Title: Income Redistribution:Conceptual Issues
1Income RedistributionConceptual Issues
- Tonight, well consider a framework for thinking
about the normative and positive aspects of
government income redistribution policy.
2Introduction
- A Question to Begin Should economists be
concerned with distributional issues at all? - Some say NO.
- Value judgments embodied in the right income
distribution. - No scientific basis for the right distribution.
- Economists should focus exclusively on efficiency
and leave equity considerations alone.
3Introduction
- A Question to Begin Should economists be
concerned with distributional issues at all? - Others say YES.
- A Focus on efficiency alone also has problems.
- Efficiency by itself is an inadequate normative
standard. To focus on it exclusively, is itself
a value judgment. - Policymakers certainly care about income
distribution. If economists ignore distributional
issues, policy makers will ignore economists and
focus exclusively on distribution and ignore
efficiency.
4Introduction
- Related Question Should government try to
change the existing income distribution? - Arguments for NO. Reasons similar to why
economists should not consider distribution in
first place. - Arguments for YES. Almost anything the
government does will affect income distribution. - Example Tax the public to build public works.
- Losers Taxpayers who do not (on net) benefit
from projects. - Winner Taxpayers who do and contractors who
receive lucrative contracts.
5Distribution of Income
- Can analyze household income, and see how equally
or unequally the pie is distributed. - Table 7.1 shows the percentage of money income
among households for more than 30 years.
6Table 7.1
7Distribution of Income
- Richest 20 receives about 50 of total income.
- Poorest 20 receives about 4 of total income.
- Inequality has increased over time.
8Distribution of IncomePoverty
- The poverty line is a fixed level of real income
which is considered enough to provide a minimally
adequate standard of living. - Inherently arbitrary, but still a useful
benchmark when making comparisons. - Trends over time
- Differences across groups
9Distribution of IncomePoverty
- Poverty line for a family of four was 19,157 in
2004. - Median household income more than double that,
44,389 in 2004. - Table 7.2 shows poverty rates for selected groups
in 2001.
10Table 7.2
11Distribution of IncomePoverty
- Poverty rates in U.S. in 2004 might be considered
surprisingly high 12.7 for population as
whole. - Concentrated among certain groups, such as female
headed households, children, and minorities. - Elderly have lower poverty rates than the U.S.
average.
12Distribution of IncomePoverty
- Can also look at trends over time.
- See Table 7.3.
- Poverty considerably lower than in 1960s, but not
much progress since 1970.
13Table 7.3
14Interpretation Problems
- Poverty line (and poverty rate) is subject to a
number of criticisms. - When interpreting the numbers, it is useful to
know the conventions and limitations.
15Interpretation Problem 1
- Income consists only of cash receipts.
- Excludes in-kind transfers like health insurance,
food stamps, and housing. - Excludes non-market work such as childcare or
housework. - Ignores income flow from durable goods.
16Interpretation Problem 2
- Income is before tax.
- It ignores cash refunds from the Earned Income
Tax Credit, which has grown dramatically in the
last decade, and now amounts to more than 31
billion annually. - Ignoring this overstates poverty rates and also
affects the trends over time.
17Interpretation Problem 3
- Income is measured annually.
- Not obvious what the correct time frame should
be. - Income does fluctuate from year to year.
- Lifetime income considerations seem relevant.
- Consider a starving college student, for
example. Not really poor in a lifetime sense.
18Interpretation Problem 4
- Unit of observation
- Person, family, household?
- People often make decisions as an economic unit,
and there are economies of scale in household
production. - Classifications can matter for poverty numbers
- Bauman (1997) calculates that including the
income of nonfamily members (such as nonmarried
cohabitors) would reclassify 55 of people who
are poor out of official definition. - His methodology controversial and strongly
criticized by other researchers
19Interpretation Problem 5
- A Nutritional Standard is totally unrelated to
actual expenses required to not be poor. - In 1950s, average family spent 1/3 on income on
food. - Today, average family spends less than 1/5.
- No reason to believe 2/3 (or 4/5) of remaining
income is adequate to pay for rent, clothing,
heathcare, child-related expenses,
transportation, incidentials. - In fact, empirical evidence suggests 2/3 is not
adequate.
20Interpretation Problem 6
- No attempt is made to control for regional
variations in costs-of-living - It will clearly require a higher income to not be
poor in California or New York than it would to
not be poor in Iowa or Mississippi because
housing and other costs are so much higher. - The official poverty measure creates a
one-size-fits-all poverty line.
21An Alternative to the Official Poverty Measure
- In 1995, a panel from the National Academy of
Sciences proposed a whole new poverty measure. - Their alternative measure addresses all the
interpretation problems cited above. - Census Bureau has since refined this alternative.
Still not adopted officially. - Alternative measure shows slightly higher poverty
overall than official measure. - Alternative measure shows increases in poverty
for some groups and regions, decreases in poverty
for other groups and regions.
22Rationales for Income Redistribution
- Different kinds of social welfare functions
- Utilitarian
- Maximin criterion (Rawlsian)
- Pareto efficient
- Non-individualistic
23Simple Utilitarianism
- The utilitarian social welfare function is
- W F(U1, U2, , Un)
- Which depends on all n members of society. One
specific function form is - W U1 U2 Un
- This special case is referred to as an additive
social welfare function.
24Simple Utilitarianism
- With the additive SWF that was given, also
assume - Identical utility functions that depend only on
income. - Diminishing marginal utility of income.
- Societys total income is fixed.
- Implication government should redistribute to
obtain complete equality.
25Simple Utilitarianism
- This can be illustrated with two people.
- See Figure 7.1.
- Any income level other than I does not maximize
the SWF. - I entails equal incomes.
26Figure 7.1
27Simple Utilitarianism
- So, should Full Income Equality be pursued?
- Assumptions are too limiting to make such a
conclusion reliable. - Assumes identical utilities.
- Assumes decreasing marginal utility.
- Assumes total income fixed
- e.g., no disincentives from this kind of
redistributive policy.
28The Maximin Criterion
- The Rawlsian social welfare function is
- W Minimum(U1, U2, , Un)
- Social welfare in this case depends only on the
utility of the person who has the lowest utility. - Rawls (1971) asserts it has ethical validity
because of the notion of original position. - Notion that ex-ante individuals do not know where
in the income distribution they will be.
29The Maximin Criterion
- These ethical claims are controversial
- Still selfish view in original position
- Individuals extremely risk averse here
- All that is relevant is the welfare of the
worst-off person, even if a policy is extremely
detrimental to everyone else.
30Pareto Efficient Income Redistribution
- Under both Utilitarian and Maximin social welfare
functions, by making some better off,
redistribution made others worse off. - Given these approaches, redistribution would
never lead to a Pareto improvement. - Each individuals utility depends only upon their
own income.
31Pareto Efficient Income Redistribution
- Suppose that an individuals utility depends not
only upon their own income, but the income of
others. - For example, suppose Peter is rich, and Paul is
poor but that Peters utility function takes the
following form - UPETER U(IPETER , U(IPAUL))
- Now it would be efficient to transfer income from
Peter to Paul so long as Peters utility gain
from improving Pauls utility is greater than
Peters utility loss from lower consumption.
32Pareto Efficient Income Redistribution
- Government redistribution in this case might
improve efficiency. It may be difficult for
private actions to do this, if, for example, the
rich lack information on just who really is poor,
or if there are free rider aspects. - Formally, this amounts to an externality problem
Pauls consumption (or lack thereof when he is
poor) affects Peters welfare in a way that is
external to the market.
33Pareto Efficient Income Redistribution
- This argument assumes people would not give in
absence of governmental coercion. But there is,
in fact, a great deal of private charitable
giving. - Additional Self-Interest Arguments
- Social insurance aspects reflect self-interest,
not altruism. Pay in when you are rich to protect
yourself in case you need a pay-out if you become
poor. - Social peace aspects also reflect self interest.
Pay in when you are rich to protect yourself by
preventing poor from rioting and staging
revolution.
34Nonindividualistic views
- In previous cases, social welfare derived from
individuals utilities. - Some theorists specify a social welfare function
independent of individual preferences or
utilities. - Plato the richest person should have no more
than 4 times the income of the poorest. - A less extreme example commodity egalitarianism.
- Right to vote, food, shelter, education, perhaps
health insurance.
35Processes versus Outcomes
- Some argue that a just distribution of income is
defined in terms of the process that generated
it. - For example, equal opportunity in U.S.
- Ensuing outcome would be considered fair,
regardless of the income distribution it happened
to entail. - Gottschalk finds a substantial amount of income
mobility. - Does raise problem of how to evaluate social
processes.
36Expenditure Incidence
- Relative Price Effects
- Public Goods
- Valuing In-Kind Transfers
37Relative Price Effects
- Example suppose government subsidizes housing
for the poor. - As a first pass, redistribution strictly from
rich to poor. - But what if subsidy increases the poors demand
for housing and pushes up housing prices? - Landlords may reap part of the gain.
- Contractors and construction workers may also
gain. - Generally, any government program sets off a
complicated chain of price changes, and the
complete effects on winners and losers is unclear.
38Public Goods
- Do rich and poor benefit similarly from the
provision of public goods? - Example with national defense, almost 400
billion spent annually. Do rich and poor receive
same level of benefit? - These kinds of questions are difficult to answer,
because they are sensitive to assumptions made
concerning the utility functions of rich and poor.
39Valuing In-kind Transfers
- Government provides many benefits to the poor
in-kind that is, direct provision of goods
rather than cash. - Food stamps
- Medicaid
- Public Housing
- Estimating value is difficult. Not always valued
at dollar-for-dollar (if resale is difficult).
40Valuing In-kind Transfers
- Consider how the provision of an in-kind benefit
changes the budget constraint in Figure 7.2. - In this case, giving an in-kind benefit lowers
utility relative to an equally costly cash
transfer. - Although the person is better off by having the
in-kind transfer than not having it, she would be
even happier with the cash transfer.
41Valuing In-kind Transfers
- Assumptions
- Poor person has 300 in cash income.
- Price of cheese 2.00 per pound.
- Price of other goods normalized to 1.00.
42Figure 7.2
43Valuing In-kind Transfers
- A person can never be made better off with an
in-kind transfer that is equal in cost to a cash
transfer. - There are instances, however, when a person is
indifferent between the two transfer schemes. - See Figure 7.3.
44Figure 7.3
45Valuing In-kind Transfers
- Why give in-kind transfers if they tend to be
inefficient? - Iggy Pop Syndrome Public concerned that poor
would spend cash transfers on Liquor and Drugs. - Commodity egalitarianism.
- May reduce welfare fraud (especially if the
in-kind transfer is an inferior good). Non-poor
might cheat to get cash, but not food stamps or
public housing. - Politically viable because they help the producer
of the in-kind good. Food stamps supported by
Agricultural
46Recap of Income Redistribution Conceptual Issues
- Distribution of income
- Poverty line
- Social welfare functions
- Valuing In-kind transfers