Income redistribution Today: Conceptual issues Programs for the poor

Previously Income redistribution through Social Security Redistribution from young to old Redistribution from rich to poor Redistribution from those that die young to those that die old

Today More on income redistribution Chapter 12 Chapter 13 Conceptual issues Distribution of income Rationales for redistribution In-kind versus cash transfers Chapter 13 Various welfare programs for the poor TANF, EITC, Supplemental Security Income, Medicaid, Unemployment insurance, Nutrition programs, Housing assistance, Education/Job training

Conceptual issues How is income distributed? Is there such a thing as “too much” income inequality? Why should there be redistribution? Simple utilitarianism Maximin criterion In-kind versus cash transfers When income is redistributed, should recipients be forced to consume a minimum amount of certain goods?

Is there “too much” income inequality Some people would argue yes “Marginal utility of income is lower for somebody with high incomes” “Each person has a right to a minimum standard of living” “Social unrest may occur unless each person is above the poverty line”

Is there “too much” income inequality Some people would argue no “When economic incentives to make a good living go away, the economic pie becomes smaller” Think about communist systems “People that have a good work ethic and work hard should make more money” “There are plenty of opportunities for anybody born today in the US to become successful” Free K-12 education; subsidized colleges and universities

Absolute income Quintile 1980 1990 2000 Real income growth, 1980-2000 Bottom 20 percent $12,756 $12,625 $14,232 Second 20 percent $27,769 $29,448 $32,268 Middle 20 percent $41,950 $45,352 $50,925 Fourth 20 percent $58,200 $65,222 $74,918 Top 20 percent $97,991 $121,212 $155,527 Top 5 percent $139,302 $190,187 $272,349 Real income growth, 1980-2000 Bottom 20% has been flat Top 20% has seen huge growth (59%) Note that the “economic pie” is getting bigger See also Table 12.1, p. 259, for more on this topic Source: “Principles of Microeconomics” 3rd edition, by Frank and Bernanke

Problems with annual income figures Ignores number of workers in a household General trend from one earner to two Expenses, such as child care, could be higher with in two-worker households In-kind transfers ignored Taxes change over time Disposable income changes over time (given the same income) Income changes over time If a rich person earns no income in a calendar year, should she be considered “poor?”

Different views of income redistribution Some people believe that utility, not income, should be maximized within a population Additive social welfare function W = U1 + U2 + … + Un See Figure 12.2, p. 264, for a model of optimal income distribution

Different views of income redistribution Others believe that social welfare should be the minimum of the utilities of each person in society “Veil of ignorance” argument developed by John Rawls Conceals knowledge and talents from people Risk averse people will want to have income equality under these conditions No inferiority, jealousy or envy based on income

Different views of income redistribution Commodity egalitarianism Some things should be made available to everyone without restrictions Right to vote (if 18 or older) Basic education “Needed” items such as food, shelter, and clothing Basic medical care Recall issues presented in Chapters 9 and 10

Some other factors Income redistribution does not directly take into account other factors Number of hours worked If our goal is to maximize utility from income, why not reduce leisure? Not necessarily, since additional leisure likely increases utility Income depends on number of hours worked Does relative income matter? Does someone get a decrease in utility when his income remains the same and someone else’s increase?

In-kind versus money transfers With some views, such as commodity egalitarianism, in-kind transfers have more appeal than monetary ones How does this affect individual utility? See Figures 12.3, p. 272, and 12.4, p. 273

Summary: Conceptual issues People have conflicting opinions as to whether or not there is too much income inequality Most increases in income in recent decades have gone to the wealthiest of Americans Some arguments support the use of in-kind transfers rather than monetary transfers

Welfare programs for the poor Over $500 billion in expenditures in 2002 TANF EITC Supplemental Security Income Medicaid Unemployment insurance Nutrition programs Housing assistance Education/Job training

TANF Temporary Assistance for Needy Families Federal government provides block grants to states for welfare spending Over 80% of recipients in every state must be on TANF for five years or less States face penalties if a substantial percentage of recipients are not working or in work preparation programs

TANF TANF replaced Aid to Families with Dependent Children (AFDC) Under AFDC, some argued that many women on AFDC had children out of wedlock to continue get benefits and not have to work If the mother had to work once the child reached kindergarten, then there would be an economic incentive to have another child

TANF and benefit reduction rates TANF benefits are reduced when income reaches a certain level Example: In California, recipients can earn up to $225 per month before benefits are reduced at a rate of 50% of money earned How do people respond to these incentives in the short run?

Work incentives The Basic Trade-offs B = G – tE The Basic Trade-offs B = G – tE B = 0 if E = G/t G – basic grant if not working t – rate at which grant reduced when recipient earns money B – benefit received the higher G, the higher t higher G or lower t leads to a higher breakeven E which raises the costs of the system and includes more people

Analysis of work incentives Figure 13.1, p. 281 Budget constraint for leisure and income Figure 13.2, p. 282 Utility maximization based on the labor-leisure options

Analysis of work incentives Figure 13.4, p. 284 In this example, someone can get $100 in TANF benefits if not working Between point Q and point S, an implicit tax rate of 25% is imposed Note that there are some incentives to work while still receiving benefits Figure 13.6, p. 286 In this case, a 100% implicit tax rate is imposed after a benefit of $338 is received

Analysis of work incentives This person is indifferent between working and receiving benefits. See also Figure 13.7, p. 286, for a case in which an individual chooses to work. D E2 Income per month (= earnings + transfers) R P G Hours worked (if working) M T Hours of leisure per month

EITC The earned income tax credit A success story for the working poor Provides credits to workers within low incomes How it worked in 2006 for a family with 2 or more kids 40% credit for first $11,340 earned No additional credit for next $5,470 earned Phased out at a 21.06% rate after $16,810 is earned, until the credit is gone at $38,348 earned See Figure 13.8, p. 289, for two graphs about this

What has the EITC done? Households with nobody working Encourages one person to work Households with one person working Additional work not encouraged once a family with 2+ kids earns $11,340 Does not encourage additional hours of work of the person already working Does not encourage a second worker in the household to work

Supplemental Security Income (SSI) Federal program that provides benefits for the aged, blind, and disabled with little or no assets In 2003, average benefit was $342 SSI recipients can earn up to $65 per month without loss in benefits After $65 is earned, additional earnings have a 50% implicit tax rate

Medicaid Medicaid affects incentives to work Under old incentive structures, people often lost eligibility once they earned enough money to get off of welfare This created a “Medicaid notch” See Figure 13.9, p. 292 For main details about Medicaid, see Chapter 10

Solving the Medicaid notch problem In recent years, families that earn enough to leave welfare can often stay on Medicaid 12 month coverage after leaving TANF Low-income children and pregnant women

Unemployment insurance (UI) States provides insurance for unemployment due to adverse selection and moral hazard reasons Benefits Average weekly benefit in 2005: $266 Maximum length of benefits in most states: 26 weeks Typically financed by a payroll tax on employers Empirical studies find that increasing benefits increases the duration of unemployment

Food stamps Many poor households are eligible for food stamps Can only be used for purchasing domestically-produced food, excluding alcohol and animal food 2004 averages Monthly benefit was about $200 23.9 million people on food stamps in a given month

Housing assistance Public housing projects Section 8 Largest program, currently about 1.3 million units When kids see building with everyone with low incomes, there are no role models for being successful Crime is a big problem Section 8 Recipients rent a unit in the private market Government provides subsidy if unit meets certain requirements

Education and job training Programs aimed at poor families Head Start Results mixed, but mostly positive Training programs Evidence shows that costs are higher than benefits Job search programs Not effective in increasing living standards of many people

Overview See Figure 13.10, p. 299 Estimates marginal tax rates for a one-parent, two-child household residing in Wisconsin Negative until about $10,000 per year Over 40% from about $12,000-$31,000 per year

Future of social insurance? Academics are starting to study alternate ideas to help the poor Providing benefits to those most in need, rather than those that are already “in the system” “One-stop shopping” for help Faith-based support Government provides cash to the faith-based organization, and the organization provides the service

Summary: Welfare programs for the poor Many programs exist to support poor people Some programs give little economic incentive to work Exception: Earned income tax credit

End of Unit 3 Next lecture, begin Unit 4 Tax-related topics Read Chapters 14 and 15