Poverty is a problem everywhere in the world. In some countries it is more severe than in others, but there are always some people who have to live below the poverty line. The poverty line describes an absolute level of income below which an individual or family is deemed to live in poverty. In most European countries, this level is set at 60% of median income.
This definition already implies that poverty is a relative concept. Because of this, many economists distinguish between absolute and relative poverty. Absolute poverty describes a situation, where individuals have no access to the basic requirements of life – food, shelter and clothing. By contrast, we speak of relative poverty when people are unable to take part in what is considered a normal, acceptable standard of living in a society.
The government plays an important role in the fight against poverty. Most people agree that it should at the very least try to help those most in need. However, there is an ongoing debate on how this should be done. In fact, there are a number of different government policies to reduce poverty. We will look at four of them in more detail below: minimum wage laws, social security, negative income taxes, and in-kind benefits.
Minimum wage laws
Minimum wage laws require all employers to pay their employees a minimum amount of wage that is determined by the government. The idea behind minimum wage laws is to help the working poor without directly increasing government spending. Labor unions are some of the most influential advocates of minimum wages. They often try to establish a minimum wage for their members.
However, minimum wage laws are highly controversial. Critics argue that they essentially hurt an economy more than they help. This argument is based on the law of supply and demand. If the minimum wage increases above the equilibrium wage, employers can’t afford to hire the same amount of workers anymore. Hence, unemployment increases. As a result, those who are still employed are indeed better off because they profit from a higher wage. But at the same time the increase in unemployment will put even more people at risk of poverty.
Whether the effects if the employee’s higher incomes outweigh the increase in unemployment ultimately depends on the elasticity of labor demand. Advocates of minimum wages argue that labor demand is inelastic (i.e. it will not decrease much) while critics say it is elastic (i.e. it will decrease significantly). Especially in the long run, when firms can adjust their factors of production more freely.
Another thing to keep in mind here is that not all industries are affected equally by minimum wage laws. Industries that rely on unskilled labor (e.g. cleaning, assembly line work) would be hit much harder by a minimum wage than industries that require a higher skill level (e.g. banking, law). However, because most industries depend on each other at some point, it is impossible to predict the exact effects of minimum wage laws on the economy.
At the end of the day, minimum wage laws are a delicate and highly complex issue. There is not one perfect solution for any economy which makes it difficult to say if and where a government should impose minimum wage laws. What we can say however, is that answering this question requires an in-depth analysis of the economy and a thorough understanding of the respective country and its society.
Social security refers to a number of different government benefits, such as income support, tax credits, social welfare or unemployment benefits. A countries social security system is another option the government has to reduce poverty by supplementing the incomes of poor families and individuals.
Not unlike minimum wage laws, social security is a controversial topic. Critics argue that it can create wrong incentives. For instance, people who work full-time at a low-paying job might have an incentive to stop working and live on unemployment benefits instead. That way, they might lose a small part of their income, but they would not have to get up every morning and go to work anymore. To counteract this, many countries require applicants to provide proof that they are actively seeking employment (e.g. a certain number of job applications per month).
Again, social security is an complex issue. However, most people agree that any government should provide at least a basic social security system (i.e. a “security net”) to prevent people from falling too deep into poverty. In most cases, those people who qualify for social security will still experience a difficult existence at best. Therefore, it is widely regarded as unlikely that many people would be encouraged to pursue such a lifestyle anyways.
Negative Income Tax
Negative income taxes are essentially a subsidy for individuals with a low income (i.e. they pay a negative tax). This works well in a progressive tax system, where individuals with a higher income also pay a larger percentage of their income in taxes. A part of those additional tax revenues can be used to subsidize individuals and families with a low income.
To see how negative income taxes work, let’s look at a simple example. Assume that you have to pay 30% of your income minus USD 20’000 in taxes (i.e. taxes = [income*0.3]-20’000). If you earn USD 90’000 a year, you have to pay USD 7’000 in taxes ([90’000*0.3]-20’000). Meanwhile, someone who earns USD 30’000 will have to pay a negative income tax (i.e. will receive a subsidy) of USD 11’000 ([30’000*0.3]-20’000).
Many economists consider this a good option to redistribute wealth within a country. According to this system poor individuals and families receive financial assistance depending solely on their income. However, this can be seen as an advantage or a disadvantage. On the one hand, it does not incentivize certain unfavorable lifestyles (such as getting a divorce to increase income support). On the other hand it may also support people who are simply to lazy and unwilling to work.
In-kind benefits are a non-cash alternative to regular benefits. The idea behind this is to provide poor families and individuals directly with access to certain goods and services they need most in order to increase their standard of living. For instance, there are a large number of charities (government and non-government) that provide food, shelter, or clothing for those most in need.
Advocates of in-kind benefits argue that this type of support ensures that the poor really get access to what they need most. They also prevent recipients from using government benefits to buy undesirable products and services (e.g. drugs or alcohol). On the other hand, critics argue that non-cash benefits are inefficient and disrespectful. They point out that in-kind benefits essentially deprive the poor of their right of decision. According to the critics, the government does not always know what people need most, so it has no right or obligation to decide for them.
In a Nutshell
Poverty is a problem everywhere in the world and governments play an important role in the fight against it. They can employ at least four different policies to reduce poverty: minimum wage laws, social security, negative income taxes, and in-kind benefits. Minimum wage laws require all employers to pay their employees a minimum amount of wage that is determined by the government. Social security refers to a number of different government benefits, such as income support, tax credits, social welfare or unemployment benefits. Negative income taxes are essentially a subsidy for individuals with a low income. And last but not least, in-kind benefits are a non-cash alternative to regular benefits.