ChainWhat it assumes · how to break it
Start
The government cuts the basic rate of income tax, for example from 20% to 18%.
1
As a result, taxpayers keep more of each pound they earn between the personal allowance and the higher-rate threshold.
marginal tax rate
marginal tax rate
Assumes: The cut applies across all taxable income in the basic-rate band.
But: This holds for the basic rate; the effect would differ for a cut in the higher or additional rate.
2
This means the cash gain rises with income up to the threshold: someone on £15,000 gains about £50 a year, while someone on £45,000 gains about £650.
progressive taxation
progressive taxation
Assumes: The biggest gains go to the richest.
But: Gains stop at the higher-rate threshold, so the very highest earners gain no more than someone on about £50,000. The cut mainly favours the middle, not the top.
3
At the same time, people who pay no income tax, including many pensioners, part-time workers and the unemployed, gain nothing at all.
personal allowance
personal allowance
Best link to attack
Assumes: Non-taxpayers get no compensation.
Assumes: Non-taxpayers get no compensation.
But: If benefits or the state pension are raised at the same time, the poorest households are protected.
4
Consequently, the gap in disposable income between middle and low-income households widens.
distribution of income
distribution of income
Assumes: People do not change their behaviour.
But: If the cut draws low earners into work, their incomes rise and the gap may narrow.
End
Income inequality widens and the Gini coefficient rises.
Attack the whole chain: Raising the personal allowance instead gives every taxpayer the same cash gain and takes some low earners out of tax altogether, so it does much less to widen inequality.
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Questions this answers
- Assess the impact of a reduction in income tax rates on income inequality.
- Discuss the use of taxation to reduce inequality.
- Evaluate the view that tax cuts benefit the rich most.
Diagram
Lorenz curve: the curve moves further from the line of equality and the Gini coefficient rises.
Reverse and related
Income tax rise → larger cash losses for higher earners → inequality narrows.