McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 12 INCOME REDISTRIBUTION: CONCEPTUAL ISSUES

12-2 The Distribution of Income Among Households Percentage Share Year Lowest Fifth Second Fifth Middle Fifth Fourth Fifth Highest Fifth Top 5 Percent Source: U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements URL: These figures do not include the value of in-kind transfers.

12-3 Who is Poor? GroupPoverty RateGroup Poverty Rate All persons12.7%Under 18 years17.8% White years and older9.8 Black22.8 Female households, no husband present Hispanic origin Source: US Bureau of the Census, “Historical Poverty Tables.” [WWW Document] URL: Figures are for 2004.

12-4 Poverty Rate ( ) Source: US Bureau of the Census, “Historical Poverty Tables.” [WWW Document] URL:

12-5 Measuring Poverty  Poverty line

12-6 Interpreting the Distributional Data  Census income consists only of family’s cash receipts in-kind transfers  Official figures ignore taxes  Income measured annually  Consumption data may provide better assessment of well-being  Problems defining unit of observation

12-7 Simple Utilitarianism  Utilitarian Social Welfare Function: W = F(U 1, U 2,,,,, U n )  “Promote Greatest Good for Greatest Number”  Additive Social Welfare Function W = U 1 + U 2 + … + U n Assume  Individuals have identical utility functions that depend only on their incomes  Utility functions exhibit diminishing marginal utility of income  Total amount of income is fixed

12-8 Implications for Income Inequality Paul’s marginal utility Peter’s marginal utility Paul’s income Peter’s income 00’ MU Paul MU Peter a e c d f I* b Paul’s income Peter’s income Take ab from Peter and give to Paul Paul gains this much utility Peter loses this much utility This is the net gain to society Social welfare maximized

12-9 Evaluating the Assumptions  Assumption 1  Assumption 2  Assumption 3

12-10 The Maximin Criterion  Social Welfare Function W = Minimum(U 1, U 2, …, U n )  Maximin criterion - No inequality acceptable unless it works to the advantage of the least well off  Original position – “behind the veil of ignorance”  Critique of Rawls

12-11 Pareto Efficient Income Redistribution  Will redistribution always make someone worse off?  Utility Function Ui = F(X 1, X 2, …, X n, U 1, U 2, …, U i-1, U i+1, …, U m )  Redistribution if gain in utility from charity exceeds loss from reduced consumption  Government reduces cost of redistribution  Income distribution as a Public Good  Social safety net  Social stability

12-12 Nonindividualistic Views  Fundamental principles specifying income distribution derived independent of tastes Incomes distributed equally as matter of principle Plato’s 4:1 ratio of highest to lowest income  Commodity Egalitarianism

12-13 Other Considerations  Processes versus Outcomes Fairness of distribution of income judged by fairness of process that generated it Robert Nozick  Society cannot redistribute income because society has no income to redistribute  Mobility  Corruption

12-14 Expenditure Incidence  Relative price effects  Public goods  Valuing in-kind transfers

12-15 In-kind Transfers Pounds of cheese per month Other goods per month B A D F E1E1 U E3E H

12-16 In-kind Transfers Pounds of cheese per month Other goods per month B A D 210 F E4E4 E5E5 420 H

12-17 Reasons for In-Kind Transfers  Commodity egalitarianism  Reduce welfare fraud  Political factors