ChainWhat it assumes · how to break it
Start
The government makes income tax more progressive, for example raising the 45% additional rate paid on the highest incomes.
1
As a result, the highest earners pay more tax on each extra pound, so their average tax rate rises.
marginal tax rate · average tax rate
marginal tax rate · average tax rate
Best link to attack
Assumes: Top earners' taxable income stays the same.
Assumes: Top earners' taxable income stays the same.
But: High earners can shift income into pensions, dividends or company structures that are taxed differently, so less income is caught by the higher rate.
2
This means post-tax income at the top falls relative to the median and the bottom.
disposable income
disposable income
Assumes: Lower earners' tax is unchanged.
But: If the rise comes with a freeze in tax thresholds or a lower personal allowance, lower earners pay more too.
3
Consequently, the gap between the top and the rest narrows, the Lorenz curve moves towards the line of equality and the Gini coefficient for post-tax income falls.
Lorenz curve · Gini coefficient
Lorenz curve · Gini coefficient
Assumes: Narrowing the top of the distribution is what matters.
But: Taxing the top does nothing to raise incomes at the bottom, so relative poverty is unchanged unless the revenue is spent on poorer households.
4
In addition, if the extra revenue funds benefits or public services used most by poorer households, incomes at the bottom rise, narrowing inequality further.
redistribution
redistribution
Assumes: The revenue is spent on poorer households.
But: The revenue may be used to reduce borrowing or to fund services used across the whole income distribution.
End
Post-tax income inequality narrows and the Gini coefficient falls.
Evaluation chain
- E1However, the effect on inequality depends on whether top earners' taxable income stays the same when the rate rises.
- E2Because high earners can use pension contributions, dividends, incorporation and the timing of bonuses to reduce taxable income, part of the rise can be avoided legally.
- E3As a result, measured top incomes fall on paper while the real resources of the richest change much less.
- E4So inequality narrows by less than the headline rate rise suggests, unless the rise is paired with rules that close avoidance routes.
Another way to attack it: Income tax does not reach wealth held in property, shares and pensions, so a more progressive income tax narrows income inequality but leaves wealth inequality largely unchanged.
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Questions this answers
- Assess the effectiveness of progressive income taxes in reducing income inequality.
- Discuss whether the government should raise the top rate of income tax.
- Explain how a progressive tax system redistributes income.
Diagram
Lorenz curve for post-tax income: the curve moves towards the line of equality and the Gini coefficient falls.
Reverse and related
Cut in the top rate of income tax → post-tax incomes at the top rise → inequality widens and the Gini coefficient rises.