1. Chapter 6 Equity and Income Distribution
Chapter outline
1.Government and Redistribution
2.Concepts of Equity
3.Equity, Administrative Efficiency, and Incentives
4.Markets, Poverty, and Inequality
5.Poverty in the United States
6.Balancing Donor Goals and Recipient Needs
7.Responsibility for Redistribution
8.Redistribution among Governments

2. 1.Government and edistribution
Everything the government does is redistributive.
Redistribution is not limited to taxing and spending programs. Regulatory actions also redistribute income and wealth among citizens.
Because government is such a powerful tool for redistributing income and wealth, organized groups attempt at using government for that purpose.

3. 2.Concepts of Equity
There are many different concepts of distributional equity. The problem of defining and measuring equity result from
the difficult of making interpersonal comparisons of utility.
①Horizontal Equity
Horizontal equity means treating people alike if they are in the same or similar economic situations.
Economic situation is not simply income. It could include the concept of permanent or lifetime income rather than simply current annual income.

4. ②Vertical Equity
Vertical Equity means treating people differently according to the differences in their income, wealth, or other measure of need or ability to pay.
The difficulty with using vertical equity as a guide to public policy is in measurement.

5. ③The Compensation Principle
Most policy proposals involve both winners and losers. A criterion of Pareto optimality would rule out such changes.
When Pareto optimality is not attainable, it is possible to provide a guide to making second-best decisions.
One of the most useful criteria is the compensation principle.
Whether compensation should actually be paid is a political rather than an economic question.

6. ④The Coase Theorem Revisited: Efficiency Challenges Equity
The Coase theorem states that the property will tend toward its highest and best use as valued by market prices as long as the number of parties involved is small enough.
But even though the outcome is likely to be efficient, it is not necessarily perceived as equitable, because the parties do not have equal resources.

7. 3.Equity, Administrative Efficiency, and Incentives
①Efficiency, Administrative Cost, and Fraud
Efficiency is also an issue in the process of distribution, because efficiency in redistribution means targeting aid to those who deserve it, with minimal expenditures for administration and minimal diversion of revenue to those who are perceived as undeserving.
These two aspects of efficiency are in conflict because the cost of excluding those who seek to defraud the system can be very high.

8. ②Efficiency and Work Incentives
When redistribution of one’s earnings to others reduces the return to work or investment effort, many rational, calculating members of society will respond by making less effort than they would otherwise have done.
The availability of public assistance, and the likelihood of losing that assistance when moving into paid employment, can also create disincentive effects on the recipient side.

10. 4.Markets, Poverty, and Inequality
The distribution of income and wealth that results purely from market processes tends to be highly unequal.

11. 5.Poverty in the United States
In1999 the official poverty rate in the United States was 11.8%, a modest decline from the 13.5% at the beginning of the decade.
①The "Deserving Poor"
Inability to work because of age, having a disability, or lack of access to jobs; workers who lack the skills, training, or experience to earn an adequate wage; and special circumstances such as health, family size, or obligations that make it impossible to maintain an above-poverty standard of living on their earnings.
Poor children live in poor families.

12. ②Interdependence, Externalities, and Market Failure
Some economists regard certain types of poverty as a form of market failure.
Poverty can diminish the quality of life of the community.
③The Social Safety Net as a Public Good
The market fail to provide insurance
Social insurance has been one of the fastest growing categories of government activity.
④Redistribution and Free-riding Behavior
Private redistribution will be less than adequate because of free-riding behavior.

13. 6.Balancing Donor Goals and Recipient Needs
①Equality of Opportunity Versus Equality of Results
Donors are more interested in creating equality of opportunity, while recipients are more interested in equality of results.
Equity of opportunity means that everyone is ensured equal access to employment and other means of acquiring income and wealth through such means as education and health care.
Equity of results means that everyone is ensured an equal share of society’s income and wealth regardless of their contribution.

14. ②In-kind Versus In-cash
Recipients prefer cash, which gives them more flexibility in how they use the funds. Donors, however, are often looking for specific outcomes and want to impose their preferences rather than those of recipients on the use of funds.

15. 7.Responsibility for Redistribution
Whether the redistribution should be the responsibility of the central government, state government, or local government.

16. 8.Redistribution among Governments
Redistribution also takes place between governments.
Vertical equalization
Horizontal equalization
Both processes take place from federal to state and local and from state to local governments in the United States.
①General Revenue Sharing
General Revenue Sharing was the most famous experiment in vertical equalization in recent decades.

17. ②State Aid to Local Governments
State play an important role in redistribution between richer and poorer local communities both through paying directly for services, funding services that the state wants provided at the local level, and reducing tax-based competition for residents and industry between local governments.

18. True-false questions
If false, change the statement to make it true.
1. Vertical equity calls for treating people differently if they are in different economic situations, with the differences proportional to income or wealth.
2. According to the compensation principle, a policy change should not be made unless the gainers could compensate the losers and still have something left over.

19. 3. As a general rule, applying the compensation principle and the Coase theorem will lead to the same outcomes with the same resulting distribution of costs and benefits.
4. Providing free public education for all children is an example of equality of results.
5. Income in the United States is distributed more unequally than in many other advanced industrial countries.

20. Answers:
1. F (The first part of the statement is true, but there are different conceptions of what kind of differential treatment is appropriate.)
2. T
3. F ( They will generally lead to the same outcome, but different distributions of costs and benefits.
4. F (Equality of opportunity.)
5. T