18 Income Distribution and Poverty  How much inequality and poverty exist in our society?  What policies are used to fight poverty?  What are the problems with these policies?

1 Introduction  Income is generally determined by earnings  Earnings are a function of productivity  What if productivity of resources varies across individuals?  The result is income inequality.

2 The U.S. Income Distribution: 2005 GroupAnnual household income Bottom fifthUnder $19,178 Second fifth$19,179 – $36,000 Middle fifth$36,001 – $57,658 Fourth fifth$57,659 – $91,705 Top fifth$91,706 and over Top 5 percent$184,500 and over

3 The U.S. Income Distribution: 2005 Group Share of total household income Bottom fifth3.4 Second fifth8.6 Middle fifth14.6 Fourth fifth23.0 Top fifth50.4 Top 5 percent22.2

4 U.S. Inequality Over Time Income share of the top 20% divided by income share of the bottom 20%

5 Lorenz Curve  The distribution of income can be represented by a Lorenz curve.  In a Lorenz curve: the horizontal axis measures the cumulative percentage of households the vertical axis measures the cumulative percentage of households

6 A C T I V E L E A R N I N G 1 : Lorenz Curve 6 Using the distribution of income for 2005, draw a Lorenz curve. GroupIncome Share Bottom 20%3.4 2nd 20%8.6 Middle 20%14.6 4th 20%23.0 Top 20%50.4

7 A C T I V E L E A R N I N G 1 : Answer 7 Create cumulative totals of the columns. GroupTotal Income Share Total Share Bottom 20%20%3.4 2nd 20%40% Middle 20%60% th 20%80% Top 20%100%

8 A C T I V E L E A R N I N G 1 : Answer 8 Plot the cumulative number of households against the total share.

9 A C T I V E L E A R N I N G 1 : Answer 9 A Lorenz curve that is a straight diagonal line would indicate an equal distribution of income.

10 Gini Coefficient  Another way to describe income inequality is by using a Gini coefficient. related to the Lorenz curve

11 Gini Coefficient Let A = area between the line of perfect equality and the Lorenz curve Let B = area below the Lorenz curve A B Gini coefficient = A /(A + B) A higher Gini coefficient means greater inequality

12 Gini Coefficient for the U.S.

13 Inequality Around the World Income share of the top 20% divided by income share of the bottom 20%

14 Gini Coefficients Around the World CountryGini Coefficient South Africa77.0 Brazil60.7 Mexico53.1 Nigeria50.6 China52.2 Russia48.7 United States46.9 United Kingdom34.0 Canada33.1 India38.0 Germany30.0 Japan24.9

15 Gini Coefficients Around the World Green = greater equality Red = greater inequality

16 Poverty  Poverty line: an absolute level of income set by the government for each family size below which a family is deemed to be in poverty  Poverty rate: the percentage of the population whose family income falls below the poverty line  In 2005 in the U.S., median household income = $46,326 poverty line for family of four = $19,806 poverty rate = 12.6%

17 The U.S. Poverty Rate Over Time Percent of the population below poverty line

18 U.S. Poverty Rates by Group, 2005 GroupPoverty Rate All persons12.6% White, not Hispanic8.3 Black24.9 Hispanic21.8 Asian, Pacific Islander11.1 Children17.6 Elderly10.1 Married-couple families5.1 Female household, no spouse present 28.7

19 Policies to Reduce Poverty  Poor families more likely to experience homelessness drug dependence health problems teen pregnancy illiteracy unemployment  Most people believe the government should provide a “safety net.”  We now consider a few such policies…

20 1. Minimum-Wage Laws  Arguments for: helps the poor without any cost to the government little impact on employment if demand for unskilled labor is relatively inelastic  Arguments against: In the long run, demand for unskilled labor is likely elastic, so minimum wage causes substantial unemployment among the unskilled. Those helped by minimum wage are more likely to be teens from middle-income families than low-income adult workers.

21 2. Welfare  Welfare: government programs that supplement the incomes of the needy Temporary Assistance for Needy Families (TANF) Supplemental Security Income (SSI)  Critics argue that such programs create incentives to become or remain needy argue that welfare contributed to the rise of the single- parent family  The severity of such incentive problems is unknown

22 3. Negative Income Tax  Negative income tax: a tax system that collects revenue from high-income households and gives transfers to low-income households  Example: Taxes owed = (1/3 of income) – $10,000 If earnings = $90,000, taxes owed = $20,000 If earnings = $60,000, taxes owed = $10,000 If earnings = $30,000, taxes owed = $0 If earnings = $15,000, taxes “owed” = –$5,000 i.e., would receive $5000 payment from gov’t  The Earned Income Tax Credit (EITC) is similar to a negative income tax.

23 4. In-Kind Transfers  In-kind transfers are goods or services provided to the needy. Examples: homeless shelters soup kitchens food stamps Medicaid  An alternative: cash payments

24 Anti-Poverty Programs and Work Incentives  Assistance from anti-poverty programs declines as income rises.  Poor families face high effective marginal tax rates (exceeding even 100% in some cases!)