Inheritance tax: 40% above £325,000 threshold (UK)
• Capital gains tax: on profits from selling assets
• Proposals for annual wealth taxes (Piketty advocates a global progressive wealth tax)
• Evaluation: may be avoided through trusts, offshore holdings; difficult to value illiquid assets (art, property); may reduce savings and investment; but addresses intergenerational inequality directly

Evaluation: Equity vs Efficiency Trade-Off

The fundamental debate is whether reducing inequality conflicts with economic efficiency:

Equity side (Rawls, A Theory of Justice, 1971):

• The "veil of ignorance": rational people would choose a society with a safety net
• Diminishing marginal utility of income: £1 is worth more to a poor person than a rich one → redistribution increases total welfare
• Investment in human capital of the poor benefits the whole economy

Efficiency side (Nozick, Hayek, free-market economists):

• Inequality reflects differences in productivity and provides incentives
• Redistribution distorts market signals (high taxes reduce work effort, saving, investment)
• "A rising tide lifts all boats" — growth benefits everyone (trickle-down)
• Government failure in redistribution (poorly targeted benefits, bureaucratic costs)

Modern consensus (IMF, OECD): extreme inequality harms growth, but some inequality is needed for incentives. The optimal policy is not maximum equality but inclusive growth — ensuring the benefits of growth are widely shared.

Exam Technique

• Define income vs wealth clearly at the start
• Use the Lorenz curve and Gini as analytical tools
• Name specific policies AND evaluate each with strengths/weaknesses
• Reference named economists: Piketty (r > g), Rawls (justice), Nozick (libertarian), Wilkinson & Pickett (Spirit Level), Becker (human capital, discrimination)
• In 25-mark essays, reach a justified conclusion on whether inequality is beneficial or harmful overall — avoid sitting on the fence