Government Policies to Reduce Inequality

Governments use a range of fiscal, labour market, and social policies to reduce inequality and poverty. This lesson examines the main policy tools available, evaluates their effectiveness using UK evidence, and considers the trade-offs involved. Understanding these policies — and being able to evaluate them critically — is essential for A-Level Economics.

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The Tax System

Progressive Taxation

Key Definition: A progressive tax is one where the proportion of income paid in tax rises as income rises. The marginal tax rate exceeds the average tax rate.

UK Income Tax Rates (2024/25):

Band	Taxable Income	Rate
Personal Allowance	Up to £12,570	0%
Basic Rate	£12,571 – £50,270	20%
Higher Rate	£50,271 – £125,140	40%
Additional Rate	Over £125,140	45%

Income tax is clearly progressive — a worker earning £20,000 pays approximately 5% of their total income in income tax, while a worker earning £200,000 pays approximately 35%.

National Insurance Contributions (NICs) are less clearly progressive. Employee NICs are charged at 8% on earnings between £12,570 and £50,270, and 2% above that — making them regressive at higher incomes (the marginal rate falls as income rises).

Regressive Taxation

Key Definition: A regressive tax is one where the proportion of income paid in tax falls as income rises, even if the absolute amount paid rises.

Value Added Tax (VAT) at 20% is regressive because lower-income households spend a higher proportion of their income on consumption (and therefore on VAT). The IFS estimates that the poorest fifth of households pay approximately 27% of their disposable income in indirect taxes, compared with approximately 14% for the richest fifth.

Overall Progressivity of the UK Tax System

Tax	Progressive or Regressive?
Income tax	Progressive
NICs	Regressive at high incomes
Capital gains tax (CGT)	Regressive (lower rates than income tax; mainly paid by the wealthy)
Council tax	Regressive (based on 1991 property valuations; does not scale with current values)
VAT	Regressive
Inheritance tax (IHT)	Progressive (40% above £325,000 threshold; but extensive avoidance)

The overall UK tax system is only mildly progressive — the impact of regressive indirect taxes partly offsets the progressivity of income tax. The ONS estimates that the tax and benefit system combined reduces the Gini coefficient by approximately 18 percentage points (from 0.49 for original income to 0.31 for post-tax income).

Exam Tip: Do not simply state that "the UK has a progressive tax system." A more accurate and higher-scoring statement is: "The UK income tax system is progressive, but the overall tax system is only mildly progressive because of regressive elements such as VAT, council tax, and the structure of NICs."

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Transfer Payments and the Benefit System

Types of Benefits

Type	Description	Examples
Means-tested	Eligibility depends on income and assets	Universal Credit, Housing Benefit, Pension Credit
Universal	Available to all who meet non-income criteria	Child Benefit (though taxed back above £50,000), State Pension
Contributory	Based on National Insurance contribution record	Jobseeker's Allowance (contributory), Statutory Sick Pay

Universal Credit

Universal Credit (UC) was introduced from 2013 to replace six previous "legacy benefits" (Income Support, income-based JSA, income-related ESA, Housing Benefit, Child Tax Credit, and Working Tax Credit) into a single monthly payment.

Key features:

• Single taper rate of 55% — for every £1 earned above the work allowance, UC is reduced by 55p. This was reduced from 63% in the October 2021 Budget.
• Designed to "make work pay" by ensuring workers are always better off in employment than on benefits.
• Paid monthly (like a salary) to encourage budgeting.
• Administered online.

Evaluation of Universal Credit:

Advantage	Disadvantage
Simplifies a complex benefits system	The five-week wait for first payment pushes claimants into debt and destitution (Trussell Trust: 3 million emergency food parcels in 2022/23)
Single taper rate reduces high marginal deduction rates	55% taper + income tax + NICs means some workers face effective marginal tax rates of 70%+
Work allowances encourage employment	Monthly payment is difficult for those used to weekly budgets
Automatic adjustments reduce fraud and error	Digital-only application excludes those without internet access or digital literacy
In-work conditionality can encourage progression	Sanctions regime criticised as punitive — removing benefits for minor infractions

The "Poverty Trap" and Marginal Deduction Rates

Key Definition: The poverty trap (or unemployment trap) occurs when the combined withdrawal of benefits and imposition of taxes means that a worker gains little or no net income from working additional hours or from moving into employment.

The marginal deduction rate (MDR) measures the percentage of each additional £1 earned that is lost to taxation and benefit withdrawal:

MDR = (Tax paid + Benefits lost) / Increase in gross income × 100

Before Universal Credit, some families faced MDRs of over 90% — earning an extra £1 left them with less than 10p. UC has reduced this, but MDRs of 70–75% remain common for many low-income workers with children.

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In-Work Benefits and Tax Credits

The principle of in-work benefits — supplementing low wages with state payments — was pioneered by Gordon Brown as Chancellor through the introduction of Working Families Tax Credit (1999) and later Working Tax Credit and Child Tax Credit (2003), now being replaced by Universal Credit.

Arguments for in-work benefits:

• Increase the incentive to work (compared with out-of-work benefits only)
• Top up low wages without directly increasing labour costs for employers
• Target support at low-income working families with children

Arguments against:

• Effectively subsidise low-paying employers — the state bears the cost of inadequate wages
• Complex to administer (overpayments and clawbacks were a major problem with tax credits)
• Create high marginal deduction rates (the poverty trap)
• Stiglitz (2012) argued that in-work benefits allow employers to pay below-subsistence wages, transferring costs from firms to taxpayers

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The National Minimum Wage / National Living Wage

As discussed in Lesson 6, the NMW/NLW directly raises the wages of the lowest-paid workers. Its impact on inequality depends on: