McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Who Gets What? The Distribution of Income Chapter 17

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Laugher Curve Two economists were walking down the street when they noticed two women yelling across the street at each other from their apartment windows.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Laugher Curve “Of course they will never come to an agreement,” stated the first economist. “And why is that?” inquired his companion. “Why, of course, because they are arguing from different premises.”

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Ways of Considering the Distribution of Income n Share distribution of income is the name given to this relative division of total income among income groups.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Ways of Considering the Distribution of Income n Socioeconomic distribution of income is the allocation of income among relevant socioeconomic groupings.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Share Distribution of Income n The share distribution of income measures aggregate family income by quintile.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Lorenz Curve n A Lorenz curve is a geometric representation of the size distribution of income among families in a given nation at a given time.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Lorenz Curve n The cumulative percentage of families is on the horizontal axis, arranged from poorest to richest. n The cumulative percentage of family income is on the vertical axis.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Lorenz Curve n Both axes start at zero and end at 100 percent. n A perfectly equal distribution of income is represented by a diagonal line. n An unequal distribution of income is represented by a Lorenz curve that is below the diagonal line.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Lorenz Curve n If income were equally distributed, the Lorenz Curve would be a diagonal line. n All real-world Lorenz curves are below the diagonal since income is always distributed unequally.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. A B C Lorenz Curve of U.S. Income, 2001 Cumulative percentage of families Cumulative percentage of income Income Quintile Percentage of Total Family Income Cumulative Percentage of Total Family Income Lowest fifth Second fifth Third fifth Fourth fifth Highest fifth % F G H I J

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. U.S. Income Distribution Over Time n From 1929 to 1970, income inequality in the U.S. decreased. n From 1970 to 2001, it increased.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. U.S. Income Distribution Over Time n Up to 1970, equality increased because: l Welfare programs. l Unemployment insurance. l Social security. l Progressive taxation. l Improved macroeconomic performance of the economy.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. U.S. Income Distribution Over Time n Inequality increased because: l Wage increases have not kept up with price increases. l A movement away from progressive taxation. l A reduction in government funding for some social programs.

Lorenz Curve for the U.S. 1929, 1970, % Cumulative percentage of income % Cumulative percentage of population 40 Line of absolute equality McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Defining Poverty n It is difficult to say where poverty begins. n The official definition of poverty is a combination of a relative and an absolute measure

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Official Definition of Poverty n The poverty threshold is the income below which a family is considered to live in poverty.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Official Definition of Poverty n The U.S. government definition of poverty is: l Equal to or less than three times an average family’s USDA-calculated minimum food expenditures.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Official Definition of Poverty n The number of people in poverty: l Decreased during the 1960s. l Increased during the 1970s through early 1990s. l Decreased during the mid- through late 1990s. l Increased in the early 2000s.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Debates about the Definition of Poverty n The food budget used to determine the poverty line was established in the 1960s. n It is not recalculated to account for rising standards of living.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Definition of Poverty Is Too Low n Food prices are adjusted for inflation meaning the definition includes significant aspects of relativity.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Definition of Poverty Is Too Low n Those favoring a relative measure of poverty want to multiply the food figure by roughly four rather than three.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Definition of Poverty Is Too High n Those favoring an absolute measure of poverty argue that the current measure is too high. l Poverty figures do not include noncash assistance or the value of assets or savings recipients may have.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Cost of Poverty n Some feel that society suffers when some of its people are in poverty. n When poverty decreases, the incentives for crime also decreases.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Cost of Poverty n Some people argue that poverty increased as a result of government tax and spending policies. n Others argue that it is the result of demographic changes.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. International Dimensions of Income Inequality n Another way of judging income inequality is to compare conditions in one country with those of another. n One could also look at the total level of world income.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Comparing Income Distribution With Other Countries n The U.S. has less income inequality than most developing nations, but more income inequality than many developed nations.

U.S. Income Distribution Compared to Other Countries Sweden Japan Brazil Cumulative percentage of population Cumulative percentage of income United States McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Distribution Among Countries n Income is highly unequally distributed among countries. n A Lorenz curve for world income would show much more inequality than the Lorenz curve for a particular country.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Total Amount of Income in Various Countries n Is the absolute level of income as important as the distribution of income? l Which is it better? u Earning $3,000 per year in Bangladesh, which puts you in the top 10 percent of that nation’s income distribution? u Earning four times as much in the U.S., which places you in the bottom 10 percent in the U.S.?

Per Capita Income (GDP) in Various Countries in 2001 $40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 United States JapanSwedenUnited Kingdom New Zealand TaiwanBrazil Bang- ladesh Congo, Dem. Rep. Kenya McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Distribution of Wealth n Wealth and income are often used In considering equality. l Wealth is the value of the things individuals own. l Income is payments received plus or minus changes in value in one’s assets in a specified time period.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. A Lorenz Curve of the Distribution of Wealth n Wealth is more unequally distributed in the U.S. than is income. n The bottom 40 percent of U.S. population has zero net worth.

Wealth Compared to Income in the U.S. Family income Household wealth Cumulative percentage of wealth/income Cumulative percentage of families/households Bottom fifth Second fifth Third fifth Fourth fifth Top fifth – Wealth Quintile Percentage of total household wealth McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. How Much Wealth Do the Wealthy Have? n A million dollars is no longer what it used to be. n To be in the top 5 percent of the wealthy would require holdings of $4 million.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Socioeconomic Dimensions of Income Inequality n Income distribution can be shown according to socioeconomic characteristics: l Race. l Ethnicity. l Geographic region. l Gender. l Type of job.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Distribution According to Socioeconomic Characteristics n There seems to be a professional- nonprofessional class distinction rising in the U.S. n Substantial differences also exist between the incomes of women and men and among races.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Distribution According to Class n The U.S. has socioeconomic classes with some mobility among classes. n Class divisions are currently not determined solely by income source.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Importance of the Middle Class n Class structure in developing countries looks like a pyramid, with the upper class on top. n In developed nations, class structure looks more like a diamond, with the middle class – the largest class – in the middle.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Developing Country’s Class System U.S. Class System Lower class Middle class Upper class The Class System as a Pyramid and as a Diamond Upper class Middle class Lower class

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Distributional Questions and Tensions in Society n Both radicals and conservatives describe the tensions among classes in society better than the mainstream, classless analysis.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Distributional Questions and Tensions in Society n Mainstream economists tend to focus on the size distribution of income. n Radical economists focus on class and group structures in their analysis.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Distributional Questions and Tensions in Society n Conservative economists emphasize the role of special interests in shaping government policy.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Distributional Questions and Tensions in Society n Americans recognize that there are class, gender, and racial differences in income and wealth. n Rather than seeking radical solutions, they work for change within the present system.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Distribution and Fairness n Whether the distribution of income is fair or should be changed involves a value judgment.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Philosophical Debates about Equality and Fairness n Some philosophers argue that inequality creates diversity in our lives, and that diversity enriches the lives of everyone.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Philosophical Debates about Equality and Fairness n The Declaration of Independence asserts that “all men are created equal.” l Believing in equality does not necessarily mean that income should be equally distributed.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Philosophical Debates about Equality and Fairness n In their objective role, economists limit themselves to explaining the effect of various policies on the distribution of income.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Philosophical Debates about Equality and Fairness n Value judgments must be made when judging economic policies.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Fairness and Equality n Fairness is not the same as equality. n Fairness has many dimensions and it is often difficult to say what is fair and what is not fair.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Fairness and Equality n There are three problems in determining whether an equal income distribution is fair. l People do not start from equivalent positions. l People’s needs differ. l People’s efforts differ.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Fairness as Equality of Opportunity n Most Americans see fairness as equality of opportunity. n There are great differences of opinion as to what constitutes “equal opportunity.”

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Problems of Redistributing Income n Society may decide to redistribute income from the rich to the poor to meet its ideal of fairness. n Redistribution programs can have substantial side effects which can subvert the intention of the program.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Important Side Effects of Redistributive Programs n There are three side effects of redistribution of income: l The labor to leisure incentive effect. l The tax avoidance or evasion incentive effect. l The incentive to look more needy than you really are.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Politics, Income Redistribution, and Fairness n Often politics, not value judgments plays a central role in determining what taxes an individual will pay.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Politics, Income Redistribution, and Fairness n Although the poor outnumber the rich, there is limited political support for income redistribution programs: l Many poor do not bother to vote. l Politicians do not see the poor as a solid voting block. l Poor people who vote often cast their votes with other issues in mind.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Redistribution Policies n The government redistributes income through direct and indirect methods.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Redistribution Policies n The direct methods include: l Taxation —policies that tax the rich more than the poor. l Expenditures —programs that help the poor more than the rich.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Redistribution Policies n The indirect method involves the establishment and protection of property rights.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Taxation to Redistribute Income n The federal government gets most of its taxes from the personal income tax, the corporate income tax, and the Social Security tax.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Taxation to Redistribute Income n State and local governments get most of their taxes from income taxes, sales taxes, and property taxes.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Taxation to Redistribute Income n Taxes can be: l Progressive – the average tax rate increases with income. l Proportional – the average rate of tax is constant regardless of income. l Regressive – the average tax rate decreases with income.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Federal Income Taxes n The personal income tax was more progressive in the 1940s than it is today. l The top tax was 90 percent in the early 1940s. l It is almost 40 percent today.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Federal Income Taxes n The Social Security tax is initially proportional up to a limit of about $85,000, then it becomes regressive.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. State and Local Taxes n State and local governments get most of their income from: l Income taxes – which are somewhat progressive. l Sales taxes – which tend to be proportional but are slightly regressive. l Property taxes – which are roughly proportional.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Taxation to Redistribute Income n Taxation has not proven to be an effective means of redistribution income.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Expenditure Program to Redistribute Income n Expenditure programs have been more successful than taxation for redistributing income.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Social Security n Social Security – a social insurance program that provides financial benefits to the elderly and disabled and to their eligible dependents and/or survivors. n Medicare – a multibillion-dollar medical insurance program.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Public Assistance Programs n Public assistance programs – means- tested social programs targeted to the poor and providing financial, nutritional, medical, and housing assistance.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Public Assistance Programs n The main types of public assistance programs are: l Temporary Assistance for Needy Families (TANF). l Food stamps. l Medicaid. l General assistance.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Supplemental Security Income n Supplemental Security Income (SSI) – a federal program that pays benefits, based on need, to the elderly, blind, and disabled.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Unemployment Compensation n Unemployment compensation – short- term financial assistance, regardless of need, to eligible individuals who are temporarily out of work.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Housing Programs n Housing programs – federal and state governments have many different programs to improve housing or to provide affordable housing.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Success of Income Redistribution Programs n After-transfer income is significantly closer to being equally distributed. n The increase in equality comes at the cost of a reduction in the total amount of income earned by society.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Success of Income Redistribution Programs n The most important redistribution decisions the government makes involve the establishment and protection of property rights.

Distribution of Income Before & After Taxes & Transfers, 1998 Cumulative percentage of income Cumulative percentage of households Before taxes and transfers After taxes and transfers McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Who Gets What? The Distribution of Income End of Chapter 17