More on income distribution

1
More on income distribution

• Today Family income distribution
• Should we redistribute income? Why?
• Some government programs

2
Reminder on Test 2

• Test 2 Wednesday
• 65 minutes
• Restrictions on calculators are the same as for
  Test 1

3
Income distribution

• How is income distributed?
• Is there such a thing as too much income
  inequality?
• Why should there be redistribution?
• In-kind versus cash transfers
• When income is redistributed, should recipients
  be forced to consume a minimum amount of certain
  goods?
• What are the problems of redistribution?

4
Mean income table (families)
Quintile 1980 1990 2000
Bottom 20 percent 12,756 12,625 14,232
Second 20 percent 27,769 29,448 32,268
Middle 20 percent 41,950 45,352 50,925
Fourth 20 percent 58,200 65,222 74,918
Top 20 percent 97,991 121,212 155,527
Top 5 percent 139,302 190,187 272,349
Source Principles of Microeconomics 3rd
edition, by Frank and Bernanke

• Real income growth, 1980-2000
• Bottom 20 has been flat
• Top 20 has seen huge growth (59)

Note More recent figures show that family
incomes in the bottom 60 have stayed about the
same since 2000 (source http//www.census.gov/hh
es/www/income/histinc/h01AR.html)
5
The gap between rich and poor widens

• The rich are getting richer, but the poor are not
  getting poorer
• The middle class has seen moderate real growth in
  income
• 16-29 growth for the categories in the middle
  60
• Some of this is due to more middle-class families
  having two incomes

6
Problems with annual income figures

• Ignores number of workers in a household
• General trend from one earner to two
• Expenses, such as child care, could be higher
  within two-worker households
• In-kind transfers ignored
• Taxes change over time
• Disposable income changes over time (given the
  same income)
• Income changes over time
• If a rich person earns no income in a calendar
  year, should she be considered poor?

7
Is there too much income inequality

• Some people would argue no
• When economic incentives to make a good living
  go away, the economic pie becomes smaller
• Think about communist systems
• People that have a good work ethic and work hard
  should make more money
• There are plenty of opportunities for anybody
  born today in the US to become successful
• Free K-12 education subsidized colleges and
  universities

8
Arguments for less income inequality

• Marginal utility of income is lower for somebody
  with high incomes
• Each person has a right to a minimum standard of
  living
• Social unrest may occur unless each person is
  above the poverty line

9
Other problems with income inequality

• Those that are relatively poor may feel inferior
• This problem may perpetuate to their children
• Jealousy towards other people
• Envy towards other peoples accomplishments

10
More on fairness

• There are different views of fairness
• Additive social welfare function
• Veil of ignorance
• Social welfare function should be minimum utility
  of all people in a society
• Commodity egalitarianism

11
Different views of fairness

• Some people believe that utility, not income,
  should be maximized within a population
• Additive social welfare functionW U1 U2
  Un

12
Implications for additive utilities
0
This is the net gain to society
Paul gains this much utility
Pauls marginal utility
Peters marginal utility
e
f
Peter loses this much utility
d
c
Take ab from Peter and give to Paul
Social welfare maximized
MUPeter
MUPaul
Pauls income
Peters income
0
0
a
b
I
Pauls income
Peters income
13
Different views of fairness

• Others believe that social welfare should be the
  minimum of the utilities of each person in
  society
• Veil of ignorance argument developed by John
  Rawls
• Conceals knowledge and talents from people
• Risk averse people will want to have income
  equality under these conditions
• No inferiority, jealousy or envy based on income

14
Problem

• The economic pie will shrink with Rawls ideas
• If income was guaranteed to be equal to everyone,
  nobody will have an economic incentive to gain
  human capital
• Smaller economic pie
• Less human capital
• People work less

15
Optimal amount of income inequality?

• Impossible to answer
• Different people have different opinions about
  effectiveness of realistic ways to redistribute
  income

16
Different views of fairness

• Commodity egalitarianism
• Some things should be made available to everyone
  without restrictions
• Right to vote (if 18 or older)
• Basic education
• Needed items such as food, shelter, and
  clothing
• Basic medical care
• Recall issues presented in Chapters 9 and 10

17
Some other factors

• Income redistribution does not directly take into
  account other factors
• Number of hours worked
• If our goal is to maximize utility from income,
  why not reduce leisure?
• Not necessarily, since additional leisure likely
  increases utility
• Income depends on number of hours worked
• Does relative income matter?
• Does someone get a decrease in utility when his
  income remains the same and someone elses
  increase?

18
In-kind versus money transfers

• With some views, such as commodity
  egalitarianism, in-kind transfers have more
  appeal than monetary ones
• How does this affect individual utility?

19
In-kind Transfers
H
Other goods per month
420
E3
340
A
F
U
300
E1
260
B
D
20
150
210
60
Pounds of cheese per month
20
In-kind Transfers
H
Other goods per month
420
A
F
300
E5
168
E4
136
B
D
82
150
210
126
Pounds of cheese per month
21
If income redistribution is good

• then how do we move money from one person to
  another?
• Welfare payments
• We will spend most of our time on this
• The earned-income tax credit
• Negative income tax
• Minimum wage
• Public employment of the unemployed

22
Some methods of income redistribution

• Welfare payments
• Little economic incentive to get off of welfare
  without time limits
• Many types of programs
• TANF
• Supplemental Security Income
• Medicaid
• Unemployment insurance

23
TANF

• Temporary Assistance for Needy Families
• Federal government provides block grants to
  states for welfare spending
• Over 80 of recipients in every state must be on
  TANF for five years or less
• States face penalties if a substantial percentage
  of recipients are not working or in work
  preparation programs

24
TANF

• TANF replaced Aid to Families with Dependent
  Children (AFDC)
• Under AFDC, some argued that many women on AFDC
  had children out of wedlock to continue get
  benefits and not have to work
• If the mother had to work once the child reached
  kindergarten, then there would be an economic
  incentive to have another child

25
TANF and benefit reduction rates

• TANF benefits are reduced when income reaches a
  certain level
• Example In California, recipients can earn up
  to 225 per month before benefits are reduced at
  a rate of 50 of money earned
• How do people respond to these incentives in the
  short run?

26
Work incentives
0
The Basic Trade-offs

• B G tE
• B 0 if E G/t

G basic grant if not working t rate
at which grant reduced when recipient earns
money B benefit received
27
Analysis of work incentives
D
Slope w
Income per month
c
Time Endowment
b
2w
w
a
0
T
Hours of leisure per month
28
Analysis of work incentives
D
Slope w
Income per month
E1
G
iii
ii
Income
Leisure
Work
i
0
T
F
Hours of leisure per month
29
Analysis of work incentives
In this example, someone can get 100 in TANF
benefits if not working Between point Q and point
S, an implicit tax rate of 25 is imposed Note
that there are some incentives to work while
still receiving benefits
D
Slope w
Income per month ( earnings transfers)
Slope 3/4w
S
G
Hours after TANF
Hours before TANF
Q
100
0
T
F
V
K
Hours of leisure per month
30
Analysis of work incentives
In this case, a 100 implicit tax rate is imposed
after a benefit of 338 is received
D
Budget constraint with t 100
0 hours of work selected
P1
P
Income per month ( earnings transfers)
S
R
G
338
0
T
F
Hours of leisure per month
31
Analysis of work incentives
This person is indifferent between working and
receiving benefits
D
E2
Income per month ( earnings transfers)
R
P
G
Hours worked (if working)
0
T
M
Hours of leisure per month
32
Analysis of work incentives
This person prefers working to receiving benefits
D
E2
Income per month ( earnings transfers)
R
P
G
Hours worked
0
T
M
Hours of leisure per month
33
Supplemental Security Income (SSI)

• Federal program that provides benefits for the
  aged, blind, and disabled with little or no
  assets
• In 2003, average benefit was 342
• SSI recipients can earn up to 65 per month
  without loss in benefits
• After 65 is earned, additional earnings have a
  50 implicit tax rate

34
Medicaid

• Medicaid affects incentives to work
• Under old incentive structures, people often lost
  eligibility once they earned enough money to get
  off of welfare
• This created a Medicaid notch

• For main details about Medicaid, see Chapter 10

35
The Medicaid notch
M
Income per year
D
R
S
Z
N
1,000
0
T
X
Hours of leisure per year
36
Solving the Medicaid notch problem

• In recent years, families that earn enough to
  leave welfare can often stay on Medicaid
• 12 month coverage after leaving TANF
• Low-income children and pregnant women

37
Unemployment insurance (UI)

• States provides insurance for unemployment due to
  adverse selection and moral hazard reasons
• Benefits
• Average weekly benefit in 2005 266
• Maximum length of benefits in most states 26
  weeks
• Typically financed by a payroll tax on employers
• Empirical studies find that increasing benefits
  increases the duration of unemployment

38
EITC

• The earned income tax credit
• A success story for the working poor
• Provides credits to workers within low incomes
• Essentially a negative income tax for some levels
  of income

39
EITC

• How it worked in 2006 for a family with 2 or more
  kids
• 40 credit for first 11,340 earned
• No additional credit for next 5,470 earned
• Phased out at a 21.06 rate after 16,810 is
  earned, until the credit is gone at 38,348 earned

40
The earned income tax credit
41
What has the EITC done?

• Households with nobody working
• Encourages one person to work
• Households with one person working
• Additional work not encouraged once a family with
  2 kids earns 11,340
• Does not encourage additional hours of work of
  the person already working
• Does not encourage a second worker in the
  household to work

42
Other ideas

• Negative income tax
• Supply a lump sum to everyone, then tax income
  more heavily
• Problem Incentive to work for pay diminishes
• Some people will stop working and will pay no
  taxes
• Minimum wage
• Unemployment

43
What about public employment?

• Public employment of the unemployed
• To be successful
• Needs to have enough incentives for unemployed
  people to want to work
• Needs to have incentives low enough for employed
  people to stay in their old job

44
Future of social insurance?

• Academics are starting to study alternate ideas
  to help the poor
• Providing benefits to those most in need, rather
  than those that are already in the system
• One-stop shopping for help
• Faith-based support
• Government provides cash to the faith-based
  organization, and the organization provides the
  service

45
Overview
Figure 13.10 Estimated effective marginal tax rates for a one-parent, two-child household residing in Wisconsin (2000)
Source Holt 2005, Part D, Figure 1.
46
Summary Welfare programs for the poor

• Many programs exist to support poor people
• Some programs give little economic incentive to
  work
• Exception Earned income tax credit

47
Recall Timothy

• Timothy is currently working 1,500 hours per year
• Hourly wage is 10
• He also receives government health care, valued
  at 3,000 per year
• Timothy could work a second job for 700 hours per
  year
• Hourly wage is 8
• With the second job, Timothy would make too much
  money for government health care

48
Now we add value to leisure

• New problem
• Tabitha has 24 hours per day
• Each hour can be used only for labor (L) or
  leisure (l)
• Tabithas wage is 10 per hour worked
• She receives 5 in Medicaid benefits per day if
  she earns no more than 60
• M denotes the daily earnings plus Medicaid
  benefits, if any
• Tabitha has the following utility function
• U(M, l) 2(M½) l

49
Tabithas problem

• Two cases
• No Medicaid benefits
• Work 6 hours or less and receive Medicaid benefits

50
No Medicaid benefits

• Maximize 2(M½) l
• subject to (M/10) l 24
• Same as Maximize 2(M½) l
• subject to l 24 (M/10)
• Same as Maximize 2(M½) 24 (M/10)
• FOC set equal to 0 1/M½ 1/10 0
• M 100
• 10 hours worked, 14 hours of leisure

51
What is Tabithas utility w/o Medicaid?

• 10 hours worked, 14 hours of leisure
• U(100, 14) 2(100½) 14 34

52
What about if she works less?

• Notice that this problem is almost the same
• Maximize 2(M½) l
• subject to (M/10) l 24.5
• The Medicaid benefit acts like 0.5 hour of work
  benefits
• Using the same steps as previously, M 100
• We cant work that much to get the benefit, so
  the closest we can get is by working 6 hours
• Total M is 65 (60 in wages, 5 in Medicaid
  benefits)

53
What is Tabithas utility with Medicaid?

• 6 hours worked, 18 hours of leisure
• U(65, 18) 2(65½) 18 34.12

54
What should Tabitha do?

• If she works 10 hours (no Medicaid benefit)
• U(100, 14) 2(100½) 14 34
• If she works 6 hours (with a Medicaid benefit)
• U(65, 18) 2(65½) 18 34.12
• Tabitha should work 6 hours and accept the
  Medicaid benefit

5
55
How do we solve poverty?