One of the most important areas of discussion in development Economics is poverty reduction. Poverty often deepens and reduces due to the policies of the government. Poverty is affected positively and negatively due to the policies which are implemented to achieve other economic objectives.
Policies to reduce poverty
- Policies to promote economic growth
- Policies to reduce unemployment
- Progressive taxes
- Increasing benefits to the poor
- Pension reforms
- Education and training
Sustainable economic growth will generate wealth which can be used to re-distribute within the society. Economic growth is sustainable when more supply-side economic growth policies are used.
If we look at the countries today, those whith higher economic growth tend to reduce poverty in absolute terms.
Unemployment is always a problem for each and every economy, and poverty will increase if there is high unemployment. Therefore governments can use both demand-side and supply-side policies to reduce unemployment.
The purpose of progressive taxes is to take more taxes from those on high income levels. This will re-distribute income and will reduce relative poverty. It also enables the government to reduce indirect taxes and to increase benefits to the poor.
Problems of Using Taxes to Redistribute Income
1. Disincentives of Higher Tax
Critics argue higher income taxes create a disincentive to work., leading to less output. This is because higher tax makes work less attractive and reduces the opportunity cost of leisure. Therefore people work less and enjoy more leisure. This is known as the Substitution Effect.
2. Higher corporation tax may discourage investments
However this is disputed by other economists. Higher Tax reduce incomes and this may encourage people to work more, to maintain their income. (This is known as the income effect)
Evidence suggests that higher income tax has little effect on the supply of labour, suggesting Labour supply is relatively inelastic. However, it also depends at what level income tax is set. There is certainly a level where higher income tax will reduce incentives to work.
2. Tax Evasion
High levels of tax will encourage more people to use off shore accounts to avoid paying income tax at home country.
3. Firms may adjust wages to compensate
E.g firms may increase wages to those who are taxed and pay lower wages to those who pay less tax.
4. There are administrative costs of collecting taxes.
If costs of collecting taxes is high, it is one of the ways in which government fails in its policies to correct market failure.
5. Distortion effect of putting taxes on goods
Indirect taxes are levied to overcome market failure for demerit goods such as cigarettes, therefore cutting such taxes may encourage consumption of demerit goods.
Increasing benefits to the poor
About giving benefits to the poor, the best way is to give means-tested benefits. Means-tested benefits are benefits that are available only to individuals whose income is below a certain level. For example, in the U.S. food stamps are a means-tested benefit. They are available only to low-income families.
Advantages of means-tested benefits
1. They allow money to be targeted to those who need it most. e.g family tax credit or pension credit.
2. It is cheaper than universal benefits and reduces the burden on the tax payer· However, means-tested benefits are often unpopular because people are stigmatized as being poor.
3. Also it may create a disincentive to earn a higher wage, because if you do get a higher paid job you will lose at least some of your benefits and pay more tax. This is known as “the benefit trap” or the “poverty trap”
4· Some relatively poor may fall just outside the qualifying limit.
5· Also not everyone entitled to means-tested benefit will collect them because of ignorance or difficulties in applying.
Governments used to prefer universal benefits because it avoided the above problem, and people feel if they contribute towards taxes they deserve their benefits regardless of their wealth.
However in recent years, the welfare state has faced increased demands due to demographic factors leading to more calls for means-tested benefits.
– Linking State pensions to earnings and not inflation.
This would increase pensioners income and reduce inequality as poor pensioners would have more income
However this would be very costly because of the demographic changes and if the country is experiencing ageing population.
– Means Tested Pensions.
This enables more money to be targeted to those who need it . However it may discourage people from putting money into private pension schemes.
– Compulsory Company pensions schemes
Education and training
Some people are not able to come out of poverty because they are not able to get employment due to the lack of necessary skills. Improving education and giving training will make them employable. Education also helps to make the workforce more skilled and productive which in turn will help economic growth of the country.
Next topic: Factors affecting population growth