1. Income Inequality and Poverty
Web Chapter B
Income Inequality and Poverty
In this chapter we will explore income inequality and actions that can be taken by government to try to correct income inequality, using the Lorenz curve and Gini ratio to help with this evaluation. We will then define poverty and look at how it affects different groups. We will also discuss government programs to aid families in poverty. Lastly we analyze discrimination and how this impacts wages.
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved

2. Facts about Income Inequality
Average household income
$66,424 in 2008
Among the highest in the world
Distribution by quintiles
Income mobility
People change quintiles
Government redistribution
Taxes and transfers
Income inequality is a continuing concern in much of the world. The classic case of the “haves” versus the “have-nots” has caused major disruptions in society. How to correct the disparity is of great debate among many. The United States’ average household income of $66,424 is among the highest in the world, but the distribution of income among the different groups varies with the top 20 percent of households earning more than 50 percent of total income. Over an individual’s lifetime, the individual or household may change quintiles as income changes. The government also attempts to redistribute the income through taxes and transfers, such as welfare and Social Security.
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3. Facts about Income Inequality
(1)
Personal
Income Category
(2)
Percentage of All
Households in This Category
Under $10,000
7.3
$10,000–$14,999
5.8
$15,000–$24,999
11.9
$25,000–$34,999
11.0
$35,000–$49,999
14.1
$50,000–$74,999
18.1
$75,000–$99,999
11.5
$100,000 and above
20.2
100.0
In this table, we can see the distribution of income among households in Note that approximately 25 percent of all households have an income of less than $25,000 while 20 percent have income of more than $100,000. That means about 55 percent of households have income between $25,000 and $99,999.
Source: Bureau of the Census, Numbers do not add up to 100 percent due to rounding.
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4. Facts about Income Inequality
Distribution by Quintiles
(2)
Percentage of
Total Income
(3)
Upper
Income Limit
(1)
Quintile
Lowest 20%
Second 20%
Third 20%
Fourth 20%
Highest 20%
Total
3.4
8.6
14.6
23.2
50.3
100.0
$20,453
38,550
61,801
100,000
No Limit
In this table, we see the households sorted into quintiles or fifths. This distribution also shows the upper income limit, meaning all households in that quintile have income below that level and above the previous level. Quintiles contains an equal number of households so the bottom quintile only produces 3.4 percent of total income while the top quintile makes over 50 percent of it.
Source: Bureau of the Census,
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5. Facts about Income Inequality
Lorenz Curve and Gini Ratio 20 40 60 80
100 e
Lorenz curve
(actual distribution)
Percentage of Households
Percentage of income
Perfect equality d A B c
Complete
inequality
The Lorenz curve is a graphical way to look at the relationship. The diagonal line that bisects the graph would illustrate perfect income equality, meaning all groups would have an equal distribution of income. Graphing the results of the U.S. income inequality gives us the curved line showing the unequal distribution. The Gini ratio is a numerical measurement of the overall dispersion of income. Lower ratios reflect less inequality while higher ratios indicate more inequality. b a f
Gini ratio =
Area A
Area A + Area B
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6. Facts about Income Inequality
Effect of Government Redistribution
Distribution by Quintiles
(1)
Before Taxes
and Transfers
(2)
After Taxes
and Transfers
Quintile
Lowest 20%
Second 20%
Third 20%
Fourth 20%
Highest 20%
0.9
7.0
14.5
24.2
53.5
4.2
10.5
16.4
24.1
44.8
The distribution of income is significantly more equal after taxes and transfers are taken into account than before. Transfers account for most of the lessening of inequality and provide most of the income received by the lowest quintile of households.
Source: Bureau of the Census,
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7. Facts about Income Inequality
Impact of Government Taxes and Transfers 20 40 60 80
100
Percentage of households
Percentage of income
Lorenz curve
After taxes and
transfers
One economic function of government is to redistribute income. They do this by taxing households in higher income brackets and then distributing that money to households in lower brackets. The effect of these actions is to move the Lorenz curve closer to the perfect equality line.
Lorenz curve
Before taxes and
transfers
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8. Causes of Income Inequality
Ability
Education and training
Discrimination
Preferences and risks
Unequal distribution of wealth
Market power
Luck, connections, and misfortune
There are many different causes of income inequality. People have different abilities and talents, and this enables some people to perform in high-paying occupations such as being a doctor or star athlete while others can only perform basic tasks. Education and training can also impact a person’s earning capacity. Typically the higher the education level obtained, the higher the earning capacity. Discrimination of all forms as well as personal preferences and risk-aversions also affect an individual’s earnings. Being born into wealth certainly helps, as does just plain being lucky or having connections. Being in the right place at the right time is sometimes just the luck of the draw.
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9. Causes of Income Inequality
In this chart, we see the share of income in various nations that goes to the top 10% of receivers. For example, in Colombia, the top 10 percent of receivers get almost 50 percent of the total income of the nation.
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10. Income Inequality over Time
Rising income inequality since 1970
Causes of growing inequality
Greater demand for highly skilled workers
Demographic changes
International trade, immigration, and decline in unionism
Since 1970, there has been growing income inequality in the United States. The most likely reason for this growing inequality has been the increased demand for highly skilled workers. Modern manufacturing requires a highly educated workforce. Demographic changes also contributed; the “baby boomers” were entering the workforce during this time in waves of less-experienced and less-skilled workers. The growth of international trade and the transfer of jobs to lower-wage workers in other countries were factors as well.
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11. Income Inequality over Time
Percentage of Total Before-Tax Income Received by Each One-Fifth and by the Top 5 Percent of Households
Quintile
1970
1975
1980
1985
1990
1995
2000
2009
Lowest 20%
4.1
4.4
4.3
4.0
3.9
3.7
3.6
3.4
Second 20%
10.8
10.5
10.3
9.7
9.6
9.1
8.9
8.6
Third 20%
17.4
17.1
16.9
16.3
15.9
15.2
14.8
14.6
Fourth 20%
24.5
24.8
24.9
24.6
24.0
23.3
23.0
23.2
Highest 20%
43.3
43.2
43.7
45.3
46.6
48.7
49.8
50.3
Total
100.0
Top 5%
16.6
15.8
17.0
18.6
21.0
22.1
21.7
This is another table showing the income earned by the different quintiles in the United States over time. We can see that income is more and more unequal as the percentage of total income in the lowest quintile is falling and the percentage of total income earned by the highest quintile continues to rise.
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12. Equality versus Efficiency
The case for equality
Maximizing total utility
The case for inequality
Incentives and efficiency
The equality-efficiency trade-off
The main policy issue regarding income inequality is how much is necessary and justified. The cash for an equal distribution of income starts with the idea that income equality maximizes total consumer satisfaction from any particular level of output and income. Critics attack this assumption that there is some fixed amount of output produced and therefore income to be distributed. They argue that the way in which income is distributed is an important determinant of the amount of output or income that is produced and available for distribution. Regardless, there is a fundamental trade-off between equality and efficiency in that greater income equality comes at the opportunity cost of reduced production and income. Society must choose how much redistribution it desires in view of the costs.
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13. Equality versus Efficiency
The Utility-Maximizing Distribution of Income
Anderson’s Marginal
Utility from Income
Brooks’ Marginal
Utility from Income
Marginal Utility
Income
Utility gain
(entire blue area)
Utility loss
(entire red area)
These graphs illustrate the utility-maximizing distribution of income. Both Anderson and Brooks will maximize their combined utility when any amount of income is equally distributed. If income is unequally distributed, the marginal utility derived from the last dollar will be greater for Anderson than for Brooks. a b’ a’ b
MUA
MUB
$2500
$5000
$5000
$7500
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14. The Economics of Poverty
Definition of poverty in 2009
Single person < $10,956
Family of 4 < $21,954
Family of 6 < $29,405
43.6 million Americans
14.3 percent in poverty
Poverty is defined as a condition in which a person or family does not have the means to satisfy basic needs for food, clothing, shelter, and transportation. The federal government has established minimum income thresholds below which a person or family is considered to be “in poverty.” As shown in the slide, in 2009, 14.3 percent of the population of the United States was living in poverty.
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15. Incidence of Poverty Percentage in Poverty
Poverty is disproportionately borne by African Americans, Hispanics, children, foreign-born residents who are not citizens, and families headed by women. People who are employed full time, have a college degree, or are married tend to have low poverty rates.
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16. Stable in 11–13 percent range since Rises with recession
Poverty Trends
Poverty rate trends
Significant decline 1959–1969
Stable in 11–13 percent range since
Rises with recession
Measurement issues
Arbitrary threshold
Consumption versus income
In the decade between 1959 and 1969, the poverty rate declined significantly and was fairly stable in the range of 11–13 percent until the early 1980s when it started to rise. In 1993, the rate peaked at 15.1 percent and then began declining. The recession that began in December of 2007 increased the poverty rate for all groups, and many economists expect to see the rates rise even further as data for 2009 and 2010 become available. The rates and trends need to be interpreted cautiously. The income levels used to determine the rates are arbitrary thresholds and may not truly measure the extent of poverty in the United States. The high cost of living in major metropolitan areas means that the official poverty thresholds may exclude many families whose income is slightly above the threshold but inadequate to meet basic needs.
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17. Poverty Trends Poverty Rate Trends, 1959-2009 Poverty rate (percent)
This graph shows the trend of the poverty rate among different groups between 1959 and Although the national poverty rate declined sharply up to 1969, it stabilized in the 1970s and then increased in the early 1980s.
Year
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18. The U.S. Income-Maintenance System
Entitlement programs
All those eligible receive aid
Social insurance programs
Social Security and Medicare
Unemployment compensation
Public assistance programs
Welfare
To help those who have very low income, the United States has a wide array of antipoverty programs including subsidized employment, education and training programs, and antidiscrimination policies. These programs are referred to as entitlement programs because all eligible persons are legally entitled to receive their benefits.
The social insurance programs such as Social Security and unemployment compensation are designed to partially replace earnings that have been lost due to retirement, disability, or temporary unemployment. They are financed primarily out of federal payroll taxes, and the benefits are viewed as earned rights as the recipients must have worked in order to be eligible to receive them.
Public assistance programs or welfare provides benefits to people who are unable to earn an income because of permanent disabling conditions, or who have no, or very low, income and also have dependent children. These programs are financed out of general tax revenues and are regarded as public charity.
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19. The U.S. Income-Maintenance System
Program
Basis of Eligibility
Source of Funds
Form of Aid
Expenditures
Beneficiaries
Social Insurance Programs
Social Security
Age, disability, death of a parent or spouse; lifetime work earnings
Federal payroll tax on employers and employees
Cash
$676 billion
53 million
Medicare
Age or disability
Subsidized health insurance
$502 billion
47 million
Unemployment Compensation
Unemployment
State and federal payroll tax on employers
$43 billion
10 million
Public Assistance Programs
SSI
Age or disability; income
Federal revenues
$47 billion
8 million
TANF
Certain families with children; income
Federal-state-local revenues
Cash and services
$15 billion
5 million
SNAP
Income
Cash via EBT cards
$65 billion
40 million
Medicaid
Persons eligible for TANF and SSI and medically indigent
Standardized medical services
$297 billion
59 million
EITC
Low-wage working families
Refundable tax credit, cash
$58 billion
26 million
This table summarizes the characteristics of major income-maintenance systems in the United States.
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20. Public Assistance Programs
Supplemental Security Income (SSI)
Temporary Assistance for Needy Families (TANF)
Supplemental Nutrition Assistance Program (SNAP)
Medicaid
Earned income tax credit
There are a wide variety of public assistance programs. The SSI program provides a uniform nationwide minimum income for the aged, blind, and disabled who are unable to work and who do not qualify for Social Security aid.
TANF assists families with children and has work requirements and a limit on the time a family can receive benefits.
SNAP, formerly known as the food-stamp program, permits low-income persons to obtain vouchers with which to buy food. Its goal is to ensure all low-income Americans have a nutritionally adequate diet.
Medicaid is a federal program to provide basic medical care to people covered by the SSI and TANF programs.
The earned income tax credit is a refundable federal tax credit provided to low-income wage earners. It is designed to supplement families’ income while encouraging them to work. These are just a few of the many programs administered by the government to assist those families faced with the challenges of poverty.
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