Next Discussion Session

1
Next Discussion Session

• Choices
• Mon, June 7th
• Wed, June 9th
• Mon, June 14th
• Also, review for exam on June 9th, exam June
  11th. Covers Chapters 1-9 in Rosen, lecture
  material through next Monday.
• Practice exam will be posted by 5pm this Friday.
• Answers posted by 5pm Sunday. I will answer
  questions during office hours and review session.

2
Special Interest Groups

• Recall from last time Community/Group voting
  pressure. People are more likely to vote if they
  are part of a group that actively encourages
  voting (ie. unions)
• Further, these people tend to vote the same way
  (unions traditionally vote Democratic in the USA)
• This implies that these groups exercise a level
  of power that individual voters cannot. As such,
  there is an incentive to form special interest
  groups.

3
Special Interest Groups (SIGs)

• SIG members generally share a common trait. SIGs
  generally form to encourage politicians to make
  policy decisions that benefit the shared
  interests of their members.
• Example NRA and gun control.

4
What are these common traits?

• Level of income people at different income
  levels may have different ideas on what programs
  to fund.
• Industry of Employment Unions, Firm Owners
• Region People in the breadbasket (Kansas,
  Oklahoma, etc) have preferences for the level of
  farm subsidies
• Personal Characteristics AARP, religious groups,
  ethnic groups, even gender.

5
Lobbyists

• SIGs may hire lobbyists to meet with
  politicians. These lobbyists may attempt to
  provide information (could it be biased?) on the
  state of the world, or they may attempt to offer
  campaign contributions or bribes in exchange for
  favors.

6
SIGs continued

• These groups may engage in rent-seeking behavior,
  in order to win favorable outcomes for their
  members. It is to be noted that SIGs with
  opposing interests may be operating at the same
  time in the same legislative body
• Tobacco lobbyists spend millions each year
  attempting to limit the level of cigarette taxes
  imposed by states.
• Non-smoker rights groups spend millions each
  year trying to promote healthier lifestyles
  through banning public smoking and raising
  cigarette taxes.

7
Who are some of the big SIGs?

• National Rifle Association (NRA) a group that
  seeks to protect the constitutional right to bear
  arms. Outspoken opponents of gun control. Pay for
  pro 2nd amendment publications, lobby, organize
  congressional letter campaigns. Members receive
  discounts at hotels such as Best Western and
  Ramada, rental car companies Hertz and Avis. 4.3
  million members.

8
Mothers Against Drunk Driving (MADD)

• Group dedicated to ending drunk-driving through
  legislative and grassroots action, and
  victim-counseling. 47 million dollars of funding
  in the 2002-2003 fiscal year. Frequently called
  to testify before congressional subcommittees.
  Instrumental in helping legislators propose and
  enact tougher drunk-driving legislation, etc.

9
Chapter 7 Conceptual Issues in Income
Redistribution

10
Introduction

• Will provide framework for thinking about the
  normative and positive aspects of government
  income redistribution policy.

11
Introduction

• Some questions whether economists should be
  concerned with distributional issues.
• Value judgments embodied in the right income
  distribution.
• No scientific basis for the right distribution.

12
Introduction

• Focus on efficiency alone has problems.
• That focus, too, is a value judgment.
• Multiple equilbria.
• Decision makers do care about the income
  distribution economic analysis ineffective if it
  doesnt consider this policy-maker constraint.

13
Distribution of Income

• Can analyze household income, and see how equally
  or unequally the pie is distributed.
• Table 7.1 shows the percentage of money income
  among households for more than 30 years.

14
Table 7.1
15
Distribution of Income

• Richest 20 receives about 50 of total income.
• Poorest 20 receives about 4 of total income.
• Inequality has increased over time.

16
Are the rich getting richer and the poor getting
poorer?

• Most of you have heard this at some point or
  another.
• Half true. The rich are getting richer. But the
  poor are also getting richer.
• Inequality is increasing because the rich are
  getting more as a of income, relative to the
  poor.
• Note that using our current definition of the
  poverty line, almost everyone in the US would
  have been below the line in 1880. Economists
  predict that almost nobody will be below this
  line in the year 2090.

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Distribution of IncomePoverty

• The poverty line is a fixed level of real income
  which is considered enough to provide a minimally
  adequate standard of living.
• Inherently arbitrary, but still a useful
  benchmark.
• Trends over time
• Differences across groups

18
Quick digression on the poverty line

• Created in 1965 by Mollie Orshansky for the SSA.
• Based on food requirements. Dept. of Ag. (1955)
  found that poor families spend 1/3 income on
  food. Orshansky estimated the cost of providing a
  basic level of nutrition and multiplied by 3.
• Note poverty line increases with size of family,
  but at a decreasing rate (due to the belief that
  there are certain fixed costs in households)

19
Absolute vs. Relative poverty lines

• Some debate as to whether or not our poverty line
  is appropriate.
• Poor families now spend about 1/5 income on food.
  
• Others have proposed relative poverty lines.
  Victor Fuchs (1967) proposed setting the line at
  45-50 of the median households income.
• US still uses a version of Orshanskys poverty
  line.

20
Distribution of IncomePoverty

• Poverty line for a family of 4 was 18,244 in
  2001.
• Median household income more than double that,
  42,228.
• Table 7.2 shows poverty rates for selected groups
  in 2001.

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Table 7.2
22
Distribution of IncomePoverty

• Poverty rates in U.S. in 2001 might be considered
  surprisingly high 11.7 for population as
  whole.
• Concentrated among certain groups, such as female
  headed households, children, and minorities.
• Elderly have lower poverty rates than the U.S.
  average.

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Distribution of IncomePoverty

• Can also look at trends over time.
• See Table 7.3
• Poverty considerably lower than in 1960s, but
  not much progress since 1970.

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Table 7.3
25
Interpretation Problems

• Poverty line ( poverty rate) is subject to a
  number of criticisms.
• When interpreting the numbers, it is useful to
  know the conventions and limitations.

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Interpretation Problem 1

• Income consists only of cash receipts.
• Excludes in-kind transfers like health insurance,
  food stamps, and housing.
• Would reduce poverty rate by more than 20.
• Excludes non-market work such as childcare or
  housework.
• Ignores income flow from durable goods.

27
Interpretation Problem 2

• Income is before-tax.
• It ignores cash refunds from the Earned Income
  Tax Credit, which has grown dramatically in the
  last decade, and now amounts to more than 31
  billion annually.
• Ignoring this overstates poverty rates, and also
  affects the trends over time.

28
Interpretation Problem 3

• Income is measured annually.
• Not obvious what the correct time frame should
  be.
• Income does fluctuate from year-to-year.
• Lifetime income considerations seem relevant.
• Consider a starving college student, for
  example. Not really poor in a lifetime sense.

29
Interpretation Problem 4

• Unit of observation
• Person, family, household?
• People often make decisions as an economic unit,
  and there are economies of scale in household
  production.
• Classifications can matter for poverty numbers
• Bauman (1997) calculates that including the
  income of non-family members (such as nonmarried
  cohabitors) would reclassify 55 of people who
  are poor out of official definition.

30
Upshot

• It is quite likely that the official poverty rate
  is overstated.
• This is not to say that there is no real reason
  for income distribution.
• Also, just because ones family is officially
  above the poverty line isnt to say his family is
  doing well for itself. A family of 4 with 19,000
  annual income is still in some sense struggling.

31
Rationales for Income Redistribution

• Different kinds of social welfare functions
• Utilitarian
• Maximin criterion (Rawlsian)
• Pareto efficient
• Non-individualistic

32
Simple Utilitarianism

• The utilitarian social welfare function is

• Which depends on all n members of society. One
  specific function form is

• This special case is referred to as an additive
  social welfare function.

33
Simple Utilitarianism

• With the additive SWF that was given, also
  assume
• Identical utility functions that depend only on
  income
• Diminishing marginal utility of income
• Societys total income is fixed
• Implication government should redistribute to
  obtain complete equality.

34
Simple Utilitarianism

• This can be illustrated with 2 people.
• See Figure 7.1
• Any income level other than I does not maximize
  the SWF.
• I entails equal incomes.

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Figure 7.1
36
Numerical Example

• 2 identical individuals (Betty and Al),
  diminishing marginal utility of income. 40 in
  economy.
• Additive social welfare function
• For example. If Al has 30 dollars and Betty has
  10, Social welfare W 21 9 30.
• Total Utility is maximized when each individual
  receives 20. W 1616 32.

37
Simple Utilitarianism

• Striking result is that full income equality
  should be pursued, but some scrutiny required.
• Assumes identical utilities
• Assumes decreasing marginal utility
• Assumes total income fixed
• E.g., no disincentives from this kind of
  redistributive policy.

38
The Maximin Criterion

• The Rawlsian social welfare function is

• Social welfare in this case depends only on the
  utility of the person who has the lowest utility.
• Rawls (1971) asserts it has ethical validity
  because of the notion of original position.
• Notion that ex-ante individuals do not know where
  in the income distribution they will be.

39
Original Position

• Rawls proposed a thought experiment
• Individuals start from a position of knowing
  nothing about themselves.
• They then choose how to organize society.
• The Maximin criterion is what Rawls believes
  people would choose for themselves.

40
The Maximin Criterion

• These ethical claims are controversial
• Still selfish view in original position
• Individuals extremely risk averse here
• All that is relevant is the welfare of the
  worst-off person, even if a policy is extremely
  detrimental to everyone else.

41
Pareto Efficient Income Redistribution as
Justification for Income Redistribution

• Suppose that utility of richer person does depend
  on poorer persons utility. That is

• Government redistribution in this case could
  improve efficiency. It may be difficult for the
  private market to do this, if, for example, the
  rich lack information on just who really is poor.
• Simply an externality problem.

42
Pareto Efficient Income Redistribution

• Altruism plays a role in this example, but
  private market could conceivably give charity.
• But not just altruism. Self-interest could play
  a role. Suppose there is a possibility that, for
  circumstances beyond your control, you become
  poor.
• When well-off, pay premiums. When bad times
  hit, collect payoff.
• Motivation of some social insurance programs.

43
Nonindividualistic views

• In previous cases, social welfare derived from
  individuals utilities.
• Some specify what the income distribution should
  look like independent of individual preferences.
• One example commodity egalitarianism.
• Right to vote, food, shelter, education, perhaps
  health insurance.

44
Processes versus Outcomes

• All the above examples are concerned with
  outcomes of distribution (who ends up with what)
• Some argue that a just distribution of income is
  defined by the process that generated it.
• For example, equal opportunity in U.S.
• Ensuing outcome would be considered fair,
  regardless of the income distribution it happened
  to entail.
• Fair bit of income mobility (Gottschalk, 1997).
• Does raise problem of how to evaluate social
  processes.

45
Expenditure Incidence- the impact of expenditure
policy on distribution of real income

• Relative Price Effects
• Public Goods
• Valuing In-Kind Transfers

46
Relative Price Effects

• Suppose government subsidized housing of the
  poor.
• As a first pass, redistribution from rich to
  poor.
• May have overall effects on housing prices
• Landlords may reap part of gain.
• Affects wages of construction workers
• Generally, any government program sets off a
  chain of price changes, and the incidence is
  unclear.

47
Public Goods

• Do rich and poor benefits similarly from the
  provision of public goods?
• Difficult to measure, sensitive to assumptions
  that are made.

48
Valuing in-kind transfers

• Government provides many benefits to the poor
  in-kind that is, direct provision of goods
  rather than cash.
• Food stamps
• Medicaid
• Public Housing
• Estimating value is difficult. Not always valued
  at dollar-for-dollar (if resale is difficult).

49
Valuing in-kind transfers

• Consider how the provision of an in-kind benefit
  changes the budget constraint in transparency.
• In this case, giving an in-kind benefit lowers
  utility relative to an equally costly cash
  transfer.
• Although the person is better off by having the
  in-kind transfer than not having it, she would be
  even happier with the cash transfer.

50
Valuing in-kind transfers

• A person can never be made better off with an
  in-kind transfer that is equal in cost to a cash
  transfer.
• There are instances, however, when a person is
  indifferent between the two transfer schemes.
• See overhead.

51
Valuing in-kind transfers

• Why give in-kind transfers if they tend to be
  inefficient?
• Commodity egalitarianism/ tax-payer sovereignty.
  Congress (or taxpayers) may only want to provide
  health-care or housing, rather than just give
  cash.
• May reduce welfare fraud (especially if the
  in-kind transfer is an inferior good)
• Politically viable because they help the producer
  of the in-kind good.

52
Recap of Income Redistribution Conceptual Issues

• Distribution of income
• Poverty line
• Social welfare functions
• Valuing In-Kind transfers