Chapter 12 · Economics of inequality and poverty
Income redistribution using Lorenz curves
Compare Lorenz curves before and after taxes and transfers. Explain how redistribution can reduce income inequality and change the Gini coefficient.
The economic idea
Income redistribution changes the distribution produced by markets and asset ownership. Governments use progressive direct taxes, cash transfers, tax credits, benefits in kind and publicly provided services to alter households’ command over goods, services and opportunities.
Market income is earned before redistributive taxes and transfers, including wages, profit, rent and interest. Disposable income is the income available after direct taxes and cash transfers. Final income may additionally include the value of benefits in kind and deduct indirect taxes, so comparisons must use clearly defined income concepts.
A progressive tax takes a larger proportion of income as income rises. A transfer payment is a government payment for which no current good or service is supplied in return. Together, well-targeted progressive taxes and transfers can raise the cumulative income share received by lower-income households and move a Lorenz curve toward perfect equality.
Redistribution may also reduce poverty, improve access to health and education and widen equality of opportunity. These effects are related to, but not identical with, a lower Gini coefficient.
Evaluation must consider effective marginal tax rates, labour supply, saving, investment, tax avoidance, benefit take-up, administrative and exclusion errors, fiscal cost and how revenue is used. The size of each behavioural effect is an empirical question, not something the Lorenz diagram settles.
Reading the movement from Before redistribution to After redistribution
“Cumulative percentage of population” orders households cumulatively from the lowest to the highest income; “Cumulative percentage of income” records their cumulative income share.
“Before redistribution” represents the initial distribution and “After redistribution” the distribution after the selected tax-and-transfer system.
“Perfect income equality” is the benchmark. Curves closer to it represent a more equal relative distribution, provided the same income concept and population are compared.
Starting distribution: Before redistribution
“Before redistribution” shows how the initial total income is distributed across cumulative population groups. Its distance below “Perfect income equality” creates the initial inequality area and initial Gini coefficient.
Policy-adjusted distribution: After redistribution
“After redistribution” lies closer to “Perfect income equality” than “Before redistribution”. The area between the two Lorenz curves, labelled “Equality gained after redistribution” when shading is shown, represents the reduction in measured inequality; the post-redistribution Gini coefficient is lower.
What the comparison means for households
“After redistribution” being above “Before redistribution” means the lower cumulative population groups receive a larger share of the measured post-policy income total. It does not mean every household’s money income rose or that the richest group became poor.
Does a more equal share guarantee higher living standards?
A Lorenz curve closer to the line of equality shows a more equal relative distribution of the income measured. It does not tell us whether total income is higher or whether every household has more real income.
Taxes and transfers can change disposable-income shares without directly increasing productive capacity. Evaluate the redistribution by considering its effect on poverty, incentives, administrative costs and access to public services. The two curves alone do not measure those effects.
From progressive redistribution to the displayed Lorenz shift
Market income reflects earnings, asset ownership, employment, skills, bargaining power and other pre-policy influences.
Progressive direct taxes reduce higher-income households’ disposable income proportionately more, while transfers and tax credits raise resources toward the lower part of the distribution.
Lower-income cumulative groups therefore receive a larger share of measured disposable income, moving the distribution from “Before redistribution” toward “After redistribution”.
Common mistakes to avoid
- “After redistribution” closer to equality does not mean incomes are equal or that everyone receives the same income.
- A fall in the Gini coefficient is not the same as a fall in absolute poverty; both should be measured separately.
- Do not compare a market-income curve directly with a final-income curve without explaining the taxes, cash benefits, indirect taxes and services included.
- The area between the curves is a change in the inequality measure, not tax revenue, government expenditure or a welfare gain in money terms.
- Redistribution does not reveal its own incentive, administrative or fiscal effects on this graph.
How to draw this diagram
- Title the diagram “Income redistribution using Lorenz curves”. Label the horizontal axis “Cumulative percentage of population” and the vertical axis “Cumulative percentage of income”.
- Draw Perfect income equality first and label it clearly.
- Draw Before redistribution next and label it clearly.
- Draw After redistribution next and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Add the relevant guide lines and shade the economic area only after its boundaries are established.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- The curves do not identify which tax, transfer or service caused the change or the size of its behavioural response.
- The model does not display absolute incomes, poverty thresholds, government revenue, programme cost or economic growth.
- Survey under-reporting and weak coverage of very high incomes can understate inequality and the apparent effect of policy.
- A single Gini change can conceal different gains and losses across the lower, middle and upper parts of the distribution.
- Cash-income comparisons may omit benefits in kind, indirect taxes, household needs, regional prices, wealth and unpaid services.