1. More on income distribution
Today: Family income distribution
Should we redistribute income? Why?
Some government programs

2. Reminder on Test 2 Test 2 Monday 65 minutes
Restrictions on calculators are the same as for Test 1

3. Income distribution How is income distributed?
Is there such a thing as “too much” income inequality?
Why should there be redistribution?
In-kind versus cash transfers
When income is redistributed, should recipients be forced to consume a minimum amount of certain goods?
What are the problems of redistribution?

4. Mean income table (families)
Quintile
1980
1990
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
Source: “Principles of Microeconomics” 3rd edition, by Frank and Bernanke
Real income growth,
Bottom 20% has been flat
Top 20% has seen huge growth (59%)

5. What is “middle class?” This depends on who you ask Common answer
Lower middle class is usually about $40,000-$70,000
Mostly those in the middle 20% of incomes
Upper middle class is usually about $75,000-$150,000
Many people in the fourth and top 20% ranges

6. The gap between rich and poor widens
The rich are getting richer, but the poor are not getting poorer
Recent Census figures show that family incomes in the bottom 60% have stayed about the same since 2000
Working and middle class incomes have seen moderate real growth in income
16-29% growth for the categories in the middle 60%
Some of this is due to more middle-class families having two incomes

7. 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 within 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?”

8. “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

9. Arguments for less income inequality
“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”

10. Other problems with income inequality
Those that are relatively poor may feel inferior
This problem may perpetuate to their children
Jealousy towards other people
Envy towards other people’s accomplishments

11. More on fairness There are different views of fairness
Additive social welfare function
“Veil of ignorance”
Social welfare function should be minimum utility of all people in a society
Commodity egalitarianism

12. Different views of fairness
Some people believe that utility, not income, should be maximized within a population
Additive social welfare function W = U1 + U2 + … + Un

13. Implications for additive utilities
This is the net gain to society
Paul gains this much utility
Paul’s marginal utility
Peter’s marginal utility e f
Peter loses this much utility d c
MUPeter
Take ab from Peter and give to Paul
Social welfare maximized
MUPaul
Paul’s income
Peter’s income 0’ a b I*
Paul’s income
Peter’s income

14. Different views of fairness
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

15. Problem The “economic pie” will shrink with Rawls’ ideas
If income was guaranteed to be equal to everyone, nobody will have an economic incentive to gain human capital
Smaller “economic pie”
Less human capital
People work less

16. Optimal amount of income inequality?
Impossible to answer
Different people have different opinions about effectiveness of realistic ways to redistribute income

17. Different views of fairness
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

18. 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?

19. 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?

20. In-kind Transfers H Other goods per month 420 E3 340 A F U 300 E1 260B D 20 60
150
210
Pounds of cheese per month

21. In-kind Transfers H Other goods per month 420 A F 300 E5 168 E4 136 B82
126
150
210
Pounds of cheese per month

22. If income redistribution is good…
…then how do we move money from one person to another?
Welfare payments
We will spend most of our time on this
The earned-income tax credit
Negative income tax
Minimum wage
Public employment of the unemployed

23. Some methods of income redistribution
Welfare payments
Little economic incentive to get off of welfare without time limits
Many types of programs
TANF
Supplemental Security Income
Medicaid
Unemployment insurance

24. 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

25. 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

26. 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?

27. 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

28. Analysis of work incentivesD
|Slope| = w
Income per month c
Time Endowment b 2w w* a T
Hours of leisure per month

29. Analysis of work incentivesD
|Slope| = w
Income per month E1 G
iii ii
Income
Leisure
Work i F T
Hours of leisure per month

30. Analysis of work incentives
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 D
|Slope| = w
Income per month (= earnings + transfers)
|Slope| = 3/4w S G
Hours after TANF
Hours before TANF Q
$100 V F K T
Hours of leisure per month

31. Analysis of work incentives
In this case, a 100% implicit tax rate is imposed after a benefit of $338 is received D
Budget constraint with t = 100%
0 hours of work selected P1
Income per month (= earnings + transfers) P S R G
$338 F T
Hours of leisure per month

32. Analysis of work incentives
This person is indifferent between working and receiving benefits D E2
Income per month (= earnings + transfers) R P G
Hours worked (if working) M T
Hours of leisure per month

33. Analysis of work incentives
This person prefers working to receiving benefits D E2
Income per month (= earnings + transfers) R P G
Hours worked M T
Hours of leisure per month

34. 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

35. 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”
For main details about Medicaid, see Chapter 10

36. The Medicaid notch M Income per year D R S Z N $1,000 X TX T
Hours of leisure per year

37. 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

38. 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

39. EITC The earned income tax credit A success story for the working poor
Provides credits to workers within low incomes
Essentially a negative income tax for some levels of income

40. EITC 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

41. The earned income tax credit

42. 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

43. Other ideas Negative income tax Minimum wage
Supply a lump sum to everyone, then tax income more heavily
Problem: Incentive to work for pay diminishes
Some people will stop working and will pay no taxes
Minimum wage
Problem: Increased unemployment

44. What about public employment?
Public employment of the unemployed
To be successful…
Needs to have enough incentives for unemployed people to want to work
Needs to have incentives low enough for employed people to stay in their old job

45. 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

46. Overview
Figure 13.10: Estimated effective marginal tax rates for a one-parent, two-child household residing in Wisconsin (2000)
Source: Holt [2005, Part D, Figure 1].

47. 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

48. Recall Timothy Timothy is currently working 1,500 hours per year
Hourly wage is $10
He also receives government health care, valued at $3,000 per year
Timothy could work a second job for 700 hours per year
Hourly wage is $8
With the second job, Timothy would make too much money for government health care

49. Now we add value to leisure
New problem
Tabitha has 24 hours per day
Each hour can be used only for labor (L) or leisure (l)
Tabitha’s wage is $10 per hour worked
She receives $5 in Medicaid benefits per day if she earns no more than $60
M denotes the daily earnings plus Medicaid benefits, if any
Tabitha has the following utility function
U(M, l) = 2(M½) + l

50. Tabitha’s problem Two cases No Medicaid benefits
Work 6 hours or less and receive Medicaid benefits

51. No Medicaid benefits Maximize 2(M½) + l subject to (M/10) + l = 24
Same as Maximize 2(M½) + l
subject to l = 24 – (M/10)
Same as Maximize 2(M½) + 24 – (M/10)
FOC set equal to 0: 1/M½ – 1/10 = 0
M = 100
10 hours worked, 14 hours of leisure

52. What is Tabitha’s utility w/o Medicaid?
10 hours worked, 14 hours of leisure
U(100, 14) = 2(100½) + 14 = 34

53. What about if she works less?
Notice that this problem is almost the same
Maximize 2(M½) + l
subject to (M/10) + l = 24.5
The Medicaid benefit acts like 0.5 hour of work benefits
Using the same steps as previously, M = 100
We can’t work that much to get the benefit, so the closest we can get is by working 6 hours
Total M is 65 ($60 in wages, $5 in Medicaid benefits)

54. What is Tabitha’s utility with Medicaid?
6 hours worked, 18 hours of leisure
U(65, 18) = 2(65½) + 18 = 34.12

55. What should Tabitha do? If she works 10 hours (no Medicaid benefit)…
If she works 6 hours (with a Medicaid benefit)…
U(65, 18) = (65½) + 18 = 34.12
Tabitha should work 6 hours and accept the Medicaid benefit $5

56. How do we solve poverty?