CHAPTER 12 Income Redistribution: Conceptual Issues Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

12-2 The Distribution of Income Among Households Source: US Bureau of the Census [2008b Note: These figures do not include the value of in-kind transfers.

12-3 Who is Poor? Group Poverty RateGroup Poverty Rate All persons12.5% Under 18 years17.0% White years and older9.7 Black24.5 Female households, no husband present Hispanic origin Source: US Bureau of the Census, [2008a] Figures are for 2007.

12-4 Poverty Rate ( ) Source: US Bureau of the Census [2008a]

12-5 Measuring Poverty Poverty line A fixed level of real income considered enough to provide a minimally adequate standard of living.

12-6 Interpreting the Distributional Data Census income consists only of family’s cash receipts –In-kind(ayni in turkish) transfers, household production Official figures ignore taxes Income measured annually –Lifetime income would be more accurate 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 00’0’ 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 –Individuals have same identical utility functions. Assumption 2 –Marginal utility of individuals is decreasing. Assumption 3 –The size of pie is fixed and won’t change with income redistribution.

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” (insurance against being at the bottom of the income distribution. –Original position refers to the time when wealth is not distributed yet. Critique of Rawls (some people can take the risk)

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 Non-individualistic 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 Good set of rules to govern society’s operation. Mobility Corruption Positive correlation between inequality and corruption across countries.

12-14 Expenditure Incidence Relative price effects –When government uses spending program for the poor it might change relative price of goods. Public goods –Do rich receive more benefit form 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 –In kind transfers not only help the recipient but also producer of the good. –Construction companies support housing benefits. –Farmers support food stamp programs.