Inequality and Poverty

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19
CHAPTER
Inequality and Poverty
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C H A P T E R C H E C K L I S T

• When you have completed your study of this
  chapter, you will be able to

Describe the economic inequality and poverty in
the United States.
Explain how economic inequality and poverty arise.
Explain why governments redistribute income and
describe the effects of redistribution on
economic inequality and poverty.
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19.1 ECONOMIC INEQUALITY

• We measure economic inequality by looking at the
  distributions of income and wealth.
• A households income is the amount that it
  receives in a given period.
• A households wealth is the value of the things
  that it owns at a point in time.
• Table 19.1 on the next slide shows the
  distributions of income and wealth in the United
  States in 2004.

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19.1 ECONOMIC INEQUALITY
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19.1 ECONOMIC INEQUALITY

• Lorenz Curves
• A Lorenz curve is a curve that graphs the
  cumulative percentage of income (or wealth)
  against the cumulative percentage of households.
• Figure 19.1 on the next slide shows the Lorenz
  curves for the United States in 2004. They are
  based on the tables youve just seen.

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19.1 ECONOMIC INEQUALITY
The cumulative percentages of income and wealth
are graphed against the cumulative percentage of
households.
1. If each 20 percent of households received 20
percent of total income, there would be no rich
and poorthere would be equality as shown by the
Line of equality.
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19.1 ECONOMIC INEQUALITY
2. The distribution of income shows that the
poorest 20 percent of households received 3.5
percent of total income, and the richest 20
percent received 50.1 percent.
3. The distribution of wealth shows that the
poorest 40 percent of households owned 0.2
percent of total wealth, and the richest 1
percent owned 38.1 percent.
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19.1 ECONOMIC INEQUALITY
The farther the Lorenz curve is from the Line of
equality, the greater is the inequality.
The distribution of wealth is much more unequal
than the distribution of income.
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19.1 ECONOMIC INEQUALITY

• Inequality over Time
• U.S. income and wealth have become more unequal
  over the past few decades.
• The highest incomes have increased much faster
  than the lower incomes.
• The gap between rich and poor has widened.
• Figure 19.2(a) on the next slide shows how the
  distribution of income has changed.

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19.1 ECONOMIC INEQUALITY
The average income of the lowest 20 percent group
increased from 7,700 to 10,300an increase of
34 percent.
The average income of three middle groups also
increased by 34 percent.
The average income of highest 20 percent
increased by 77 percent.
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19.1 ECONOMIC INEQUALITY

• Economic Mobility
• Economic mobility is the movement of a family up
  or down the income ladder and through the income
  quintiles (20 percent groups).
• If there were no economic mobility, a family
  would be stuck at a given point in the income
  distributionpersistently rich to persistently
  poor.
• How much economic mobility has there been?.
• Figure 19.2(b) shows the percentage of families
  that moved by one quintile or more over a
  ten-year period.

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19.1 ECONOMIC INEQUALITY

• The figure shows quite a lot of economic mobility.

About 30 percent of families move up a quintile
or more in a decade Slightly smaller percentage
move down by a quintile or more Between 35 and
40 percent remain in the same quintile.
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19.1 ECONOMIC INEQUALITY

• Who are the Rich and the Poor?
• The lowest-income household in the United States
  today is likely to be a black woman over 65 years
  of age who lives alone somewhere in the South and
  has fewer than nine years of elementary school
  education.
• The highest-income household in the United States
  today is likely to be a college-educated white
  married couple between 45 and 54 years of age
  living together with two children somewhere in
  the Northeast or the West.

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19.1 ECONOMIC INEQUALITY
The median income in 2004 was 44,389.
Education is the single biggest factor affecting
household income distribution.
Size of household, marital status, and age of
householder are also important.
Race and region are the least important.
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19.1 ECONOMIC INEQUALITY

• Poverty
• Poverty is a state in which a households income
  is too low to be able to buy the quantities of
  food, shelter, and clothing that are deemed
  necessary.
• In 2004, the poverty level for a four-person
  household was an income of 19,157.
• In that year, 37 million or 12.7 percent of
  Americans lived below the poverty level.
• Figure 19.4 on the next slide shows the changing
  poverty rate in the United States.

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19.1 ECONOMIC INEQUALITY
The white poverty rate fell during the 1960s and
has remained constant since then.
The Hispanic poverty rate increased during the
1980s before falling during the 1990s.
The black poverty rate has fallen in two waves
the late 1960s and the late 1990s.
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19.1 ECONOMIC INEQUALITY

• Poverty Duration
• Another measure of poverty is duration.
• Duration of poverty is an important indicator of
  the hardship poverty brings.
• Figure 19.5 on the next slide shows the duration
  of poverty in the United States from 1996 to
  1999.

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19.1 ECONOMIC INEQUALITY
More than 50 percent of poverty last for between
2 and 4 months. But almost 30 percent of poverty
lasts for more than 9 months. These families
experience chronic poverty.
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19.2 HOW INEQUALITY AND POVERTY ARISE

• Economic inequality and poverty arise from five
  key factors
• Human capital
• Discrimination
• Financial and physical capital
• Entrepreneurial ability
• Personal and family characteristics
• We look at each in turn.

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19.2 HOW INEQUALITY AND POVERTY ARISE

• Human Capital
• High-skilled workers have a higher value of
  marginal product than low-skilled workers.
• Figure 19.6(a) on the next slide illustrates the
  demand for high-skilled and low-skilled labor.

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19.2 HOW INEQUALITY AND POVERTY ARISE
Demand for High-Skilled and Low-Skilled Labor
High-skilled labor has a higher VMP than
low-skilled labor and a greater demand.
The demand curve for high-skilled labor, DH, lies
above the demand curve for low-skilled labor, DL,
by the VMP of skill.
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19.2 HOW INEQUALITY AND POVERTY ARISE

• The Supply of High-Skilled and Low-Skilled Labor
• Skills are costly to acquire, and a worker pays
  the cost of acquiring a skill before benefiting
  from a higher wage.
• Figure 19.6(b) on the next slide illustrates the
  supply of high-skilled and low-skilled labor

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19.2 HOW INEQUALITY AND POVERTY ARISE
High-skilled labor bears the cost of acquiring
skill.
The supply curve of high-skilled labor, SH, lies
above the supply curve of low-skilled labor, SL,
by the compensation for the cost of acquiring
skill.
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19.2 HOW INEQUALITY AND POVERTY ARISE

• Wage Rates of High-Skilled and Low-Skilled
  Labor
• The combined effects of skill on the demand for
  and supply of labor generate a higher wage for
  high-skilled labor than for low-skilled labor.
• Figure 19.6(c) on the next slide illustrates the
  skilled wage differential.

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19.2 HOW INEQUALITY AND POVERTY ARISE

• The demand for low-skilled labor, DL, and the
  supply of low-skilled labor, SL, determine the
  wage rate of low-skilled laborin this example at
  10 an hour.

The demand for high-skilled labor, DH, and the
supply of high-skilled labor, SH, determine the
wage rate of high-skilled laborin this example
at 20 an hour.
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19.2 HOW INEQUALITY AND POVERTY ARISE

• Discrimination
• Human capital differences explain much of the
  income inequality that exists.
• Economists are not sure whether and by how much
  discrimination adds to income inequality.
• One line of argument is that competition prevents
  discrimination. But race and sex income
  differences do persist.

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19.2 HOW INEQUALITY AND POVERTY ARISE

• Financial and Physical Capital
• People with high incomes are usually those who
  own large amounts of financial capital and
  physical capital.
• They receive income in form of interest,
  dividends, and capital gains.
• Families with a lot of capital tend to become
  even more wealthy because
• They bequeath wealth to their children.
• Rich people marry rich people (on average).

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19.2 HOW INEQUALITY AND POVERTY ARISE

• Saving and wealth accumulation is not inevitably
  a source of inequality.
• When a family saves to redistribute an uneven
  income over the life cycle, it enjoys more equal
  consumption.
• If a lucky generation that has a high income
  saves and makes a bequest to an unlucky
  generation, this saving decreases economic
  inequality.

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19.2 HOW INEQUALITY AND POVERTY ARISE

• Entrepreneurial Ability
• Some people become extremely rich through a
  combination of hard work, good luck, and
  outstanding entrepreneurial ability.
• But others who borrow to create a business, work
  hard, and have bad luck become extremely poor.
• Personal Characteristics
• Personal and family characteristics play a
  crucial role, for good or evil, in influencing
  economic well-being.

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19.3 INCOME REDISTRIBUTION

• How Government Redistributes Income
• Three main ways in which governments in the
  United States redistribute income are
• Income taxes
• Income maintenance programs
• Subsidized services

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19.3 INCOME REDISTRIBUTION

• Income Taxes
• Income taxes may be progressive, regressive, or
  proportional.
• A progressive tax
• One that taxes income at an average rate that
  increases with the level of income.
• A regressive tax
• One that taxes income at an average rate that
  decreases with the level of income.
• A proportional tax
• One that taxes income at a constant rate,
  regardless of income.

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19.3 INCOME REDISTRIBUTION

• Income Maintenance Programs
• Three main types of program are
• Social Security programs
• Unemployment compensation
• Welfare programs

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19.3 INCOME REDISTRIBUTION

• Social Security Programs
• OASDHI or Old age, Survivors, Disability, and
  Health Insurance
• Medicare, which provides hospital and health
  insurance for the elderly and disabled.

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19.3 INCOME REDISTRIBUTION

• Unemployment Compensation
• To provide an income to unemployed workers.
• A tax is paid based on the income of each covered
  worker.
• Each worker receives a benefit when he or she
  becomes unemployed.

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19.3 INCOME REDISTRIBUTION

• Welfare Programs
• 1. Supplementary Security Income (SSI), designed
  to help the neediest elderly, disabled, and blind
  people.
• 2. Temporary Assistance for Needy Families (TANF)
  program, designed to help households that have
  inadequate income.
• 3. Food Stamp program, designed to help the
  poorest households obtain a basic diet.
• 4. Medicaid, designed to cover the costs of
  medical care for households receiving help under
  the SSI and TANF programs.

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19.3 INCOME REDISTRIBUTION

• Subsidized Services
• Services provided by the government at prices far
  below the cost of production. The most important
  of these are
• Education
• Health care

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19.3 INCOME REDISTRIBUTION

• The Scale of Income Redistribution
• Market income is the income that a household
  earns in factor markets with no redistribution.
• Money income is market income plus money benefits
  paid by the government.
• We can measure the scale of income redistribution
  by calculating the percentage of market income
  paid in taxes minus the percentage received in
  benefits at each income level.

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19.3 INCOME REDISTRIBUTION

• Figure 19.7 shows income redistribution.

In part (a), the Lorenz curve for the
distribution of income after taxes and benefits
is closer to the line of equality than the money
income distribution and the market income
distribution.
In part (b), the three lowest income groups gain
and the two highest income groups lose.
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19.3 INCOME REDISTRIBUTION

• Why We Redistribute Income
• Two approaches
• Normative approach
• Discusses why we should compel everyone to help
  the poor and looks for principles to guide in the
  appropriate scale of redistribution.
• Positive approach
• Seeks reasons why we do compel everyone to help
  the poor and tries to explain the actual scale of
  redistribution.

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19.3 INCOME REDISTRIBUTION

• Normative Theories of Income Redistribution
• Utilitarianism points to the ideal distribution
  being one of equality. But efficiency is also
  desirable.
• Greater equality can be achieved only at the cost
  of inefficiencythe big tradeoff.
• John Rawls proposed the principle that income
  should be redistributed to the point at which the
  poorest persons share is maximized.

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19.3 INCOME REDISTRIBUTION

• Libertarian philosophers, such as Robert Nozick,
  say that any redistribution is wrong because it
  violates the sanctity of private property and
  voluntary exchange.
• Modern political parties stand in the center of
  these extremessome favor a bit more
  redistribution than others, but the major parties
  are basically happy with the current scale of
  redistribution.

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19.3 INCOME REDISTRIBUTION

• Positive Theories of Income Redistribution
• There is no good positive theory, but economists
  have a promising idea called the median voter
  theory.
• Median voter theory is a theory that government
  pursues policies that make the median voter as
  well off as possible.
• In the majority voting system, the voter whose
  views carry most weight is the one in the
  middlethe median voter.
• Political parties will deliver the scale of
  redistribution that the median voter prefers.

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19.3 INCOME REDISTRIBUTION

• The Major Welfare Challenge
• The poorest people in the United States are young
  women who have not completed high school, have a
  child (or children), live without a partner, and
  are more likely to be black or Hispanic than
  white.
• These young women and their children present the
  major welfare challenge
• The long-term solution involves education and job
  training.
• The short-term solution is welfare.

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19.3 INCOME REDISTRIBUTION

• Welfare must be designed to strengthen the
  incentive to pursue the long-term solution while
  giving support in the short term.
• The Current Approach TANF
• TANF is a block grant paid to the states to
  administer payments to individuals.
• An adult member of a household receiving
  assistance must work or perform community
  service. Assistance is limited to 5 years.
• Some economists suggest a negative income tax.

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19.3 INCOME REDISTRIBUTION

• Negative Income Tax
• A negative income tax is a tax and redistribution
  scheme that provides every household with a
  guaranteed minimum annual income and taxes all
  earned income above the guaranteed minimum at a
  fixed rate.
• A negative income tax does not remove the burden
  of the tax but it does improve the incentives to
  work and save at all levels of income.

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Redistribution in YOUR Life

• You are in both sides of the redistribution
  equation. But what is your bottom line?
• Are you a net receiver or a net payer?
• First work out how much tax you are payingsum
  the income tax you pay, the sales taxes, and
  taxes on gasoline, tobacco, alcohol.
• Now work out the benefits you receiveincluding
  the value of government services and cash
  payments you receive from the government.
• So what is your bottom line?