The Distribution of Income

1
Chapter 20

• The Distribution of Income

2
The Distribution of Income

• A persons earnings depend on
• -SD for persons labor
• - natural ability,
• -human capital,
• -compensating differentials, discrimination

3
The Measurement of Inequality

• How much inequality is there in our society?
• How many people live in poverty?
• What problems arise in measuring the amount of
  inequality?
• How often do people move among income classes?

All Big Questions!
4
U.S. Income Inequality

• Imagine. . .
• Line up all families according to their income.
• Divide families into five equal groups
• Compute share of each groups share to total
  income

5
U.S. Income Inequality

• If income equally distributed across l
  families, each one-fifth of families gets 20
  percent of total income.

6
Percentage of Income By Quintiles

• Quintile 1935 1970 1994
• Poorest 4.1 5.5 4.2
• 2nd Poor 9.2 12.2 10.0
• Middle 14.1 17.6 15.7
• 2nd Rich 20.9 23.8 23.3
• Richest 51.7 40.9 46.9
• Top 5 26.5 15.6 20.1

7
Historic Trends in Income Inequality

• From 1935-1970, income distribution became more
  equal.
• Trend reversed recently

8
Reasons for Increased Inequality

• Increases in international trade with low-wage
  countries
• Technology has reduced demand for unskilled labor
  
• Wages of unskilled workers have fallen relatively

9
Income Inequality and Poverty

• The Poverty Rate is of population whose family
  income falls below poverty line.

Below the Line!
10
Income Inequality and Poverty

• Poverty does not affect all groups with equal
  frequency.
• The Poverty Rate is of population whose
  family income falls below the poverty line.

11
Insights to Poverty

• Three facts about poverty It is correlated with
• Race.
• Age
• Family Compositon

12
Poverty Rate By Demographic Group

• Group Poverty Rate
• All Persons 14.5
• White 11.7
• Black 30.6
• Hispanic 30.7
• Female house 38.6
• Children (lt18) 21.8
• Elderly (gt64) 11.7

13
International Comparison of Inequality

• Country Bottom Fifth Top Fifth
• Japan 8.7 37.5
• China 6.4 41.8
• U.S. 4.7 41.9
• U.K. 4.6 44.3
• Mexico 4.1 55.9
• Brazil 2.1 67.5

14
The Poverty Line and Income Inequality

• Poverty Line set by federal govt at three times
  cost of an adequate diet.
• With economic growth, more families pushed above
  poverty line

15
The Poverty Line and Income Inequality

• Poverty Line is set by the federal government at
  roughly three times the cost of providing an
  adequate diet.

16
Problems in Measuring Inequality

• Data give incomplete picture of inequality
  because of
• In-Kind Transfers
• The Economic Life-Cycle
• Transitory versus Permanent Income

17
In-Kind Transfers

• Income distribution poverty rate are based on
  money income.
• In-Kind Transfers given to the poor in form of
  goods services (food stamps, health care)
• Failure to include these raises measured poverty
  rate.

18
The Economic Life-Cycle

• Regular pattern of income variation over
  life-time called the life cycle
• Low income at beginning of career
• Income rises as worker gains experience
• Income peaks around age 50
• Income falls sharply at retirement

19
Transitory versus Permanent Income

• Because of random forces, incomes vary
• Acts of nature reduce income
• Temporary layoff due to illness or economy
• Familys ability to buy goods services depends
  on permanent income which excludes transitory
  changes

20
Time Series Consumption Function
Consumption
C .9 Y
Income
21
Cross -Section Consumption Function
Consumption
C 1000 .7 Y
Income
22
Why Two Consumption Functions?

• Time Series Data yield a function that is steep
  with no intercept
• Cross Series Data yield a function with a flat
  slope and a positive intercept

23
Friedmans Permanent Income Hypothesis
Consumption
C a Yp
C b c Ym
Income
Yml LOW HIGH
Ypl
Yph
Ymh
24
Income Inequality andEconomic Mobility

• Substantial economic mobility in the US --
  movement among income quintiles
• Sources of Economic Mobility
• Luck
• Hard Work
• Persistence of economic success from generation
  to generation (e.g. father/son)

25
Quick Quiz!

• What does the poverty rate measure?
• Describe three potential problems in interpreting
  the measured poverty rate.

26
Political Philosophy of Redistributing Income

• What should the government do about economic
  inequality?
• Economic theory does not have a simple, clear
  response.
• Three Political Philosophies
• Utilitarianism
• Liberalism
• Libertarianism

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Liberalism (John Rawls)

• Income to be redistributed so poorest would
  receive an adequate income.
• Development of public policy so as to maximize
  the minimum utility.
• Based on maximin criterion
• A form of social insurance

28
Liberalism (John Rawls)

• Income redistributed so poorest receive an
  adequate amount.
• Development of public policy so as to maximize
  the minimum utility.

29
Utilitarianism

• Based on assumption of diminishing marginal
  utility...
• ... an extra dollar of income to a poor person
  provides that person with more additional utility
  than does an extra dollar to a rich person.
• Utilitarian goal is to have government
  redistribute income such that the sum of
  everyone's utility is maximized.

30
Libertarianism (Robert Nozick)

• ...society itself earns no income--only
  individual members...
• Government should enforce individual rights and
  let market determine final distribution of income
  
• Equality of opportunities, not equality of
  incomes.

31
Quick Quiz!

• Pam earns more than Pauline. Someone proposes
  taxing Pam in order to supplement Paulines
  income.
• How would a utilitarian, a liberal, and a
  libertarian evaluate this proposal?

32
Policies to Reduce Poverty

• Policies to redistribute income and reduce
  poverty
• Minimum Wage Laws
• Welfare
• A Negative Income Tax
• In-Kind Transfers

33
Minimum Wage Laws

• Minimum wage benefits some poor but hurts others
• Magnitude of its effects depend on labors demand
  elasticity
• Many minimum wage earners are teenagers from
  middle class families

34
Welfare

• The government attempts to raise the standard of
  living through the welfare system.
• Welfare encompasses various government programs,
  two of which include
• Aid to Families with Dependent Children
• Supplemental Security Income

35
A Negative Income Tax

• A program advocated to supplement the income of
  the poor.
• High-income families would pay a tax based on
  their incomes. Low-income families would receive
  a subsidy -- a negative tax.
• Poor families would receive financial assistance
  without having to demonstrate need.

36
Work Earnings

• Labor Hours Wage Earnings
• 0 5 0
• 500 5 2,500
• 1000 5 5,000
• 1500 5 7,500
• 2000 5 10,000
• 2500 5 12,500

37
A Welfare Program

• Labor Earnings Benefit Income
• 0 0 7,500 7,500
• 500 2,500 5,000 7,500
• 1000 5,000 2,500 7,500
• 1500 7,500 0 7,500
• 2000 10,000 0 10,000
• 2500 12,500 0 12,500

38
A Welfare Program

• Labor Earnings Benefit Income
• 0 0 7,500 7,500
• 500 2,500 5,000 7,500
• 1000 5,000 2,500 7,500
• 1500 7,500 0 7,500
• 2000 10,000 0 10,000
• 2500 12,500 0 12,500

39
A Negative Income Tax

• Labor Earnings Benefit Income
• 0 0 7,500 7,500
• 500 2,500 6,000 8,500
• 1000 5,000 4,500 9,500
• 1500 7,500 3,000 10,500
• 2000 10,000 1,500 11,500
• 2500 12,500 0 12,500

40
A Negative Income Tax

• Labor Earnings Benefit Income
• 0 0 7,500 7,500
• 500 2,500 6,000 8,500
• 1000 5,000 4,500 9,500
• 1500 7,500 3,000 10,500
• 2000 10,000 1,500 11,500
• 2500 12,500 0 12,500

41
A Negative Income Tax

• Income Tax ( .60 Earnings - 7,500)
• Earnings Tax Income After Tax
• 0 -7,500 7,500
• 10,000 -1,500 11,500
• 20,000 4,500 15,500
• 30,000 10,500 19,500
• 40,000 16,500 23,500
• 50,000 22,500 27,500

42
In-Kind Transfers

• Direct provision of goods services to raise
  living standards.
• Examples of In-Kind Transfers
• Food
• Shelter
• Toys at Christmas
• Food Stamps
• Medicaid

Good Bye!
43
Anti-Poverty Programs and Work Incentives

• Many programs attempt to reduce poverty incidence
  and help the truly needy, but perverse effects
  exist.
• Example
• Family needs 15,000 to maintain a reasonable
  standard of living. The government promises to
  guarantee every family up to the 15,000.
• Incentive to earn more is reduced due to the
  effective marginal tax rate of 100.

44
Quick Quiz!

• List three policies aimed at helping the poor,
  and discuss the pros and cons of each.