MEASURING INCOME INEQUALITIES Featuring the Lorenz Curve, the Gini Coefficient and more…

MEASURING INCOME INEQUALITIES  Economists use quintiles to measure the amount of income earned by different segments of the population.  In a fantasy world of perfect equality, each quintile would equally share a % of the country’s total income.

THIS IS NO FANTASY WORLD  As you know, our world is far, far away from an income equality fantasy world.  When examining quintiles, we can say that in general, the less income received by the lowest quintile, or the more income received by the highest quintile, the greater the inequality of income

THE LORENZ CURVE

 The Lorenz curve plots the actual relationship between percentages of the population and the shares of income they receive.  The closer the Lorenz curve is to the 45 degree line of perfect income equality, the more equitable the distribution of income is in a country

BAD LORENZ CURVE!

SHAME ON BRAZIL  Brazil serves as an excellent example of a country with a frighteningly unequal distribution of income.  In Brazil a tiny percentage of people receive a very large amount of the income, while millions live in slums and suffer through life.

BETTER LORENZ CURVE

HOORAY FOR SWEDEN!  Sweden presents an example of a country with a more equal distribution of income. While we can certainly see that the wealthy have a higher percentage of income than the lower class, Sweden does a better job of creating a society where income is more evenly spread out

IN GENERAL…..  The closer a country’s Lorenz curve is to the 45 degree line of perfect income equality, the less discrepancy exists between the haves and the have- nots

THE GINI COEFFICIENT  The Gini Coefficient is a summary measure of the information contained in the Lorenz curve. It is defined as:  Area b/w 45 degree line and Lorenz Curve /  Entire area under 45 degree line

VALUES OF THE GINI COEFFICIENT  Perfect income equality = 0. The larger the Gini coefficient, and the closer it is to 1, the more inefficient is the distribution of income.  So a country with a Lorenz curve close to the 45 degree line would have a lower Gini coefficient, and a value closer to 0

GINI EXAMPLES Brazil =.6 Denmark =.25

REDISTRIBUTING INCOME  Countries aiming to redistribute income from the wealthy to the poor will see their Lorenz curve shift closer to the 45 degree line.  This will result in a smaller value for their Gini coefficient and create a more equal society.

SOME CONCLUSIONS  Based on some relatively recent data, highly unequal income distribution (above.45) is seen only among lesser developed countries.  The MDCs with the highest Gini numbers, thus the most unequal are New Zealand (.44) and the U.S.A. (.41)

SOME CONCLUSIONS  Considering LDCs, Gini coefficients above.45 are not at all uncommon, suggesting that in many poor countries you have a small upper class with lots of money, and a very large lower class with very little money

THE LAFFER CURVE  Or should that be spelled Laugher Curve?

LAFFER CURVE  Introduced by an American economist (the story is he wrote it on a bar napkin in 2 minutes) in 1974, Laffer’s curve argues for the idea that higher taxes are a disincentive to work.

LAFFER CURVE  Laffer reasoned that lower taxes would create incentives for people to work harder, work longer, take risks, and invest more.  All this magic would shift LRAS to the right, create economic growth, and actually result in more taxes collected!

LAFFER CURVE

 So Laffer’s curve argues that tax collected will be 0 at rates of 0% and 100%. When tax rates are low, tax revenue will begin to rise as the tax rate increases.  Eventually, a tax rate is reached after which tax revenues will decline if the tax rate increases any further.

REAGAN AND LAFFER

 Reagan thought Laffer’s curve was a work of genius and immediately cut taxes, especially on the wealthy.  Unfortunately, tax revenues did not increase, and the U.S. deficit ballooned. But people continue to believe…..

HATING ON THE LAFFER CURVE  Tax cuts don’t incentivize people to work more!  Tax cuts have a greater demand-side effect than supply-side effect. Inflation may result, interest rates may rise, leading to less aggregate demand and lower tax revenues for sure

HATING ON THE LAFFER CURVE  Laffer’s curve is far from scientific. It’s nearly impossible to identify what the ideal tax rate would be. I n addition, this rate could be variable over time, and certainly would vary among countries. Many economists dismiss the Laffer curve as an oversimplification…

HATING ON THE LAFFER CURVE  Laffer’s argument may apply to the very wealthy at high tax rates, but isn’t valid for most people at lower tax rates  The legacy of the Reagan administration provides enough evidence to reject the Laffer curve and wonder why it appears in an Economics textbook!