1. 1 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income

2. 2 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income

3. 3 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income CHAPTER 18 Public Choice, Taxes, and the Distribution of Income Fernando Quijano Prepared by: When Barack Obama became president in January 2009, he proposed a number of changes to the tax system.

4. 4 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income 18.1Public Choice Define the public choice model and explain how it is used to analyze government decision making. 18.2The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.3Tax Incidence Revisited: The Effect of Price Elasticity Understand the effect of price elasticity on tax incidence. 18.4Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. Chapter Outline and Learning Objectives CHAPTER Public Choice, Taxes, and the Distribution of Income 18

5. 5 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Public choice model A model that applies economic analysis to government decision making. Public Choice, Taxes, and the Distribution of Income

6. 6 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Public Choice POLICYLENADAVIDKATHLEEN Cancer research1st2nd3rd Mass transit2nd3rd1st Border security3rd1st2nd VOTESOUTCOME Cancer research versus mass transitCancer research wins Mass transit versus border securityMass transit wins Border security versus cancer researchBorder security wins How Do We Know the Public Interest? Models of Voting The Voting Paradox Table 18-1 The Voting Paradox Define the public choice model and explain how it is used to analyze government decision making. 18.1 LEARNING OBJECTIVE

7. 7 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Voting paradox The failure of majority voting to always result in consistent choices. Arrow impossibility theorem A mathematical theorem that holds that no system of voting can be devised that will consistently represent the underlying preferences of voters. The Voting Paradox Public Choice How Do We Know the Public Interest? Models of Voting Define the public choice model and explain how it is used to analyze government decision making. 18.1 LEARNING OBJECTIVE

8. 8 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Median voter theorem The proposition that the outcome of a majority vote is likely to represent the preferences of the voter who is in the political middle. Public Choice How Do We Know the Public Interest? Models of Voting The Median Voter Theorem Define the public choice model and explain how it is used to analyze government decision making. 18.1 LEARNING OBJECTIVE

9. 9 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income FIGURE 18-1 The Median Voter Theorem Public Choice How Do We Know the Public Interest? Models of Voting The median voter theorem states that the outcome of a majority vote is likely to represent the preferences of the voter who is in the political middle. In this case, David is in the political middle because two voters want to spend more on breast cancer research than he does and two voters want to spend less. In any vote between a proposal to spend $2 billion and a proposal to spend a different amount, a proposal to spend $2 billion will win. Define the public choice model and explain how it is used to analyze government decision making. 18.1 LEARNING OBJECTIVE

10. 10 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Rent seeking Attempts by individuals and firms to use government action to make themselves better off at the expense of others. Logrolling refers to the situation where a member of Congress votes to approve a bill in exchange for favorable votes from other members on other bills. Because becoming informed on an issue may require time and effort and the economic payoff is often low, some economists argue that many voters are rationally ignorant of the effect of rent-seeking legislation. Government Failure? Rent seeking Logrolling and Rational Ignorance Public Choice Define the public choice model and explain how it is used to analyze government decision making. 18.1 LEARNING OBJECTIVE

11. 11 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income One way in which the government intervenes in the economy is by establishing a regulatory agency or commission that is given authority over a particular industry or type of product. However, because the firms being regulated are significantly affected by the regulatory agency’s actions, the firms have an incentive to try to influence those actions. In extreme cases, this influence may lead the agency to make decisions that are in the best interests of the firms being regulated, even if these actions are not in the public interest. Regulatory Capture Government Failure? Public Choice Define the public choice model and explain how it is used to analyze government decision making. 18.1 LEARNING OBJECTIVE

12. 12 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Although government regulation can clearly provide important benefits to consumers, we need to take into account the costs of regulations. Economics can help policymakers devise regulations that provide benefits to consumers that exceed their costs. Is Government Regulation Necessary? Public Choice Define the public choice model and explain how it is used to analyze government decision making. 18.1 LEARNING OBJECTIVE

13. 13 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Individual income taxes. Social insurance taxes. Sales taxes. Property taxes. Excise taxes. However the size of government and the types of activities it engages in are determined, government spending has to be financed. The government primarily relies on taxes to raise the revenue it needs. These are the most widely used taxes: The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

14. 14 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income FIGURE 18-2 Federal, State, and Local Sources of Revenue, 2008 An Overview of the U.S. Tax System The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE Individual income taxes are the most important source of revenue for the federal government, and social insurance taxes are the second most important source. State and local governments receive the most revenue from sales taxes. State and local governments also receive large transfers from the federal government, in part to help pay for federally mandated programs. Many local governments depend on property taxes to raise most of their tax revenue.

15. 15 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Regressive tax A tax for which people with lower incomes pay a higher percentage of their income in tax than do people with higher incomes. Progressive tax A tax for which people with lower incomes pay a lower percentage of their income in tax than do people with higher incomes. Progressive and Regressive Taxes The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

16. 16 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income INCOMETAX RATE 0 to $8,35010% $8,351 to $33,95015 $33,951–$82,25025 $82,251–$171,55028 $171,551–$372,95033 Over $372,95035 ON MATT’S...MATT PAYS TAX OF... first $8,350 of income$ 835 next $25,600 of income3,840 next $48,300 of income12,075 last $17,750 of income4,970 His total federal income tax payment is$21,720 Table 18-2 Federal Income Tax Brackets and Tax Rates for Single Taxpayers, 2009 Table 18-3 Federal Income Tax Paid on Taxable Income of $100,000 Progressive and Regressive Taxes The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

17. 17 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Which Groups Pay the Most in Federal Taxes? INCOME CATEGORY PERCENTAGE OF TOTAL INCOME EARNED (1) PERCENTAGE OF TOTAL FEDERAL TAXES PAID (2) ALL FEDERAL TAXES PAID AS A FRACTION OF INCOME (AVERAGE FEDERAL TAX RATE) (3) Lowest 20% 4.0% 0.1% – 0.3% Second 20% 9.2 4.0 7.9 Third 20% 14.9 12.0 14.5 Fourth 20% 20.8 19.917.2 Highest 20% 51.3 64.022.5 Total 100.0% 18.0% Highest 1% 15.4 22.226.0 Making the Connection YOUR TURN: Test your understanding by doing related problem 2.9 at the end of this chapter. Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

18. 18 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Marginal tax rate The fraction of each additional dollar of income that must be paid in taxes. Average tax rate Total tax paid divided by total income. Marginal and Average Income Tax Rates The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE For example, in Table 18-3, Matt had a marginal tax rate of 28 percent because that is the rate he paid on the last dollar of his income. But his average tax rate was:

19. 19 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income The federal government taxes the profits earned by corporations under the corporate income tax. Some economists argue that if the purpose of the corporate income tax is to tax the owners of corporations, it would be better to do so directly by taxing the owners’ incomes rather than by taxing the owners indirectly through the corporate income tax. The Corporate Income Tax The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

20. 20 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income COUNTRYTAX IN 2000TAX IN 2008 France37%33% Germany5230 Ireland2413 Italy4131 Japan4241 Spain3530 Sweden28 United Kingdom3028 United States40 Table 18-4 Corporate Income Tax Rates around the World International Comparison of Corporate Income Taxes The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

21. 21 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income The goal of economic efficiency The ability-to-pay principle The horizontal-equity principle The benefits-received principle The goal of attaining social objectives Evaluating Taxes In selecting which taxes to use, governments take into account the following goals and principles: The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

22. 22 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income FIGURE 18-3 The Efficiency Loss from a Sales Tax Evaluating Taxes The Goal of Economic Efficiency The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE A sales tax increases the cost of supplying a good, which causes the supply curve to shift up from S 1 to S 2. Without the tax, the equilibrium price of the good is P 1, and the equilibrium quantity is Q 1. After the tax is imposed, the equilibrium price rises to P 2, and the equilibrium quantity falls to Q 2. After paying the tax, producers receive P 3. The government receives tax revenue equal to the green- shaded rectangle. Some consumer surplus and some producer surplus become tax revenue for the government, and some become deadweight loss, shown by the yellow-shaded triangle. The deadweight loss is the excess burden of the tax.

23. 23 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Excess burden A measure of the efficiency loss to the economy that results from a tax having reduced the quantity of a good produced; also known as the deadweight loss. The Goal of Economic Efficiency Evaluating Taxes The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

24. 24 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Should the United States Shift from an Income Tax to a Consumption Tax? Would a consumption tax be more efficient than an income tax? Making the Connection YOUR TURN: Test your understanding by doing related problem 2.11 at the end of this chapter. Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE Under the income tax, households pay taxes on all income earned. Under a consumption tax, households pay taxes only on the part of income they spend.

25. 25 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income The ability-to-pay principle holds that when the government raises revenue through taxes, it is fair to expect a greater share of the tax burden to be borne by people who have a greater ability to pay. The Horizontal-Equity Principle The horizontal-equity principle states that people in the same economic situation should be treated equally. The Ability-to-Pay Principle Evaluating Taxes The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

26. 26 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income According to the benefits-received principle, people who receive the benefits from a government program should pay the taxes that support the program. The Goal of Attaining Social Objectives Taxes intended to discourage certain activities are sometimes referred to as “sin taxes.” The Benefits-Received Principle Evaluating Taxes The Tax System Understand the tax system in the United States, including the principles that governments use to create tax policy. 18.2 LEARNING OBJECTIVE

27. 27 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Tax incidence The actual division of the burden of a tax between buyers and sellers in a market. Tax Incidence Revisited: The Effect of Price Elasticity Don’t Let This Happen to YOU! Remember Not to Confuse Who Pays the Tax with Who Bears the Burden of the Tax Understand the effect of price elasticity on tax incidence. 18.3 LEARNING OBJECTIVE YOUR TURN: Test your understanding by doing related problem 3.9 at the end of this chapter.

28. 28 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income FIGURE 18-4 The Effect of Elasticity on Tax Incidence Tax Incidence Revisited: The Effect of Price Elasticity When demand is more elastic than supply, consumers bear less of the burden of a tax. When supply is more elastic than demand, firms bear less of the burden of a tax. D 1 is inelastic between point A and point B, and D 2 is elastic between point A and point C. With demand curve D 1, a 10-cents- per-gallon tax raises the equilibrium price from $3.00 (point A) to $3.08 (point B), so consumers pay 8 cents of the tax, and firms pay 2 cents. With D 2, a 10-cents-per-gallon tax on gasoline raises the equilibrium price only from $3.00 (point A) to $3.02 (point C), so consumers pay 2 cents of the tax. Because in this case producers receive $2.92 per gallon after paying the tax, their share of the tax is 8 cents per gallon. Understand the effect of price elasticity on tax incidence. 18.3 LEARNING OBJECTIVE

29. 29 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Do Corporations Really Bear the Burden of the Federal Corporate Income Tax? Will she be paying part of Apple’s corporate income tax when she buys an iPhone? Making the Connection Understand the effect of price elasticity on tax incidence. 18.3 LEARNING OBJECTIVE YOUR TURN: Test your understanding by doing related problem 3.7 at the end of this chapter. Most economists agree that some of the burden of the corporate income tax is passed on to consumers in the form of higher prices.

30. 30 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income The Effect of Price Elasticity on the Excess Burden of a Tax Solved Problem 18-3 YOUR TURN: For more practice, do related problems 3.5 and 3.6 at the end of the chapter. Understand the effect of price elasticity on tax incidence. 18.3 LEARNING OBJECTIVE When demand is less elastic, the excess burden of a tax is smaller than when demand is more elastic.

31. 31 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income ANNUAL INCOMEPERCENTAGE OF ALL HOUSEHOLDS $0–$14,99913.2% $15,000–$24,99911.6 $25,000–$34,99910.7 $35,000–$49,99914.1 $50,000–$74,99918.2 $75,000–$99,99911.9 $100,000 and over20.2 Table 18-5 The Distribution of Household Income in the United States, 2007 Income Distribution and Poverty Measuring the Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

32. 32 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income How Has the Distribution of Income Changed over Time? YEARLOWEST 20%SECOND 20%THIRD 20%FOURTH 20%HIGHEST 20% 2007 3.4% 8.7% 14.6% 23.4% 49.7% 19903.99.615.924.046.6 19804.310.316.924.943.7 19704.110.817.424.543.3 19603.210.617.624.744.0 19503.110.517.324.145.0 19364.19.214.120.951.7 Table 18-6 Income Distribution and Poverty Measuring the Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

33. 33 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Poverty line A level of annual income equal to three times the amount of money necessary to purchase the minimum quantity of food required for adequate nutrition. The Poverty Rate in the United States Income Distribution and Poverty Measuring the Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE Poverty rate The percentage of the population that is poor according to the federal government’s definition.

34. 34 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income FIGURE 18-5 Poverty in the United States, 1960–2007 The Poverty Rate in the United States Income Distribution and Poverty Measuring the Income Distribution and Poverty The poverty rate in the United States declined from 22 percent of the population in 1960 to 11 percent in 1973. Over the past 30 years, the poverty rate has fluctuated between 11 percent and 15 percent of the population. Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

35. 35 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income All people12.5% Female head of family, no husband present (all races)28.3 Blacks24.5 Hispanics21.5 Asians10.2 White, not Hispanic8.2 Married couple4.9 Table 18-7 Poverty Rates Vary across Groups, 2007 Income Distribution and Poverty Measuring the Income Distribution and Poverty The Poverty Rate in the United States Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

36. 36 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income For most people, the most important factor of production they own is their labor. Therefore, the income they earn depends on how productive they are and on the prices of the goods and services their labor helps produce. Many people own other factors of production, such as capital in the form of stock in corporations. Ownership of capital is not equally distributed. The tax system does not seem to have played a major role in recent changes in income inequality. Earning an income is also subject to good and bad fortune. Explaining Income Inequality Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

37. 37 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Showing the Income Distribution with a Lorenz Curve Lorenz curve A curve that shows the distribution of income by arraying incomes from lowest to highest on the horizontal axis and indicating the cumulative fraction of income earned by each fraction of households on the vertical axis. Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

38. 38 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income FIGURE 18-6 The Lorenz Curve and Gini Coefficient Income Distribution and Poverty Showing the Income Distribution with a Lorenz Curve Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE Because the Lorenz curve for 1980 is closer to the line of perfect equality than the Lorenz curve for 2007, we know that income was more equally distributed in 1980 than in 2007. In panel (b), we show the Gini coefficient. The closer the Gini coefficient is to 1, the more unequal the income distribution.

39. 39 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Problems in Measuring Poverty and the Distribution of Income Income Mobility in the United States FIGURE 18-7 Income Mobility in the United States, 1996–1999 Income Distribution and Poverty Each column represents one quintile—or 20 percent—of households, arranged by their incomes in 1996. Reading up the column, we can see where the households that started in that quintile in 1996 ended up in 1999. Only 62 percent of the households that were in the bottom quintile of income in 1996 were still in the bottom quintile in 1999. Only 66 percent of the households that were in the top quintile of income in 1996 were still in the top quintile in 1999. Note: Incomes are in 1999 dollars to correct for the effects of inflation. Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

40. 40 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Evaluate the following statement: Government statistics indicate that 12 percent of the population is below the poverty line. The fraction of the population in poverty has never dropped below 10 percent. Therefore, more than 10 percent of the population must cope with very low incomes year after year. YOUR TURN: For more practice, do related problem 4.7 at the end of the chapter. Are Many Individuals Stuck in Poverty? Solved Problem 18-4 Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

41. 41 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Because individuals with low incomes are more likely to receive transfer payments and other benefits from the government than are individuals with high incomes, the distribution of income is more equal if we take these benefits into account. The Effect of Taxes and Transfers Problems in Measuring Poverty and the Distribution of Income Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

42. 42 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Table 18-8 Income Inequality around the World COUNTRYLOWEST 20%HIGHEST 20%RATIO Bolivia 1.5% 63.0% 42.0 Paraguay2.461.9 25.8 Brazil2.861.1 21.8 Chile3.860.0 15.8 United states3.449.7 14.6 Thailand6.349.0 7.8 United kingdom6.144.0 7.2 Ireland7.442.0 5.7 France7.240.2 5.6 Canada7.239.9 5.5 South Korea7.937.5 4.7 Germany8.536.9 4.3 Norway9.637.2 3.9 Japan10.635.7 3.4 Income Distribution and Poverty around the World Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

43. 43 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Table 18-9 Poverty in Sub-Saharan Africa Is Much Greater Than Elsewhere in the World PERCENTAGE OF THE POPULATION IN POVERTY REGION19702000 World20.2%7.0% East Asia32.72.4 China32.03.1 South Asia30.32.5 Middle East and North Africa10.70.6 Latin America10.34.2 Sub-Saharan Africa35.148.8 Income Distribution and Poverty around the World Income Distribution and Poverty Discuss the distribution of income in the United States and understand the extent of income mobility. 18.4 LEARNING OBJECTIVE

44. 44 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income AN INSIDE LOOK at Policy Should the Government Use a Tax on Soda to Pay For an Overhaul of Health Care? >> AN INSIDE LOOK at Policy A tax decreases the supply of sugary soft drinks. The amount of revenue raised by the tax depends on the elasticity of the demand and the elasticity of supply of the drinks.

45. 45 of 45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 18: Public Choice, Taxes, and the Distribution of Income Arrow impossibility theorem Average tax rate Excess burden Lorenz curve Marginal tax rate Median voter theorem Poverty line K e y T e r m Poverty rate Progressive tax Public choice model Regressive tax Rent seeking Tax incidence Voting paradox KEY TERMS