1. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Who Gets What? The Distribution of Income Who Gets What? The Distribution of Income Chapter 18

2. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-2 Learning points Explain what a Lorenz curve is. Discuss how the poverty definition is both an absolute and a relative measure. Present U.S. income inequality in a global context. Summarize the statistical findings on income and wealth distribution.

3. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-3 Discuss two alternative ways to describe the distribution of income. Explain three problems in determining whether an equal distribution of income is fair. Present three side effects of redistributing income. Summarize the U.S. tax and expenditure programs to redistribute income.

4. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-4 Ways of Considering the Distribution of Income Share distribution of income is the relative division of total income among income groups.  For example, it measures how much income the top 5% get. Socioeconomic distribution of income is the allocation of income among relevant socioeconomic groups.  For example, how much do women get compared to men?

5. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-5 Cumulative percentage of income Lorenz Curve of U.S. Income, 2005 A B C 100 80 60 40 20 0 406080100 F G H I J Income Quintile Percentage of Total Family Income Cumulative Percentage of Total Family Income Lowest fifth Second fifth Third fifth Fourth fifth Highest fifth 8.6 14.6 23.0 50.4 3.4 % 12.0 26.6 49.6 100.0 Cumulative percentage of families Line of absolute equality

6. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-6 Lorenz Curve for the U.S. 1929, 1970, and 2005 1970 2005 1929 100% 80 60 40 20 0 Cumulative percentage of income 206080100% Cumulative percentage of population 40 Line of absolute equality

7. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-7 Definition of Poverty The U.S. Gov’s definition:  Equal to or less than 3 times an average family’s USDA-calculated minimum food expenditures. The U.N.’s definition:  Dollar-a-day The World Bank’s definition:  $1.25 a day The EU’s definition (relative poverty):  How far an income is to 60% of median income (GINI coefficient) The poverty threshold is the income below which a family is considered to live in poverty.

8. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-8Debates Poverty line is too low: The food budget definition was established in the 1960s and is not recalculated to account for inflation. It excludes costs of housing and transportation, which increased higher than inflation. Poverty line is too high: Poverty figures do not include noncash assistance or assets or savings recipients may have.

9. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-9 The number of people in poverty:  Decreased during the 1960s.  Increased during the 1970s through the early 1990s.  Decreased during the mid through late 1990s.  Increased in the early 2000s.

10. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-10 Causes of Poverty. Misdistribution of income and wealth due to government policies. Increase in single-parent households

11. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-11 People in Poverty, 1960 - 2005

12. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-12 Costs of Poverty Poverty is inhumane Poverty  Crime

13. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-13 U.S. Income Distribution Compared to Other Countries Japan Brazil Cumulative percentage of population Cumulative percentage of income 100 80 60 40 20 0 40608010020 United States Sweden

14. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-14 Per Capita Income (GDP) in Various Countries, 2005

15. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-15 Wealth Compared to Income in the U.S. Family income Household wealth Cumulative percentage of wealth/income 100 80 60 40 20 0 Cumulative percentage of families/households 204060 10080 Bottom fifth Second fifth Third fifth Fourth fifth Top fifth 0 1.2 4.8 13.6 80.4 Wealth Quintile Percentage of total household wealth

16. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-16 Income Distribution by Occupations

17. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-17 The Class System as a Pyramid, a Diamond, and a Pentagon Developing Country’s Class System U.S. Class System in 1960s and 1970s U.S. Class System in Recent Years

18. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-18 Debates about Equality Those who favor inequality: Fair ≠ Equal. Fairness is equality in opportunity. What is fair? People’s starts, needs and wants are different. Inequality motivates

19. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-19 Debates about Equality Those who frown upon inequality: Inequality is immoral Inequality spells a dysfunctional society The Declaration of Independence asserts that “all men are created equal.” Inequality (plutocracy) is undemocratic

20. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-20 Welfare State A government that redistributes income from rich to poor to meet its ideal of fairness

21. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-21 Income Redistribution Policies Government can redistribute directly and indirectly. The indirect method involves the establishment and protection of property rights. The direct methods include:  Taxation – policies that tax the rich more than the poor.  Expenditures – programs that help the poor more than the rich.

22. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-22Taxation The federal government gets most of its taxes from:  Personal income tax  Corporate income tax  Social Security tax State and local governments get most of their tax from:  Income tax  Sales tax  Property tax

23. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-23 Types of taxation Progressive – the average tax rate increases with income.  It redistributes income from the rich to the poor. Proportional – the average tax rate is constant regardless of income.  It is neutral in regard to income redistribution. Regressive – the average tax rate decreases as income increases.  It redistributes income from poor to rich.

24. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-24 Expenditure Programs to Redistribute Income Social Security – a social insurance program that provides financial benefits to the elderly and disabled and to their eligible dependents and/or survivors. Medicare – a medical insurance system for retired people. Public assistance programs – means-tested social programs that provide financial, nutritional (Food Stamps), medical (Medicaid), and housing assistance.

25. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-25 Expenditure Programs Supplemental Security Income (SSI) – a federal program that pays benefits, based on need, to the elderly, blind, and disabled. Unemployment Compensation – short-term financial assistance, regardless of need, to eligible individuals who are temporarily out of work. Housing programs – federal and state programs to improve housing or to provide affordable housing.

26. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-26 Distribution of Income Before & After Taxes and Transfers, 2005 Cumulative percentage of income Cumulative percentage of households 100 90 80 70 60 50 40 30 20 10 0 2030405060708090100 Before taxes and transfers After taxes and transfers

27. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-27 Welfare State (+) outcomes:. Better distribution of income and wealth. Lower social instability and crime (-) outcomes:. It incentivizes labor for leisure. It incentivizes tax avoidance or evasion. It incentivizes people to appear more needy than what they really are

28. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-28Summary The Lorenz curve is a measure of the distribution of income among families in a country. The farther the Lorenz curve is from the diagonal, the more unequally income is distributed. The official poverty measure is an absolute measure because it is based on the minimum food budget for a family. It is a relative measure because it is adjusted for inflation.

29. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-29Summary Income is less equally distributed in the U.S. than in some industrialized countries, such as Sweden, but more equally distributed than in many developing countries, such as Brazil. Wealth is distributed less equally than income. Income differs substantially by class and by other socioeconomic factors, such as age, race, and gender. Fairness is a philosophical question, so people must judge a program’s fairness for themselves.

30. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-30Summary Income is difficult to redistribute because of incentive effects of taxes, avoidance and evasion of taxes, and incentive effects of distribution programs. The U.S. tax system is roughly proportional, so it is not a very effective means of redistributing income. Government spending programs are more effective than taxes in reducing income inequality in the U.S.

31. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 18-31 Review Question 17-1 What is the official definition of poverty? Why is it both a relative and an absolute measure? A family is in poverty if its income is equal to or less than three times an average family’s minimum food expenditures. The definition is relative because it is adjusted for inflation. It is absolute because it is based on a fixed minimum food budget for a family. Review Question 17-2 What has happened to the distribution of income in the U.S. since 1970 and why? Income in the U.S. has become more unequally distributed since 1970 because real wages did not keep up with inflation, taxes became less progressive, and government funding for many social programs was reduced.