0. 20 Income Inequality and Poverty P R I N C I P L E S O F
Income Inequality and Poverty 20
P R I N C I P L E S O F
F O U R T H E D I T I O N
This is the third of three chapters on the economics of labor markets. In Chapter 18, students learned that equilibrium wages equal the value of the marginal product of labor. In Chapter 19, students learned about various factors that affect equilibrium wages, as well as discrimination.
In Chapter 20, students will learn about the extent of inequality and poverty in the U.S. The chapter also introduces some of the leading political philosophies on the role of government in redistributing income. Finally, the chapter discusses some policies designed to help the poor.
This chapter is shorter than average. Most students find it less difficult than average. Therefore, most instructors are able to cover it in minutes of class time.

1. In this chapter, look for the answers to these questions:
In this chapter, look for the answers to these questions:
How do we measure inequality and poverty, and what are the trends in our society?
What is the major philosophical debate about the merits of income redistribution policies?
What are the major income redistribution programs, and what are the issues in evaluating their effects?
How do programs affect work incentives, and how might programs be better designed?
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2. Introduction
The distribution of earnings (and wealth) reflects how markets value the productivity of workers. Even in the absence of discrimination, the income distribution in a market economy may not be equitable or otherwise desirable.
In this chapter, we examine
Measures of inequality and poverty
The structure of policies designed to help the poor
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3. Some Issues
Is the United States a nation of the “middle class” with more or less equal opportunity, or are there significant differences in income and opportunity? Is income inequality in the U.S. growing or shrinking?
Is economic opportunity and economic success being transmitted across generations, and if so should this be a concern?
Should we provide income transfers for households that are poor, can earn little, and would otherwise live very difficult lives?
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4. The U.S. Income Distribution: 2003
Group
Annual family income
Bottom fifth
Under $24,117
Second fifth
$24,117 – $42,057
Middle fifth
$42,057 – $65,000
Fourth fifth
$65,000 – $98,200
Top fifth
$98,200 and over
Top 5 percent
$170,082 and over
Source: Table 1, Chapter 20.
Original source: U.S. Bureau of the Census.
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5. U.S. Inequality Over Time
Income share of the top 20% divided by income share of the bottom 20%
Each point is the ratio of two numbers:
The share of U.S. income received by the top 20%, relative to the share of U.S. income received by the bottom 20%.
As the graph shows, this indicator of inequality fell from the Great Depression until 1970, and then rose.
Source: Table 2, Chapter 20.
Original source: U.S. Bureau of the Census.
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6. Inequality Around the World
At least for this sample of countries, the U.S. is roughly in the middle with respect to inequality.
Source: Table 3, Chapter 20.
Original source: World Development Report, 2005
Income share of the top 20% divided by income share of the bottom 20%
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7. Pre-tax Incomes of Households with Children, in real terms.
Income Percentile
1979
2003
0-20 percentile
$20,400
$20,300
21-40 percentile
$40,100
$42,900
41-60 percentile
$58,000
$66,500
61-80 percentile
$78,100
$97,000
percentile
$148,400
$242,100
Top 5%
$274,600
$527,600
Top 1%
$580,300
$1,368,100
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8. Poverty
Poverty line: an absolute level of income set by the govt for each family size below which a family is deemed to be in poverty (a single standard applies nationwide!).
Poverty rate: the percentage of the population whose family income falls below the poverty line
In 2003 in the U.S.,
median family income = $52,680
poverty line for family of four = $18,810
poverty rate = 12.5%
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9. Percent of the population below poverty line
U.S. Poverty Over Time
Percent of the population below poverty line
The poverty rate appears correlated with business cycles. For example, was the longest economic expansion on record, and it coincided with a gradual fall in the poverty rate. In the early 2000s, the U.S. experienced a recession, and the poverty rate rose.
Source: Figure 1, Chapter 20.
Original source: U.S. Bureau of the Census.
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10. U.S. Poverty Rate by Group, 2003
Group
Poverty Rate
All persons
12.5%
White, not Hispanic
8.2
Black
24.4
Hispanic
22.5
Asian, Pacific Islander
11.8
Children
17.6
Elderly
10.2
Married-couple families
5.4
Female household, no spouse present
28.0
Source: Table 4, Chapter 20.
Original source: U.S. Bureau of the Census.
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11. Problems Measuring Inequality
1. In-kind transfers: assistance that takes the form of goods and services rather than cash
Omitted from measures of inequality and poverty, biasing them upward
2. The Life Cycle and transitory changes in income: a person’s income may be low or high in different times in their life, and may be low only temporarily.
People can borrow and save to offset life-cycle changes or temporary changes in income.
A better measure of poverty would examine people’s income average over a longer time.
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12. Problems Measuring Inequality
3. Economic mobility:
Many people move among income classes.
The poverty and inequality measures discussed above do not distinguish between the temporarily poor and the persistently poor.
One Viewpoint: # 2 and #3 above imply that a single cross section measure of how many are in poverty is a misleading measure, since many in poverty are only “temporarily” poor, and will enjoy satisfactory income over a multi-year time horizon.
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13. The Persistence of Earnings Levels
Earnings statistics reveal a very high correlation over time in earnings from one time period to the next – a worker’s earnings this period reflect his/her human capital, and tends to be replicated in subsequent years. (Correlations over periods more than 15 years are surprisingly high.)
Job experience has a cumulative effect on subsequent job and earnings levels. It is increasingly hard to obtain a better job with a growing history of poor jobs with limited responsibility and skill growth, and layoffs.
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14. U. S. Earnings Mobility: 17 years
U.S. Earnings Mobility: 17 years! (Table shows changes in income quintiles)
Year 17
QuintilesYear 1
0-20%
21-40%
41-60%
61-80%
81-100%
42%
23%
14%
13% 8%
29%
36%
19% 9% 7%
15%
21%
32%
12%
10%
24%
22% 3%
25%
54%
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15. Intergenerational Wealth Transfers: Parents to Children
Parents Wealth a generation before
Child Wealth (as adults)
Lowest 20%
Highest 20%
0-20% (lowest)
35%
10%
21-40%
34%
11%
41-60%
17%
16%
61-80%
27%
81-100% (highest) 3%
37%
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16. Factors Influencing Wealth Transfers
Parent’ peer group affects your peer group: neighborhood income stratification affects where you attend school, school quality and peer group
Gifts, inheritances, loans (education, home, car, start a business, emergencies). Affordability of higher education.
Whom you marry often reflects your peer group, with education and income significant factors.
Parents’ networks sometimes open doors.
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17. Education and Marriage
Education of wife
H.S College
Educ-husband
H.S % % %
% % %
College % % %
totals % % %
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18. The Political Philosophy of Redistributing Income
A simple summary:
Conservative viewpoint: Government should provide equal opportunity. However, imposing taxes for income redistribution imposes a cost in the form of disincentives to work and earn on both taxpayers and on recipients -- who have incentive to earn less and live on benefits.
Liberal viewpoint: Society should tax those able to pay to help those who can not help themselves, providing a “safety net”. Support is especially warranted when such assistance increases opportunities over the long run for ‘self-help.’
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19. Challenges in Confronting Poverty Issues
Poor families more likely to experience
health problems and drug dependence
teen pregnancy
illiteracy
unemployment
Poor families typical include adults with less education and human capital, low labor market productivity, and limited job opportunities.
Single parent families face the special challenge of how to earn a living and provide child care.
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20. Issues in Designing Programs
1. How should the eligible population be defined, and how can such rules avoid the problem that the existence of benefit programs provide incentives for the “less needy” to apply?
2. How should benefits be related to income, such that the largest benefits go to the most needy (poorest) but without reducing the incentives for recipients to work/earn more?
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21. Negative Income Taxes: EITC
Negative income tax: a tax system that collects revenue from high-income households and gives transfers to low-income households
The Earned Income Tax Credit (EITC) is similar to a negative income tax. Families with children earn a tax credit of 40 cents for each dollar earned up to $11,340 (total credit of $4,536), with the credit phased out at higher incomes.
The EITC is equivalent to a wage subsidy, and provides significant incentives to earn for low-wage workers.
With a negative income tax, the marginal tax rate is as low for low income persons as it is for high income persons. This is in sharp contrast to other welfare-type programs, which take away benefits as income rises, thus creating very high effective marginal tax rates.
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22. Programs for Disability and Aged Poor
Federal Disability Insurance: persons declared disabled and unable to work. Benefits equal to the Social Security benefit earned to date. In 2005, included 7.5% of men ages 55 and 6% of women. Program growing rapidly, 6.8 million people, cost $94 billion.
Supplementary Security Income: persons over 65 with inadequate earning from working, and younger persons with mental or physical disabilities with little work history million people, received about $8K per year. Cost $45 billion
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23. Programs for Non-elderly Poor
Temporary Assistance to Need Families (welfare). Cash to 6 million persons, $26 billion.
Food Stamps. Debit cards to buy food at reduced price. Eligible if income up to 185% of poverty standard. $27 billion.
School lunches (free or subsidized). $8 billion.
Public housing. Rent subsidized housing, if income less than 50% of median family income. $33 billion.
Medicaid. Virtually free (low quality) medical care, $292 billion, growing 11%/year since 1990.
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24. Why do we use In-Kind Transfers?
In-kind transfers are goods or services provided to the needy, rather than income.
Most taxpayers oppose the alternative of only providing cash payments; cash would allow people to buy what they most need, but concern that recipients will spend money unwisely (drugs, alcohol, etc.)
Suppliers of in-kind services are also a lobby: homebuilders, agricultural sector, medical sector.
A cash payment would let workers buy whatever they think they most need. Many economists believe that the government cannot know what people need better than the people themselves.
Regarding the argument that the recipients could spend the money on drugs:
Suppose the choice is giving the person $50 cash or $50 worth of food. If you give them $50 cash, they could buy drugs. If you give them $50 worth of food, then they have $50 that would otherwise have been used to buy food which they can now use to buy drugs.
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25. Welfare: Temp. Assistance for Needy Families
What should be eligibility rule – and implied incentives:
Single parent vs two parent household?
Income limit?
How can you provide a generous benefit, work incentives, and still limit eligibility and costs?
Welfare before and after 1996 TANF program: new rules give states flexibility to provide benefits, child care, training, etc.; imposes lifetime limits; and require education and training to receive benefits. Welfare has fallen sharply since 1996, reflecting a strong economy and welfare reforms.
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26. Anti-Poverty Programs and Work Incentives
Assistance from anti-poverty programs declines as income rises.
The result: Poor families face high effective marginal tax rates (exceeding even 100% in some cases!).
Such policies therefore discourage the poor from escaping poverty on their own.
“Solving” this problem is difficult, since benefits must be reduced if recipients’ incomes increase!
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27. CHAPTER SUMMARY
Data on income distribution show a wide disparity in our society. The richest 20% of families earn about ten times as much as the poorest 20%. Income inequality is widening in the United States.
Political philosophers and voters differ in their views of the proper role of government in altering the income distribution. Policies designed to improve equity often sacrifice efficiency, so the proper scope of policy is the subject of ongoing controversy.
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28. CHAPTER SUMMARY
Policies such as welfare, minimum-wage laws, negative income taxes, and in-kind transfers can help the poor.
Since financial assistance falls as income rises, the poor face high effective marginal tax rates, discouraging them from escaping poverty on their own.
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