Question

1. What effect will each of the following proposed changes have on income inequality?

(a) Increasing the minimum wage.

(b) Increasing the benefit level paid to transfers to people who are not in the labor force.

(c) Increasing wage subsidies paid to firms that hire low-skill workers.

(d) Switching to a more progressive tax system.

(e) Earned income tax credit program for low income workers.

Answer 1

Q. What effect will each of the following proposed changes have on income inequality?

(a) Increasing the minimum wage.

Answer. When the minimum wage is increased, then gap between the wages earned by the higher income groups and lower income groups will get reduced leading to reduction in income ineqiality. Therefore, the increasing wage rate will have a positive effect on the income inequality or with increase in minimum wage rate, the purchasing power will increases and also the income inequality will fall depicting a negative ralationship.

(b) Increasing the benefit level paid to transfers to people who are not in the labor force.

Answer. When the benefit level of tranfer payments such as old age pension, unemployment allawance, scholarship pad to people out of the Working force will not decrease the income inequality as these payments are unilateral payments i.e. one way transactions that do not result in production of goods. Moreover, these payments are mostly used for consumption purposes but never / and very less for investment or saving purpose leading to rise only in demand for goods & services but no effect on income inequality. Therefore, the increase in level of transfers paid will not have any effect on income inequality.

(c) Increasing wage subsidies paid to firms that hire low-skill workers.

Answer. When wage subsidies paid to firms that hirelow skilled workers are increased, it benefits only the firms but not the low-skilled workers because the firm is not going to increase the wages for the low-skilled workers with the increase in government share of giving wages in the form of subsidies. Moreover, there will be buden only on government for meeting this expenditure. Therefore, increasing wage subsidies paid to firms that hire low-skill workers will not have any effect on income inequality.

(d) Switching to a more progressive tax system.

Answer. When more progressive tax system is adopted i.e. increasing tax rates with increase in income levels will be very helpful for govenrment to collect more tax revenue and utilise the same for providing emenities for the development of the poor with which the income inequality in the economy will decline. Hence, switching onto a more progressive tax regime will lead to reduction in income inequality positively.

(e) Earned income tax credit program for low income workers.

Answer. This kind of programes focus on encouraging and rewardind work as well as reducing federal payroll and income taxes for the low and moderate level income groups with which the tax burden on these income groups gets reduced and purchasing power increases with increse in disposable income and thereby helps in reduing income inequallity. Therefore, Earned Income Tac Credit Programes (EITC Programe) will be handy in bringing the income inequlity problew down.