Income Redistribution

1
Income Redistribution

• Conceptual Issues

2
Should government redistribute income?

• This is a normative question.
• It involves a value judgment about whether or not
  government should take income from one person or
  group of persons and give it to another.
• As a positive matter, every decision made by the
  government, whether taxing, spending, or
  regulation involves the redistribution of income.
  
• Some programs have unintended redistribution
  effects.
• Some programs of income redistribution are
  intended to redistribution income from wealthy
  individuals to lower income individuals.
• Such programs are quite explicit in their
  purpose.
• Politicians take great pains to insure that the
  recipients of this redistribution are aware of
  the benefit.

3
The politics of income redistribution

• In the case of income redistribution to the poor,
  the number of recipients are quite large (lots of
  voters, perhaps?) and the number of payers is
  quite smallonly the fat cats in the top 2 of
  income earners.
• Or so the politicians would have you believe.
• But is there such a thing as income distribution
  to the wealthy?
• What about the sugar program?
• In this case, the number of recipients is very
  small and very wealthy.
• The payers are spread over the entire population
  so that the cost to each consumer and/or taxpayer
  is very small.
• Do you think large campaign contributions from
  the sugar growers have anything to do with the
  enormous political support they enjoy?

4
Other programs of redistribution

• The same argument could be made about dairy
  producers, steel workers, certain firms engaged
  in foreign trade, and farmers in Iowa.
• All of these programs represent redistribution of
  income away from the public at large to a very
  small group of people who are not living at the
  poverty line.
• There are also subsidies to a wide range of
  individuals who are not living at the poverty
  line.
• Home owners
• Students
• Recipients of health care
• Retired individuals

5
What is the poverty line?

• In the early 60s Lyndon Johnson asked his
  advisors for information on the number of
  Americans living in poverty.
• When no one could give him an answer, he went on
  the warpath.
• In fact, no one could even give him a straight
  answer on what constituted poverty.
• Word went out to the bureaucracy to get an
  answer.
• By the time it reached some low level bureaucrat
  in the bowels of the Department of Health,
  Education, and Welfare (since renamed Health and
  Human Services), an answer magically appeared.
  (Actually, Mollie Orshansky of the Social
  Security Administration is the mother of the
  poverty line)
• Thus was born the poverty line.
• The definition has since scientized, but it
  started out as a SWAG.

6
The poverty line

• Today, the poverty line is defined as a fixed
  level of real income considered enough to provide
  a minimally adequate standard of living.
• Today, it is scientifically measured by
• Estimating the minimum cost of a diet that meets
  adequate nutritional standards.
• Finding the proportion of income spent on food in
  families of different sizes.
• And, multiplying the reciprocal of this
  proportion by the cost of an adequate diet.
• In 2001, (Click here for the 2008 poverty level)
• the poverty line for a family of 4 was 18,244.
• Median income was 42,228.
• And 32.9 million people were below the poverty
  line. (11.7)

7
Look at some of the numbers

• This chart divides the income pie into five
  parts, called quintiles.
• Each quintile represents 20 of the population.
  (or does it) (also see this)
• In a perfect egalitarian society each quintile
  would share 20 of the income.
• Caution This chart may be misleading since the
  numbers do not include the value of in-kind
  transfers, among other things. (More on this
  later.)
• Do you think this might be significant?
• In addition, income inequality may reflect
  differences in education.

8
Poverty is uneven

• First, Rosen doesnt say whether these figures
  are individuals or households. I assume
  households since he includes female head of
  household as one of the categories.
• Second, the poverty rate among this group is
  probably due to the fact that the main difference
  in family income is the wage differential between
  head of households. Also, with female heads,
  there is only one wage earner.
• Under 18 rate may reflect children of female
  headed households.
• The 65 and older probably reflects a true success
  story.

9
The poverty rate

• As for the poverty rate itself, it has been cut
  in half over a period of four decades, although
  the trend has been up and down.
• It might be interesting to note that the poverty
  rate declined during the period following the
  end of welfare as we know it.
• The decade of growth in the 90s may have had
  something to do with the decline in the poverty
  rate.

10
Some Caveats

• In-kind transfers are not included in the
  official poverty data. Some of the items excluded
  are
• Food stamps.
• Housing subsidies.
• Medical subsidies.
• One study concluded that the official poverty
  rate would be reduced by more than 20 if we
  included in-kind subsidies.
• Why do you think we do not include them?
• There are other in-kind transfers you may not
  ever think of.
• The value of adult time devoted to household.
  Think of the stay at home mom vs. the working
  mom.
• Durable goods provide in-kind transfers. Home
  ownership is the major item that provides
  income but is not included.

11
Other Caveats

• The official figures ignore taxes.
• High income people pay higher taxes.
• Many low income people pay no taxes.
• Some low income families who work, but earn below
  a certain level are eligible for the earned
  income tax credit (EITC). The EITC is not
  included.
• Income is measured on an annual basis. What about
  looking at income over a lifetime?
• Using a lifetime measure, rather than a annual
  measure could reduce the poverty rate by 3 or 4
  percent.
• And as we saw earlier, a quintile may not be a
  quintile, i.e., household composition makes a
  difference.

12
Rationale for income redistribution

• The utilitarian approach is that if you can
  increase the welfare of one person without
  hurting anyone else, then you have an increase in
  social welfare.
• This idea is based on three somewhat heroic
  assumptions
• Individuals have identical utility functions that
  depend only on income.
• Diminishing marginal utility of income.
• The total amount of income is fixed.
• The second assumption may be the least
  unrealistic, but there are serious flaws with the
  first and third. (More on this later.)
• Lets take a look at the implications.
• Let us assume there are two people in the
  economy, Peter and Paul.
• (Im not sure what happened to Mary)

13
Is there an optimal distribution of income?

• Let OO' be the fixed amount of income.
• Pauls income increases from origin O, Peters
  from O'.
• With identical MU curves, they intersect at some
  point I where each has an equal distribution of
  income.
• Assume the initial distribution is Oa for Paul
  and O'a for Peter.
• If we redistribute income away from Peter to
  Paul, say an amount ab, welfare increases by area
  cefd.
• Do you know why?
• Welfare would increase until you reach point I.

Figure 7.1 Model of the optimal distribution of
income
Pauls gain is Peters loss!
14
The assumptions

• Are individual utility functions identical?
• Even if they are identical, how can we know that
  they are, since each persons utility function is
  determined subjectively.
• Some have argued that it is an ethical question,
  and even if they are different, the government
  should act as if they are the same.
• Does MU of money decline?
• Suppose it is constant.
• Then redistribution from one to another means the
  loss to one is exactly to the gain of the other.
• The assumption that the size of the pie is fixed
  is the most unrealistic of the assumptions.
• It assumes that redistributing income does not
  affect the behavior of either the payer or the
  recipientthat they will continue to work and
  produce as before.
• Do you think this is possible?

15
Other approaches

• The Maxmin Criterion
• Here the social objective is to maximize the
  utility of the person with the lowest utility.
• John Rawls argues that this approach is ethically
  valid.
• He starts with the idea of an original
  position.
• Since we do not know if we will be rich or poor,
  then we would favor some sort of minimum
  wellbeing, just in case.
• Sort of an insurance policy against being poor.
• The spillover case
• Assume I gain satisfaction from seeing you better
  off.
• Income redistribution can be a Pareto improvement
  in this case.
• Need government to overcome free rider problem.
• Think of payments as insurance premiums.

16
Other approaches

• The social stability argument.
• Much of the upheaval in South and Latin American
  countries in past decades has been a result of a
  lop-sided distribution of income.
• Communism seemed like an attractive alternative
  for people with little hope.
• This is one of the reasons that people like Che
  Guevara and Daniel Ortega were so popular.
• Commodity egalitarianism
• Here, the idea is that only certain commodities
  should be distributed equally.
• Education and some of the basic necessities of
  life come to mind.
• Finally, there is the argument that equal
  opportunity should be the goalthus, the
  distribution of income that results would be
  fair.
• Some even argue that the marginal productivity
  distribution of income is a fair way to slice
  the pie. Shares are based on productivity.
  Problems arise with imperfections in the market.

17
Expenditure incidence

• Remember our various definitions of the word
  incidence from our discussion on taxes.
• Here, incidence means, simply, who gains the
  benefits of the expenditure.
• We assume the incidence of redistribution
  programs for the poor will be those at the low
  end of the scale.
• But this is not always true. There are
  complications
• Relative price effects. Difficult to see how
  price changes affect different groups.
• Public goods. No way to tell how much people
  value the good.
• If they have high value, but low tax share,
  income is redistributed to them.
• The opposite results when the government provides
  goods that we do not want.

18
In-kind Transfers

• When the government provides goods, rather than
  cash, direct to recipients, the result may be a
  lower level of utility.
• Let AB be the budget line.
• Initial equilibrium is at point E1.
• Assume an in-kind transfer of 60 pounds of
  cheese.
• Consumer moves to point F on U, a higher level of
  utility. Budget line becomes AFD.
• Consumer does not have to sacrifice other goods
  unless he wants more than 60 pounds.
• With cash, budget line becomes HFD, and consumer
  would be on a higher indifference curve at E3.

Figure 7.2 An in-kind transfer results in a
lower utility level than a cash transfer
In-kind transfer results in over-consumption of
cheese.
19
In-kind Transfers

• In-kind transfers such as those in figure 7.2
  cause an efficiency loss.
• That is not always the case.
• If indifference curves are skewed more toward
  cheese, then the consumer may want to consume
  more than 60 pounds.
• In this case, either cash or in-kind transfers
  result in an efficient solution.
• Can you see how fraud might occur in the
  previous case?
• In both cases, the HF portion of the budget line
  is not available with the in-kind transfer.
• Consumer can improve his wellbeing by selling
  food stamps and using the cash as he sees fit.

Figure 7.3 An in-kind transfer can also result
in the same utility level as a cash transfer
20
In-kind Transfers

• Who benefits from in-kind transfers such as food
  stamps?
• The recipients, of course.
• Farmers, who are not necessarily low income.
• Food processors and distributors, who are not
  necessarily low income.
• Who pays?
• Taxpayershigher taxes
• Consumershigher prices.
• Who is in favor of such programs, besides the
  beneficiaries?
• Bureaucrats in the Department of Agriculture and
  the Department of Health and Human Services.
• Politicians from farm states.
• Politicians in general.
• The welfare lobby (This is my polite word.
  Click on the link to see Walter Williams term.)

• Who benefits from in-kind transfers such as food
  stamps?
• The recipients, of course.
• Farmers, who are not necessarily low income.
• Food processors and distributors, who are not
  necessarily low income.
• Who pays?
• Taxpayershigher taxes
• Consumershigher prices.
• Who is in favor of such programs, besides the
  beneficiaries?
• Bureaucrats in the Department of Agriculture and
  the Department of Health and Human Services.
• Politicians from farm states.
• Politicians in general.
• The welfare lobby (This is my polite word.
  Click on the link to see

21
Any Questions?

• Lets now take a look at specific income
  redistribution programs for the poor