1 Inequality, Redistribution and Health Care Principles of Microeconomic Theory, ECO 284 John Eastwood CBA 247, address:

2 Learning Objectives Describe the inequality in income and wealth in the United States Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

3 Learning Objectives (cont.) Explain the effects of taxes and social security and welfare programs on economic inequality Explain the effects of health-care reform on economic inequality

4 Learning Objectives Describe the inequality in income and wealth in the United States Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

5 Economic Inequality in the United States Should we look at the distribution of income or wealth? Income is the amount that is received in a given period of time. In 1995, the richest 20% of families received 49.4% of total income The poorest richest 20% of families received 3.6% of total income

6 Economic Inequality in the United States Should we look at the distribution of income or wealth? Wealth is the value of the things it owns at a point in time. The wealthiest 1% of families owned 33% of total wealth. The next 9% of families owned 33% of total wealth. The remaining 90% of families owned the rest.

7 Economic Inequality in the United States Lorenz Curves A Lorenz curve graphs the cumulative percentage of income against the cumulative percentage of families.

8 Lorenz Curves for Income and Wealth Families Income Wealth CumulativeCumulativeCumulative PercentagePercentagePercentagePercentagePercentagePercentage aLowest bSecond cThird dFourth e Highest

9 Cumulative % of families Lorenz Curves for Income and Wealth Cumulative % of income & wealth 100 Line of equality

10 Cumulative % of families Lorenz Curves for Income and Wealth Cumulative % of income & wealth 100 Line of equality Income b c d e a

11 Cumulative % of families Lorenz Curves for Income and Wealth Cumulative % of income & wealth 100 Line of equality Income Wealth b c d e a

12 Trends in the Distribution of Income: 1950–1995

13 Economic Inequality in the United States Who Are the Rich and the Poor? The poorest household is likely to be: a black woman over 65 years of age lives in the South has fewer than eight years of education

14 Economic Inequality in the United States Who Are the Rich and the Poor? The wealthiest household is likely to be: a college-educated white married couple between 45 and 54 years of age has two children lives in the West

15 The Distribution of Income by Selected Family Characteristics in 1994

16 Economic Inequality in the United States Poverty Poverty is a state in which a family’s income is too low to be able to buy the quantities of food, shelter, and clothing that are deemed necessary. Poverty is a relative concept. The distribution of poverty by race is unequal. 11% of white families 27.1% of Hispanic-origin families 26.5% of black families

17 Poverty level by family size Year3 persons6 persons 9 or more persons 1980$6,565$11,269$16, $10,419$17,839$26, $12,803$21,880$32,705

18 Learning Objectives Describe the inequality in income and wealth in the United States Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

19 Comparing Like with Like How do we measure a person’s economic situation? Measure their income? Measure their wealth? Long period of time? Short period of time?

20 Comparing Like with Like Wealth Versus Income Wealth is a stock of assets. Income is a flow of earnings that results from the stock of wealth. Wealth data measures tangible assets and exclude human capital. Income data measures income from both tangible assets and human capital.

21 Capital, Wealth, and Income Lee Peter WealthIncomeWealthIncome Human Capital200,00010,000499,00024,950 Nonhuman Capital800,00040,0001,00050 Total$1,000,000$50,000$500,000$25,000 Peter has exactly one-half of Lee’s wealth and income, but measured wealth excludes human capital. Thus Lee’s measured wealth is 800x Peter’s measured wealth.

22 Comparing Like with Like Annual or Lifetime Income and Wealth? Incomes vary with age. Some inequality results from differences in peoples' stage of the life cycle Therefore, inequality of annual incomes overstates the degree of lifetime inequality. Measure lifetime income.

23 Learning Objectives Describe the inequality in income and wealth in the United States Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

24 Resource Prices, Endowment, and Choices Family income depends upon: Resource prices Resource endowments Choices

25 Resource Prices, Endowment, and Choices Resource Prices Individuals with different skill levels earn different incomes. Resource Endowments Individuals have different family endowments in capital and human abilities. Distribution of income and wealth is non- normally distributed

26 Income (thousands of dollars per year) Percentage of households The Distribution of Income

27 Income (thousands of dollars per year) Percentage of households The Distribution of Income Mode income Median = $37,000 in ’97 = $49,507 in ‘00 Mean = $50,000 in ’97 = $63,411 in ‘00

28 Resource Prices, Endowment, and Choices Choices Wages and the Supply of Labor People who earn higher wage rates tend to work more hours. Savings and Bequests Debts Cannot Be Bequeathed Assortative Mating

29 Learning Objectives (cont.) Explain the effects of taxes and social security and welfare programs on economic inequality Explain the effects of health-care reform on economic inequality

30 Income Taxes Regressive Proportional Progressive Equity & the ability to pay principle Horizontal equity - equal treatment of equals Vertical equity - unequal treatment of the unequal those with greater ability pay more according to some collectively chosen notion of fairness

31 The Scale of Income Redistribution Market income is a family’s income in the absence of government redistribution. Redistribution reduces the inequality of incomes. See Figure 17.5, page st quintile 3.6% to 13% after taxes & benefits 5 th quintile 49.4% to 31% after taxes & benefits

32 Cumulative % of families Income Redistribution Cumulative % of income & wealth 100

33 Cumulative % of families Income Redistribution Cumulative % of income & wealth 100 Line of equality Redistribution Distribution after taxes and benefits Market distribution

34 Income Redistribution The Big Tradeoff Income redistribution creates a big tradeoff Uses scarce resources Weakens incentives

35 Welfare Reform 1996 Personal Responsibility and Work Opportunities Reconciliation Act Eliminated AFDC—Created TANF AFDC Anyone could receive benefits A mother lost benefits if she worked TANF Requires work or community service Limited to 5 years during an individual’s lifetime

36 Negative Income Tax Negative Income Tax gives every family a guaranteed minimum annual income and taxes all income above the guaranteed minimum at a fixed marginal rate.

37 Market Income Income after redistribution G Comparing Traditional Programs and a Negative Income Tax 0AC Current redistribution arrangements

38 Market Income Income after redistribution G Comparing Traditional Programs and a Negative Income Tax 0AC Taxes Current programs and taxes Welfare trap No redistribution Benefits Current redistribution arrangements

39 Market Income Income after redistribution G Comparing Traditional Programs and a Negative Income Tax 0B Current programs and taxes No redistribution A negative income tax Negative income tax

40 Market Income Income after redistribution G Comparing Traditional Programs and a Negative Income Tax 0B Higher taxes Current programs and taxes Higher benefits No redistribution Break-even income A negative income tax Negative income tax

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42 Table F-1. Income Limits for Each Fifth Families (All Races, current $): Families Upper limit of each fifth (dollars) (000)LowestSecondThirdFourth ,383$24,000$41,000$61,378$91, ,03122,82639,60059,40088, ,55121,60037,69256,02083,693

43 Table F-1. Income Limits for Each Fifth Families (All Races, current $): Families Upper limit of each fifth (dollars) (000)LowestSecondThirdFourth ,884$20,586$36,000$53,616$80, ,24119,68034,31551,08675, ,59719,07032,98548,98572,260

44 Table F-1 (continued) Income Limits for Top 5 Percent of Families (All Races, current $):

45 Table F-1 (continued) Income Limits for Top 5 Percent of Families (All Races, current $):

46 Median Net Worth and Distribution of Net Worth by Monthly Household Income Quintiles

47 Median Net Worth and Distribution of Net Worth by Monthly Household Income Quintiles:

48 Learning Objectives (cont.) Explain the effects of taxes and social security and welfare programs on economic inequality Explain the effects of health-care reform on economic inequality

49 Health-Care Reform Two major problem areas: Health-care costs appear to be out of control. Private health-care insurance does not cover everyone.

50 Who Pays for Health Care?

51 Problems of Health-Care Costs Health-care costs have increased more rapidly than consumer prices due to: Limitations on labor-saving technological change Expensive technologies to treat medical conditions that were previously untreatable

52 The Rising Cost of Health Care

53 The Market for Health Care 0 P0P0 Q0Q0 D0D0 S0S0 S1S1 D1D1 P1P1 Q1Q1 Price of health care Quantity of health care

54 Health-Care Insurance Two Problems With Health-Care Insurance Moral Hazard Insured people are less concerned with health risks. Adverse Selection People who know they have a high chance of falling ill are more likely to buy insurance.

55 Moral Hazard “A situation in which one of the parties to an agreement has an incentive after the agreement is made to act in a manner that brings additional benefits to himself or herself at the expense of the other party.” Parkin’s definition

56 Adverse Selection “The tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less-informed party.” Parkin’s definition

57 Reform Proposals A Bigger Role for Government? Canada The government is the sole provider of health care services. It runs the hospitals, pays the doctors and other health care professionals, and buys drugs for people with low incomes. Private health care is illegal in Canada. Doctors ration procedures for which there is an excess demand by lengthening waiting periods.

58 Reform Proposals A Bigger Role for Government? Clinton's proposal Insurance companies could not reject anyone People would have freedom of choice of doctor and health plan Costs would be contained through competition and placing caps on insurance premium increases Everyone would have to contribute to covering the cost of health-care

59 Reform Proposals Make the Private Health-Care Market Work Better? Republican's proposal Scale back government funding Reduce tax incentives that encourage employers to buy medical insurance Any evidence? Since 1970 Real cost of Medicare & Medicaid up 4x Real cost of private care up < 2x