The effects of taxes and benefits on income distribution

Governments can influence income distribution through the system of cash benefits and personal taxes. Taxes tend to be progressive, in the sense that people with higher incomes pay a higher proportion of their income in tax. Benefits may be targeted at the poor, and even if they are flat rate they will tend to narrow the proportional difference between the incomes of the rich and the poor. When benefits are paid to people in particular circumstances, these tend to be correlated with low income or greater need (such as childhood, disability or illness) or they are specifically intended to replace income from work (unemployment benefit, pension). In seeking to understand the distributional effects of government programmes and their effectiveness in reducing income inequality and risk of poverty, it is necessary to take account of the distinct (but sometimes interacting) effects of taxes and benefits. Specifically, it is important to take account of the taxes paid on benefits when considering the impact of these on household income levels.

Moreover, it is of interest to explore whether instruments that are specifically designed to support those on low incomes (means-tested benefits, in particular) are, in fact, as effective in this respect as benefits which are intended for other purposes and which are not confined to particular income groups (universal or non-means-tested benefits). In particular, while the main purpose of public pensions is to redistribute personal income over an individual’s life cycle, they nevertheless have an inter-personal redistributive role, and it is interesting to establish the size of this role relative to that of non-pension benefits.

In addition, it is usually assumed that personal incomes are shared among members of a household, and that each income source can be treated equivalently, regardless of its recipient or function. One aspect of this is the role of general household benefits, as compared to those specifically targeted at a particular group, in reducing the risk of poverty among the group concerned, such as, in particular, in relation to children. Child benefits or family allowances, therefore, are aimed at supporting the income of parents with children, but it is assumed that they also support the income of everyone else in the household; at the same time, other benefits that the household might receive add to the income which children have access to.