How is income distributed in Australia and should government reduce inequality?
Explain how the distribution of income and wealth is measured and evaluate the role of government in reducing inequality in Australia.
Measuring income and wealth distribution with the Lorenz curve and Gini coefficient, the causes of inequality, and the equity-efficiency trade-off, with Australian policy examples.
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What this dot point is asking
A fair distribution of income is widely listed among the economy's goals. This dot point asks you to measure inequality, explain its causes, and evaluate whether and how government should reduce it, recognising that equity and efficiency can pull in opposite directions.
Income versus wealth
It is important to separate two related ideas. Income is a flow: the money received over a period, such as wages, profit, rent, interest and government benefits. Wealth is a stock: the value of assets owned at a point in time, such as housing, shares and superannuation, minus debts. Wealth is far more unequally distributed than income in Australia, largely because of housing and superannuation balances that accumulate over a lifetime.
Measuring the distribution
The Lorenz curve plots the cumulative share of income against the cumulative share of the population, ranked from poorest to richest. A perfectly equal distribution is the 45-degree line of equality; the further the Lorenz curve bows below that line, the greater the inequality. The Gini coefficient summarises this in a single number: it is the area between the line of equality and the Lorenz curve, as a proportion of the whole area under the line. Australia's Gini coefficient for income sits around the middle of the rich-country range.
Causes of inequality
Inequality arises from differences in wages (reflecting skills, education and bargaining power), ownership of wealth-generating assets, age and stage of life, and access to opportunity. Inheritance, housing wealth and the returns to capital can entrench inequality across generations. Some inequality is unavoidable in a market economy because it rewards skill, effort and risk-taking, which can be efficient. The policy question is how much is acceptable.
Government redistribution
Australian governments reduce inequality mainly through the tax and transfer system. The personal income tax is progressive, meaning higher earners pay a higher average rate, which narrows the gap between gross and disposable incomes. Welfare transfers, such as pensions, unemployment benefits and family payments, lift the incomes of the least well off. Government also reduces inequality in kind by providing services such as public health and education that benefit lower-income households most. Minimum wage laws set a floor under earnings.
The equity-efficiency trade-off
Redistribution has costs as well as benefits. Very high tax rates can blunt the incentive to work, save and invest, and generous benefits can in some cases weaken work incentives. Economists call this the trade-off between equity (a fairer share) and efficiency (the size of the pie). A good policy seeks to reduce poverty and extreme inequality without doing so much damage to incentives that the whole economy grows more slowly.
A strong answer defines and measures the distribution with the Lorenz curve and Gini coefficient, explains the causes of inequality, describes how the tax and transfer system redistributes, and evaluates redistribution by weighing greater equity against the efficiency costs to incentives and growth.