2. Chapter Outline 16 Income Distribution and Poverty The Utility Possibilities Frontier The Sources of Household Income Wages and Salaries Income from Property Income from the Government: Transfer Payments The Distribution of Income Income Inequality in the United States Poverty The Distribution of Wealth The Redistribution Debate Arguments against Redistribution Arguments in Favor of Redistribution Redistribution Programs and Policies Financing Redistribution Programs: Taxes Expenditure Programs How Effective Are Antipoverty Programs? Government or the Market? A Review

3. INCOME DISTRIBUTION AND POVERTY equity Fairness. Why do some people get more than others? What are the sources of inequality? Should the government change the distribution generated by the market?

4. THE UTILITY POSSIBILITIES FRONTIER utility possibilities frontier A graphic representation of a two-person world that shows all points at which A’s utility can be increased only if B’s utility is decreased. FIGURE 16.1 Utility Possibilities Frontier

5. THE SOURCES OF HOUSEHOLD INCOME human capital The stock of knowledge, skills, and talents that people possess; it can be inborn or acquired through education and training. Households derive their incomes from three basic sources: (1) from wages or salaries received in exchange for labor; (2) from property—that is, capital, land, and so forth; and (3) from government. WAGES AND SALARIES Required Skills, Human Capital, and Working Conditions

6. THE SOURCES OF HOUSEHOLD INCOME compensating differentials Differences in wages that result from differences in working conditions. Risky jobs usually pay higher wages; highly desirable jobs usually pay lower wages. According to experts, the Alaskan fishing industry faces the most dangerous working conditions in the country. For this reason, Alaskan fishermen are paid compensating differentials that raise their average wage high above the average wage of the U.S. general population.

7. THE SOURCES OF HOUSEHOLD INCOME Multiple Household Incomes Another source of wage inequality among households lies in the fact that many households have more than one earner in the labor force. Second, and even third, incomes are becoming more the rule than the exception for U.S. families.

8. THE SOURCES OF HOUSEHOLD INCOME The Minimum Wage Controversy minimum wage The lowest wage that firms are permitted to pay workers. Many fast-food restaurants pay their employees minimum wage. In some locations, however, restaurants find that they must pay above minimum wage to attract and retain staff.

9. THE SOURCES OF HOUSEHOLD INCOME FIGURE 16.2 Effect of Minimum Wage Legislation

10. THE SOURCES OF HOUSEHOLD INCOME Unemployment Unemployment hurts primarily those who are laid off, and thus its costs are narrowly distributed. For some workers, the costs of unemployment are lowered by unemployment compensation benefits paid out of a fund accumulated with receipts from a tax on payrolls.

11. THE SOURCES OF HOUSEHOLD INCOME INCOME FROM PROPERTY property income Income from the ownership of real property and financial holdings. It takes the form of profits, interest, dividends, and rents. The amount of property income that a household earns depends on (1) how much property it owns and (2) what kinds of assets it owns. Such income generally takes the form of profits, interest, dividends, and rents.

12. THE SOURCES OF HOUSEHOLD INCOME INCOME FROM THE GOVERNMENT: TRANSFER PAYMENTS transfer payments Payments by government to people who do not supply goods or services in exchange. Transfer programs are by and large designed to provide income to those in need. They are part of the government’s attempts to offset some of the problems of inequality and poverty.

13. THE DISTRIBUTION OF INCOME economic income The amount of money a household can spend during a given period without increasing or decreasing its net assets. Wages, salaries, dividends, interest income, transfer payments, rents, and so forth are sources of economic income.

14. THE DISTRIBUTION OF INCOME INCOME INEQUALITY IN THE UNITED STATES Source: Julie-Anne Cronin, US Department of the Treasury, OTA Paper 85, pg 19. 1.2 31.6 10.9 14.8 Top 1 percent 14.8 73.2 55.6 56.7 Top fifth 17.0 15.1 23.6 21.3 Fourth fifth 23.0 9.2 12.7 12.6 Third fifth 25.8 4.2 6.3 7.2 Second fifth 19.2 0.7 1.7 2.7 Bottom fifth TRANSFER INCOME PROPERTY INCOME LABOR INCOME TOTAL INCOME HOUSEHOLDS TABLE 16.1 Distribution of Total Income and Components in the United States, 2000 (Percentages)

15. THE DISTRIBUTION OF INCOME Changes in the Distribution of Income 20.8 47.6 23.0 15.5 9.7 4.2 2000 Source: Statistical Abstract of the United States , various editions; Department of Commerce, HHES Division. 20.7 20.1 16.0 15.3 15.9 15.9 17.2 Top 5% 47.2 46.9 42.9 41.5 41.4 41.3 43.0 Top fifth 23.0 23.3 24.4 24.3 23.9 24.0 23.1 Fourth fifth 15.7 15.7 17.0 17.5 17.5 17.8 17.0 Third fifth 9.9 10.0 11.0 11.5 11.9 12.2 11.8 Second fifth 4.2 4.2 4.7 5.2 5.4 4.8 5.0 Bottom fifth 1997 1994 1984 1980 1972 1960 1947 TABLE 16.2 Distribution of Money Income of U.S. Families by Quintiles, 1947–2000 (Percentages)

16. THE DISTRIBUTION OF INCOME money income The measure of income used by the Census Bureau. Because it excludes noncash transfer payments and capital gains income, it is less inclusive than “economic income.”

17. THE DISTRIBUTION OF INCOME Lorenz curve A widely used graph of the distribution of income, with cumulative percentage of families plotted along the horizontal axis and cumulative percentage of income plotted along the vertical axis. The Lorenz Curve and the Gini Coefficient

18. THE DISTRIBUTION OF INCOME FIGURE 16.3 Lorenz Curve for the United States, 2002

19. THE DISTRIBUTION OF INCOME Gini coefficient A commonly used measure of inequality of income derived from a Lorenz curve. It can range from 0 to a maximum of 1. If income is equally distributed, there is no shaded area (because the Lorenz curve and the 45-degree line are the same), and the Gini coefficient is zero. The Lorenz curves for distributions with more inequality are farther down to the right, their shaded areas are larger, and their Gini coefficients are higher. The maximum Gini coefficient is 1. As the Lorenz curve shifts down to the right, the shaded area becomes a larger portion of the total triangular area below 0 A. If one family earned all the income (with no one else receiving anything), the shaded area and the triangle would be the same, and the ratio would equal 1.

20. THE DISTRIBUTION OF INCOME Differences among African-American Households, White Households, and Single-Person Households Note: Totals may not add to 100 due to rounding. Source: Statistical Abstract of the United States , 2002, Tables 665 and 667. 100.0 100.0 100.0 100.0 100.0 Total 3.5 7.2 15.0 6.4 14.1 >100,000 3.7 7.5 11.6 6.7 11.0 75,-100,000 9.7 16.9 18.9 13.9 18.3 50-75,000 13.4 16.4 15.2 14.8 15.1 35-50,000 13.7 15.7 12.0 14.5 12.3 25-35,000 19.8 17.2 12.8 16.4 13.2 15-25,000 36.3 19.1 14.5 27.4 16.1 0-15,000 ONE-PERSON HOUSEHOLDS HISPANIC HOUSEHOLDS WHITE HOUSEHOLDS AFRICAN-AMERICAN HOUSEHOLDS ALL HOUSEHOLDS TABLE 16.3 Distribution of Money Income of Households, 2002 (Percentages)

21. THE DISTRIBUTION OF INCOME POVERTY The Problem of Definition Although it is difficult to define precisely, the word poverty is one that we all understand intuitively to some degree.

22. THE DISTRIBUTION OF INCOME The Official Poverty Line poverty line The officially established income level that distinguishes the poor from the nonpoor. It is set at three times the cost of the Department of Agriculture’s minimum food budget. The official poverty line has been set at a figure that is simply three times the cost of the Department of Agriculture’s minimum food budget.

23. THE DISTRIBUTION OF INCOME Poverty in the United States Since 1960 a Includes food, housing, and medical benefits. Source: Statistical Abstract of the United States , 2002-2005. 17.8 20.7 Children under 18 9.8 28.5 Elderly (65+) 28.4 45.9 Female householder – no husband present 21.8 NA Hispanic 24.7 49.6 African-American 10.8 14.9 White 12.7 19.0 All OFFICIAL MEASURE 2004 OFFICIAL MEASURE 1964 TABLE 16.4 Percentage of Persons in Poverty by Demographic Group, 1964–2001

24. THE DISTRIBUTION OF INCOME THE DISTRIBUTION OF WEALTH Source: James Poterba, “Stock Market Wealth and Consumption,” Journal of Economic Perspectives, 14(2), 99 – 118 , Spring 2000. 18.5 29.3 14.0 4.1 1.7 Bottom 80% 68.9 50.7 72.2 86.2 91.2 Top 10%t 34.0 14.8 32.0 47.7 53.2 Top 1% 25.6 10.2 24.2 37.0 41.4 Top .5% NET WORTH HOUSING EQUITY NONEQUITY FINANCIAL ASSETS ALL COMMON STOCK COMMON STOCK EXCLUDING PENSIONS PERCENTAGE OF OWNERS TABLE 16.5 Percentage of Different Assets Owned by Households, 1998 Survey of Consumer Finances

25. THE REDISTRIBUTION DEBATE ARGUMENTS AGAINST REDISTRIBUTION Those who argue against government redistribution believe that the market, when left to operate on its own, is fair. ARGUMENTS IN FAVOR OF REDISTRIBUTION The argument most often used in favor of redistribution is that a society as wealthy as the United States has a moral obligation to provide all its members with the necessities of life.

26. THE REDISTRIBUTION DEBATE Utilitarian Justice utilitarian justice The idea that “a dollar in the hand of a rich person is worth less than a dollar in the hand of a poor person.” If the marginal utility of income declines with income, transferring income from the rich to the poor will increase total utility.

27. THE REDISTRIBUTION DEBATE Social Contract Theory—Rawlsian Justice Rawlsian justice A theory of distributional justice that concludes that the social contract emerging from the “original position” would call for an income distribution that would maximize the well-being of the worst-off member of society.

28. THE REDISTRIBUTION DEBATE The Works of Karl Marx labor theory of value Stated most simply, the theory that the value of a commodity depends only on the amount of labor required to produce it. Income Distribution as a Public Good We turn to government to provide things we want that will not be provided adequately if we act separately—in this case, help for the poor and hungry.

29. REDISTRIBUTION PROGRAMS AND POLICIES FINANCING REDISTRIBUTION PROGRAMS: TAXES Redistribution always involves those who end up with less and those who end up with more. Because redistributional programs are financed by tax dollars, it is important to know who the donors and recipients are—who pays the taxes and who receives the benefits of those taxes. All people pay about the same percentage of their income in total taxes.

30. REDISTRIBUTION PROGRAMS AND POLICIES TOTAL FEDERAL 37.0 34.9 34.5 33.9 32.6 29.2 26.3 28.1 Top 1 Top 5 Top 10 Top 20 Fourth 20 Third 20 Second 20 Bottom 20% Source: Julie-Anne Cronin, US Department of the Treasury, OTA Paper 85 and authors’ estimate. 29.1 26.6 25.7 24.6 20.1 17.4 11.7 5.9 TABLE 16.6 Effective Rates of Federal, State, and Local Taxes, 2000 (Taxes as a Percentage of Total Income)

31. REDISTRIBUTION PROGRAMS AND POLICIES EXPENDITURE PROGRAMS Social Security Social Security system The federal system of social insurance programs. It includes three separate programs that are financed through separate trust funds: the Old Age and Survivors Insurance (OASI) program, the Disability Insurance (DI) program, and the Health Insurance (HI, or Medicare) program.

32. REDISTRIBUTION PROGRAMS AND POLICIES Public Assistance public assistance, or welfare Government transfer programs that provide cash benefits to (1) families with dependent children whose incomes and assets fall below a very low level and (2) the very poor regardless of whether or not they have children.

33. REDISTRIBUTION PROGRAMS AND POLICIES Supplemental Security Income The Supplemental Security Income program ( SSI ) is a federal program that was set up under the Social Security Administration in 1974. Unemployment Compensation unemployment compensation A state government transfer program that pays cash benefits for a certain period of time to laid-off workers who have worked for a specified period of time for a covered employer.

34. REDISTRIBUTION PROGRAMS AND POLICIES Medicaid and Medicare Medicaid and Medicare In-kind government transfer programs that provide health and hospitalization benefits: Medicare to the aged and their survivors and to certain of the disabled, regardless of income, and Medicaid to people with low incomes.

35. REDISTRIBUTION PROGRAMS AND POLICIES Food Stamps food stamps Vouchers that have a face value greater than their cost and that can be used to purchase food at grocery stores. Housing Programs The Earned Income Tax Credit

36. REDISTRIBUTION PROGRAMS AND POLICIES HOW EFFECTIVE ARE ANTIPOVERTY PROGRAMS? Some say economic growth is the best way to cure poverty. The opposite view is that poverty would be much more widespread without antipoverty programs.

37. GOVERNMENT OR THE MARKET? A REVIEW Remember that government is not a cure for all economic woes. There is no guarantee that public-sector involvement will improve matters. Many argue that government involvement may bring about even more inequity and inefficiency because bureaucrats are often driven by self-interest, not public interest.