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Income Distribution and Poverty

• The Lorenz curve

• The Gini coefficient

• Distribution of income and wealth in the U.S.

• Poverty threshold (level)

Questions:

• What explains income inequality?

• What can (should) be done, if anything?

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Income Distribution and PovertyPerson’s income related to primary source of income.

• If property income:

profits(entrepreneurship)

interest (capital)

rent (land)

tendency to be at the top of the distribution

• If labor income:

wages

tendency to be at the bottom of the distribution

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Measuring Income Distribution

Two ways to measure an economy’s income distribution:

The Lorenz curve.

The Gini coefficient.

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LORENZ

CURVES FOR THE

COMMUNITIES

OF WASHTENAU, SPRINGFIELD, AND HOLMES

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Lorenz curve

Shows the percentage of total income that a specific part of the population -- typically represented by quintiles, ranging from the poorest to the richest -- receives.

The percentage of population is measured along the horizontal axis and the percentage of total income is measured along the vertical axis.

Perfect income equality (diagonal)

When each percent of the population receives an equal percent of the economy’s total income.

Perfect income inequality (2 sides of right angle)

One person receives all of the income.

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LORENZ CURVES

SWEDEN, FRANCE, BRAZIL, AND THE UNITED STATES

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Gini coefficient

A numerical measure of the degree of income inequality in an economy.

The ratio of the two areas produced by the Lorenz curve.

G = A/(A+B)

Area A lies between the diagonal and the economy’s Lorenz curve.

Area B lies below the economy’s Lorenz curve.

0: perfect equality

1: perfect inequality

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THE GINI COEFFICIENT

G = A/(A+B)

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EXHIBIT 4 SHARE OF AGGREGATE INCOME RECEIVED BY HOUSEHOLDS, BY QUINTILE AND TOP 5 PERCENT, AND GINI COEFFICIENT: 1970–99

Source: U.S. Bureau of the Census, Money Income in the United States: 1995, Current Population Reports, P60-193 (Washington, D.C.: U.S. Government Printing Office, 1996); and U.S. Bureau of the Census, Money Income in the United States: 1999, Current Population Reports, P60-220 (Washington, D.C.: U.S. Government Printing Office, 1999).

0: perfect equality 1: perfect inequality

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EXHIBIT 5 PERCENTAGE CHANGE IN HOUSEHOLD GINI COEFFICIENT: 1967–99

Source: U.S. Bureau of the Census, Current Population Survey, March 1999.

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Possible Causes of Growing Income Inequality

Decrease in minimum wage (in real value).

Decrease in union membership.

Changes in tax laws favoring the wealth.

Declining resources to public education.

“Deindustrialization” (closing down manufacturing plants)

“Globalization.”

Stock market “boom” (1980-2000) [Related to unequal distribution of wealth]

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Wealth

Accumulated assets owned (financial and physical) by individuals, including inherited assets.

Net wealth (net worth) tends to be far more unevenly distributed than income.

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EXHIBIT 8 DISTRIBUTION OF NET WEALTH OF U.S. FAMILIES (1774 AND 1973)

Source: Jones, A. H., Wealth of a Nation to Be—The American Colonies on the Eve of Revolution (New York: Columbia University Press, 1980); and Greenwood, D., “An Estimation of U.S. Family Wealth and Its Distribution from Macro Data, 1973,” The Review of Income and Wealth, Series 29, I, March 1983, pp. 23–44.

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Is There an Optimal Income Distribution? The Case for Equality

Good fortune and disaster--distributed randomly.

Income inequality, then, has no more justification than a lottery result.

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Is There an Optimal Income Distribution? The Case for Equality

Economist A.P. Lerner, made the case for equality based on the argument that equality produces the greatest welfare for the greatest number of people.

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The Case for Inequality

Other economists argue for

income inequality:

productive contribution= economic reward

Without the link between reward (income) and labor, productive people would lack the incentive to work.

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Supply-Side Economics: “Trickle-Down Theory”

Income inequality

economic growth.

Because….The rich tend to do the country’s saving + investing.

The richer the rich

the greater the saving and investment

higher the rate of growth.

“A rising tide lifts all boats.”

• Problems in using taxes to redistribute incomes

– economic costs of redistribution

• distortionary effects of taxes

• deadweight welfare loss of taxes

• disincentives

TAXESTAXES

fig

0

To

tal t

ax

reve

nu

e

Average tax rate (%)

100

A Laffer curve

fig

0

To

tal t

ax

reve

nu

e

Average tax rate (%)

100

R max.

t1

A Laffer curveA Laffer curve

fig

Percentage shares of income before and after taxby decile group of households: 2000/1

Percentage shares of income before and after taxby decile group of households: 2000/1

% o

f in

com

e

Source: Economic Trends (ONS, April 2002)

15.712.9

11.19.0

7.66.0

4.7 3.82.5

25.8

15.212.6

10.9

7.86.3 5.2 4.2

2.8

26.8

9.1

0

5

10

15

20

25

30

Top 10% 11 to 20 21 to 30 31 to 40 41 to 50 51 to 60 61 to 70 71 to 80 81 to 90 Bottom10%

Income before tax

Income after tax

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EXHIBIT 6 INCOME DISTRIBUTION IN THE MID-1980s, SELECTED COUNTRIES, BY QUINTILE

Source: European Economy: 1996 Broad Economic Policy Guidelines, no. 62 (Brussels, 1996), and World Development Report, 1996 (Washington, D.C.: World Bank, 1996).

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EXHIBIT 7 INCOME DISTRIBUTION IN LESS-DEVELOPED ECONOMIES, BY QUINTILE

Source: World Development Report, 1996 (Washington, D.C.: World Bank, 1996). The footnote to the table in the report reads: “These estimates should be treated with caution.”

fig0 200 400 600 800 1000 1200

Bar staff

Sales assistants

Clerks

Factory lineworkers

Nurses

Secondary teachers

Personnel managers

Medical practioners

Financial managers

Women's earnings

Men's earnings

Average gross weekly earnings ofUK full-time adult employees: 2001Average gross weekly earnings ofUK full-time adult employees: 2001

• The causes of inequality– inequality of wealth– differences in workers’

• ability; qualifications• attitudes• hours worked• economic power• qualifications

– differences in demand for goods– differences in household composition– discrimination– degree of government support– unemployment

• Government/societal attitudes towards inequality

INEQUALITY AND POVERTYINEQUALITY AND POVERTY

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Benefits to reduce inequality/poverty

• “safety-net” temporary support

• means-tested vs universal benefitsCash assistance

Transfer payments: Government assistance in the form of direct income.

In-kind assistanceGovernment assistance in the form of goods and services, such as healthcare, education, food stamps.

fig

0

1000

2000

3000

4000

5000

6000

7000

8000B

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ium

Den

mar

k

Fra

nce

Ger

man

y

Gre

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Irel

and

Italy

Net

her

lan

ds

Po

rtu

gal

Sp

ain

Sw

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EU

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1999

Social protection benefits in variousEuropean countries: (a) €per headSocial protection benefits in variousEuropean countries: (a) €per head

Source: Eurostat, 2002

Eu

ro p

er h

ead

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CASH AND NONCASH BENEFITS FOR PERSONS WITH LIMITED INCOME: USA 1996

Source: Statistical Abstract of the United States, 1999 (Washington, D.C.: Department of Commerce, 1999), p. 389.

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EXHIBIT 15 POPULATION BELOW 50 PERCENT OF MEDIAN INCOME (LATEST OECD DATA)

Source: OECD Economic Surveys, Germany, 1996 (Paris: OECD, 1996), P. 90.

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Exh. 15: Population Below 50 Percent of Median Income (Latest OECD Data)

Has government spending to assist the poor been effective at raising families out of poverty?

• In the U.S. the effects of low-income assistance programs seem barely perceptible.

• While some countries have seen the numbers of poor drop by half, the US number have dropped by less than 1 percent.

TAXES AND BENEFITS

• The problem of the poverty trap– an argument for universal benefits

– problems with universal benefits

• The negative income tax system