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Income Distribution and Poverty

CHAPTER

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© 2003 South-Western/Thomson Learning

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Distribution of Household Income

In a market economy, income depends primarily on earnings, which depend on the productivity of one’s resources

The problem with allocating income according to productivity is that some people have difficulty earning income

Some have mental and physical disabilitiesOthers may face limited job choices and reduced wages because of age, poor education, discrimination, bad luck, or the demands of caring for small children

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Income Distribution

Consider the distribution of income and see how it has changed over time, focusing on the household as the unit of measure

After dividing the total number of U.S. households into five groups of equal size – quintiles – ranked according to income, we have Exhibit 1 by decade since 1970

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Exhibit 1: Share of Aggregate Household Income

4.1 4.3 3.9 3.6

10.8 10.3 9.6 8.9

17.4 16.7 15.9 14.9

24.5 24.0 23.2

16.6 15.8

18.6

21.5

24.9

0

5

10

15

20

25

30

35

40

45

50

55

19701980

19902000

19701980

19902000

19701980

19902000

19701980

19902000

19701980

19902000

Shar

e by

per

cent

46.643.3

43.7

49.9

Lowest Second Third Fourth Highest quintile quintile quintile quintile quintile

Middle 60 percent

Top 5 %

•Households in the lowest, or poorest, fifth of the population received only 4.1% of the income in 1970•Households in the highest, or richest, fifth received 43.3% of the income• U.S. Census Bureau measures income after cash transfer payments are received but before taxes are paid.

•Share of income going to the top fifth has increased •Share going to the bottom fifth has decreased slightly

Primary contributor to the larger share going to the highest group has been the growth of two-earner households in the top growth and the growth in single-parent households in the bottom group.

The share of income going to the top 5% of households has grown since 1980, accounting for all the growth in the top 20% of households

decrease

increase

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Lorenz CurveThe Lorenz curve is another way to picture the distribution of income in an economy

The Lorenz curve shows the percentage of total income received by any given percentage of households when incomes are arrayed from smallest to largest

Exhibit 2 provides the Lorenz Curve

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Exhibit 2: Lorenz Curve

0

20

40

60

80

100

0 20 40 60 80 100

Cumulative percent of households

Cum

ulat

ive

perc

ent o

f inc

ome

Line of e

qual dist

ributio

n

Cumulative percentage of households is shown along the horizontal axis, and cumulative percentage of income is on the vertical axis. If income were equally distributed, each 20% of households would receive 20% of the total income the Lorenz curve would be the straight line shown in blue.

As distribution becomes more uneven, the Lorenz curve is pulled down and to the right, away from the line of equal distribution.

Point a on the 1970 Lorenz curve (in red) indicates in that year the bottom 80% of families received 56.7% of the income and the top 20% received 43.3% of the income. Point b on the 2000 Lorenz curve (in green) shows the bottom 80% received 50.6% of the income and the top 20% received 49.4% of the income.

.ab

Since the Lorenz Curve for 2000 is farther from the line of even distribution than it was for 1970, income has become more unevenly distributed.

.

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A College Education Pays MoreContributing to the dominance of the top group is a growing premium paid those with a college education for a number of reasons

Trends such as industry deregulation, declining unionization, and freer international trade have reduced the demand for workers with less educationNew computer-based information technologies have reduced the demand for low-skilled clerical workersThe supply of less-educated workers increased more than the supply of more-educated workers

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Problems with Distribution Benchmarks

First is that there is no objective standard for evaluating income distributions

The usual assumption is that a more equal distribution is more desirable, but is a perfectly even distribution most preferred?

A second problem is that most distributions measure money income after cash transfers but before taxes, it omits the effects of taxes and in-kind transfers such as food stands and free medical care understates the share of income going to lower income groups

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Problems with Distribution Benchmarks

Third, focusing on the share of income going to each income quintile overlooks the fact that household size differs across quintiles

Households in the bottom quintile contain 39 million peopleThe top quintile contains 64 million peopleSo households at the top average two-thirds larger than those at the bottom

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Problems with Distribution Benchmarks

Fourth, the two exhibits presented here include only reported sources of income

Finally, a better measure of household welfare might be the distribution of expenditures

Evidence on expenditures indicates that spending by quintiles is much more evenly distributed than income

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Why Do Household Incomes Differ?

The median income of all households is the middle income when all incomes are ranked from lowest to highest

Thus, one reason household incomes differ is that the number of household members who are working differ

For example, over two-thirds of households in the bottom 20% are headed by unmarried females

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Why Do Household Incomes Differ?

Incomes also differ for all the reasons labor incomes differ, such as differences in education, ability, job experience, and so on

Differences in earnings based on age and education reflect a normal life-cycle pattern of income

In fact, most income differences across households reflect the normal workings of resource markets, whereby workers are rewarded according to their productivity

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Poverty and the PoorSince poverty is such a relative concept, how do we measure it objectively and how do we ensure that our measure can be applied with equal relevance over time?

The benchmark for poverty analysis is based on the assumption that the poor spend about one-third of their income on food the U.S. Department of Agriculture estimates the cost of a nutritionally adequate diet

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Poverty and the Poor

This nutritionally adequate diet is then multiplied by three to generate the U.S. official poverty levelThe poverty definition is based on pretax money income, including cash transfers, but it excludes the value of noncash transfers such as food stamps, Medicaid, subsidized housing, or employer provided health insuranceExhibit 3 presents some basic poverty measures

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Exhibit 3: Poverty Measures

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Programs to Help the PoorWhat should society’s response to poverty be?

Families with a full-time worker are nine times more likely to escape poverty than are families with no workers a healthy economy remains the first line of defense in fighting poverty

However, even when the unemployment rate is low, some people remain poor

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Programs to Help the Poor

Since the mid-1960s, social welfare expenditures at all levels of government have increased significantly

These programs can be divided into two broad categories

Social InsuranceIncome assistance

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Social InsuranceSocial insurance programs are designed to help make up for the lost income of those who worked but are now retired, temporarily unemployed, or unable to work because of disability or work-related injury

Social Security is designed to supplement retirement income of those with a work history and a record of contributing to the programMedicare provides health insurance for short-term medical care, mostly to the elderly, regardless of income

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Social InsuranceOther social programs include unemployment insurance and worker’s compensation which supports workers injured on the job

Both programs require that beneficiaries have a prior record of employment

The social insurance system deducts insurance premiums from workers’ pay to provide benefits to others. However, most current Social Security beneficiaries receive far more than they paid into the system

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Income Assistance Income assistance programs – what we usually call “welfare” programs – provide money and in-kind assistance to the poor

Do not require the recipient to have a history of work or have contributed to the program

Income assistance programs are normally means tested

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Income Assistance

Means-tested programs require that a household’s income and assets must fall below a certain level to qualify for benefits

Federal government funds two-thirds of welfare spending, and state and local governments the remaining one-third

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Income Assistance

The two primary cash transfer programs which vary inversely with income are:

Temporary Assistance for Needy Families (TANF) which provides cash to poor families with dependent children, replaced Aid for Families with Dependent Children (AFDC)• Controlled by each state and carries no

federal entitlement• Each state given a fixed grant program to

help fund TANF programs

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Income AssistanceSupplemental Security Income (SSI) provides cash to the elderly poor and the disabled• Is the fastest-growing cash transfer program with

outlays quadrupling from $8 billion in 1980 to nearly $32 billion in 2000

•SSI coverage has been broadened to include those addicted to drugs and alcohol, children with learning disabilities, and, in some cases, the homeless

•The federal portion of this program is uniform across states, but states can supplement federal aid

•Most states also offer General Assistance aid to those who are poor but do not qualify for TANF or SSI

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Income Assistance

The federal government also provides an earned-income tax credit which supplements wages of the working poor

In addition to cash transfer programs, a variety of in-kind transfer programs provide health care, food stamps, and housing assistance to the poor

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Income AssistanceMedicaid pays for medical care for those with incomes below a certain level; by far the largest welfare program costing twice as much as all cash transfer programs combined

It has grown more than any other poverty program, quadrupling in the last decade and accounting for nearly a quarter of the typical state’s budget

Qualifying level of income set by each stateProportion of poor covered varies by state

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Income AssistanceFood stamps are vouchers that can be redeemed for food

Funded by the federal governmentUniform across states and is aimed at reducing hunger and providing nutrition to poor families

Housing assistance programs include direct assistance for rental payments and subsidized low-income housing

Has more than doubled since 1990

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Exhibit 4: In 1959, the elderly were the poorest group, with a poverty rate of 35%. Since then, poverty among the elderly has declined to a record low of 9.7% in 2000. This decline stems from tremendous growth in spending for Social Security and Medicare.

In real terms those two programs grew tenfold from $62 billion in 1959 to over $620 billion in 2000, measured in 2000 dollars. Thus, while not welfare programs in a strict sense, Social Security and Medicare have been extremely successful in reducing poverty among the elderly.

Income Assistance

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Exhibit 4: Poverty Rates by Age: 1959–2000

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Poverty and Public ChoiceIn a democracy, public policies depend very much on the political power of the interest groups involved

In recent years, the elderly have become a powerful political force

Voter participation rate of those 65 and over is higher than that of any other age groupFor example, they show up at the polls at triple the rate of those between 18 and 24 and four times that of welfare recipients

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Poverty and Public ChoiceUnlike most interest groups, this is a group we all expect to join one dayThe elderly are actually represented by five constituencies

The elderly themselvesThose under 65 who are concerned about the current benefits to their parents & other elderly relativesThose under 65 who are concerned about their benefits in the futureThose who earn a living by caring for the elderlyThose running for office who want the votes the elderly deliver

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Feminization of PovertyOne way of classifying the incidence of poverty is by age

Another way is based on the marital status and race of the household head

Exhibit 5 compares, for black, non-Hispanic white, and Hispanic families, the poverty rates for married couples with the rates headed by females with no husband present

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Exhibit 5: Percentage of U.S. Families in Poverty by Type of Household

Three trends are unmistakable

First, poverty rates among married couples average only one-third the rates among female households

Second, Hispanic households have the highest poverty rates followed by black families, then non-Hispanic white families

Third, since the middle of the 1990s, rates have trended down for all types of families

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Feminization of PovertyWhile the exhibit shows the poverty rate among female householders, it doesn’t show the growth in the number of such households

The number of families headed by women has nearly tripled since 1960, while married-couple households grew just 40 percentThe percentage of births to unmarried mothers is five times greater today than in 1960

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Feminization of PovertyToday, one in ten children lives with a single parent who has never married

The United States has the highest teenage pregnancy rate in the developed world

Since the father in such cases typically assumes little responsibility for child support, children born outside of marriage are likely to be poorer than other children

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Feminization of Poverty

The divorce rate has also increased even children born to married couples now face a greater likelihood of living in a one-parent household before they grow up

Thus, the growth in the number of poor families since 1969 resulted overwhelmingly from a growth in the number of female householders

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Feminization of PovertyFamilies with a female head are in the worst position to take advantage of job growth children of female householders are five times more likely to live in poverty than are other children

Young, single motherhood is a recipe for poverty

Often the young mother drops out of school, which reduces her future earning possibilities when and if she seeks work outside the home

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Feminization of PovertyWorse yet, young, single mothers-to-be are less likely to seek adequate medical care a higher proportion of premature, underweight babies

The lack of education and limited job skills leads to the fact that most unwed mothers go on welfare

Poverty has therefore become increasingly feminized, mostly because female householders have become more common

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Poverty and DiscriminationTo what extent has racial discrimination limited job opportunities and increased poverty among minorities?

Discrimination can occur in many ways: in school funding, in housing, in employment, in career advancement

Also, discrimination in one area can affect opportunities in another, e.g, housing discrimination may reduce job opportunities

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Poverty and DiscriminationConsider the difference between the earnings of white and nonwhite workers

After adjusting for a variety of factors that could affect the wage – education and work experience – research shows that whites earn more than blacks, but the gap between the two has narrowed

Some research suggests that black workers received a lower quality of schooling than white workers

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Poverty and Discrimination

Direct evidence of discrimination comes from audit studies where otherwise similar white and minority candidates are sent to the same source to seek jobs, rent apartments, or apply for mortgagesThese studies find that employers are less likely to interview or offer a job to minority applicants and minority applicants tend to be treated less favorably by real estate agents and lenders

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Affirmative ActionThe Equal Employment Opportunity Commission, established by the Civil Rights Act of 1964, monitors cases involving unequal pay for equal work and unequal access to promotionResearch suggests that civil-rights legislation has played a role in narrowing the black-white earnings gapState and local governments have also introduced set-aside programs to guarantee minorities a share of contracts

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Affirmative Action

Since 1993 the median income of black families has risen faster than that of white families

The proportion of black families living below the poverty line has fallen to a record low

There is also a growing middle class among black householders

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Unintended Consequences

On the plus side, antipoverty programs increase the consumption possibilities of poor families which is especially significant since children are the largest poverty group

But programs to assist the poor may have secondary effects that limit their ability to reduce poverty

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DisincentivesSociety, through government, tries to provide families with an adequate standard of living, but society also wants to ensure that only those in need receive benefitsIncome assistance consists of a combination of cash and in-kind transfer programs, the benefits of which vary inversely with income from other sources transfers decline sharply as earned income increases high marginal tax rate on earned income

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Disincentives

Over certain income ranges, the welfare recipient may lose more than $1 in transfer benefits for each additional $1 in earnings the marginal tax rate on earned income could exceed 100%

Since holding even a part-time job involves additional expenses, the high marginal tax rate discourages employment and self-sufficiency

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DisincentivesThe longer people are out of the labor force, the more their job skills deteriorate when they do look for work, their productivity and their pay are lower than when they were last employed

Some argue that in this way, welfare benefits can lead to long-term dependency unfavorable consequences both for the family and for society

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Disincentives

Welfare programs can cause other disincentives

For example, children may be eligible for Supplemental Security Income if they have a learning disability and there is some evidence that low-income parents encouraged poor behavior in school so their children would qualify for this program

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Does Welfare Cause Dependency?

How could we examine such a question?

A relatively brief average stay on welfare would be evidence of little dependency

If, however, the same families were found on welfare year after year, this would be a matter of concern

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Does Welfare Cause Dependency?

A University of Michigan study tracked 5,000 families over a number of years, paying particular attention to economic mobility from year to year, or dependency within a generation

It found that most recipients received welfare for less than a year, but about 30 percent remained on welfare for at least eight years a core of long-term recipients

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Does Welfare Cause Dependency?

A second and more serious concern is whether the children of the poor end up in poverty as wellIs there a cycle of poverty?Why might we expect one?Children in welfare households may learn the ropes about the welfare system and may come to view welfare as a normal way of life rather than as a temporary bridge

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Does Welfare Cause Dependency?

Research indicates that daughters from welfare families are more likely than daughters in other families to participate in the welfare system themselves and are more likely to have premarital births

The evidence is weaker when it comes to sons from welfare families

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Welfare ReformThere has been much dissatisfaction with the welfare system, both among those who pay for the programs and among direct beneficiaries

Some analysts believe that one way to reduce poverty is to provide welfare recipients with job skills and make them find jobs workfare programs

Where tried these state programs indicate that they do save some money because those in the welfare-to-work left welfare rolls sooner

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Welfare ReformReforms at the state level set the stage for federal reforms

Biggest reform came with the replacement of Aid to Families with Dependent Children with Temporary Assistance for Needy Families

AFDC set eligibility rules and left federal costs open-ended through matching grants to the statsTANF offers a block grant to the states to run their welfare programs

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Welfare Reform

Under the new system, states have wide latitude to run their own welfare programs

But concerns about welfare dependency fostered some special provisions

The act imposes a lifetime limit of five years that a recipient can be on welfareAll able-bodied recipients on welfare for two years must participate in welfare-to-work programs

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Welfare Reform

States now have an incentive to constrain the growth of welfare rolls• Under the old system the federal government

paid at least half of the welfare bill, paying a larger share in poorer states

• Under the new system, each state must pay 100 percent of any welfare costs above the federal grant

Aside from the time limits and work participation rates imposed by the federal government, states are free to set benefit levels and experiment however they chooseA concern with ending federal entitlements and capping grants to states is what will happen should the economy enter a recession