WE - Poverty, inequality and polarisation 2

Def. Marginal tax rate

the percentage of tax you pay on your next euro of income earned

Def. Average tax rate

total tax paid divided by your total taxable income

How to define marginal tax rate? (formula)

Income tax + taper rate

Def. taper rate

decrease in benefits after an increase in income

Kind of traps

1) poverty trap
2) unemployment trap

Poverty trap

no financial incentive to work longer hours

Unemployment trap

no/little financial incentive to seek work

Def. taper rates

the rate at which an income-tested benefit (aimed at reducing poverty) is withdrawn as earnings rise

Taper rate & poverty trap

low-income families cannot raise their net income significantly

Effects of high marginal tax rates

1) substitution effect
2) income effect

Substitution effect

labour-supply disincentive

Key takeaway from Taper rates

the more benefits are introduced, the greater the variation in taper rates, greater complexities when different benefits interact

Individuals least likely to increase their working hours?

those who are right at the cut off of not receiving/receiving less

Why does the marginal tax rate decrease at the top?

Because at a certain point you are not eligible for any benefits = no benefits to decrease

Credit and Marginal tax rate

incentive device
= reduce the MTR and targeted at low income households to increase their labor supply

(work) Credit and tax load

reduces someone’s taxable income = reduces taxes to be paid

Pressure on Marginal tax rate

1) upwards when benefits are decreasing as income rises
2) downwards when benefits are increasing (lighten the tax burden) when income is low

Key trade off for marginal tax rate

targeting vs incentives (leakage and gaps)

Marginal Tax rate and targeting

to reduce leakages
= benefits decrease in order to ensure that rich people to not get any benefits

Taper effect

marginal tax rates increasing in income = reduces incentives to work

Paradox of Marginal Tax Rate

benefits reduce your taxable income = marginal tax rate is higher
= incentive to work is lower = moral hazard

Moral hazard effect of marginal tax rate

stronger incentive to remain on welfare benefits

Marginal Tax rate - bunching

mass of people at a specific point caused by behaviour effects

Marginal Tax rate - kinks

slope of line changes

Marginal Tax rate - notch

sudden jump/discontinuity

Differences between in-kind & cash benefits - Non Binding Constraint

occurs when in-kind benefits are less than optimum

Differences between in-kind & cash benefits - Binding Constraint

occurs when in-kind benefits are more than the optimum
= forced to consume that much

Development of income polarisation

1) pyramid
2) egg
3) Hourglass

Pyramid structure of income polarisation

Industrial city
Large working-class base, medium-size middle class, small upper class

Egg structure of income polarisation

service economy city
small working-class, large middle-class, small upper-class

Hourglass structure of income polarisation

polarised city
large-working class
small middle class
large upper class