18 Income Distribution and PovertyIncome Distribution and Poverty

How much inequality and poverty exist in our society?

What policies are used to fight poverty?

What are the problems with these policies?

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Introduction

Income is generally determined by earnings

Earnings are a function of productivity

What if productivity of resources varies across individuals?

The result is income inequality.

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The U.S. Income Distribution: 2005

Group Annual household income

Bottom fifth Under $19,178

Second fifth $19,179 – $36,000

Middle fifth $36,001 – $57,658

Fourth fifth $57,659 – $91,705

Top fifth $91,706 and over

Top 5 percent $184,500 and over

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The U.S. Income Distribution: 2005

GroupShare of total

household income

Bottom fifth 3.4

Second fifth 8.6

Middle fifth 14.6

Fourth fifth 23.0

Top fifth 50.4

Top 5 percent 22.2

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U.S. Inequality Over Time

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6

8

10

12

14

19

30

19

40

19

50

19

60

19

70

19

80

19

90

20

00

Income share of the top 20% divided by income share of the bottom 20%

Income share of the top 20% divided by income share of the bottom 20%

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Lorenz Curve The distribution of income can be represented

by a Lorenz curve.

In a Lorenz curve:

• the horizontal axis measures the cumulative percentage of households

• the vertical axis measures the cumulative percentage of households

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AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : Lorenz CurveLorenz Curve

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Using the distribution of income for 2005, draw a Lorenz curve.

Group Income Share

Bottom 20% 3.4

2nd 20% 8.6

Middle 20% 14.6

4th 20% 23.0

Top 20% 50.4

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AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : AnswerAnswer

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Create cumulative totals of the columns.

Group TotalIncome Share

Total Share

Bottom 20% 20% 3.4 3.4

2nd 20% 40% 8.6 12.0

Middle 20% 60% 14.6 26.6

4th 20% 80% 23.0 49.6

Top 20% 100% 50.4 100

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AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : AnswerAnswer

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Plot the cumulative number of households against the total share.

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20

40

60

80

100

0 20 40 60 80 100

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AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : AnswerAnswer

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A Lorenz curve that is a straight diagonal line would indicate an equal distribution of income.

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20

40

60

80

100

0 20 40 60 80 100

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Gini Coefficient

Another way to describe income inequality is by using a Gini coefficient.

• related to the Lorenz curve

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Gini CoefficientLet A = area between the line of perfect equality and the

Lorenz curve

Let B = area below the Lorenz curve

A

B

Gini coefficient = A /(A + B)

A higher Gini coefficient means greater inequality

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Gini Coefficient for the U.S.

0.30.320.340.360.380.4

0.420.440.460.480.5

1970 1980 1990 2000 2005

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Inequality Around the World

0 5 10 15 20 25 30 35

Japan

Germany

India

Canada

United Kingdom

United States

Russia

China

Nigeria

Mexico

Brazil

South Africa

Income share of the top 20% divided by income share of the bottom 20%

Income share of the top 20% divided by income share of the bottom 20%

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Gini Coefficients Around the World

Country Gini Coefficient

South Africa 77.0

Brazil 60.7

Mexico 53.1

Nigeria 50.6

China 52.2

Russia 48.7

United States 46.9

United Kingdom 34.0

Canada 33.1

India 38.0

Germany 30.0

Japan 24.9

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Gini Coefficients Around the World

Green = greater equality Red = greater inequality

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Poverty Poverty line: an absolute level of income

set by the government for each family size below which a family is deemed to be in poverty

Poverty rate: the percentage of the population whose family income falls below the poverty line

In 2005 in the U.S.,

• median household income = $46,326

• poverty line for family of four = $19,806

• poverty rate = 12.6%

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The U.S. Poverty Rate Over Time

Percent of the population below poverty line

Percent of the population below poverty line

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U.S. Poverty Rates by Group, 2005

Group Poverty Rate

All persons 12.6%

White, not Hispanic 8.3

Black 24.9

Hispanic 21.8

Asian, Pacific Islander 11.1

Children 17.6

Elderly 10.1

Married-couple families 5.1

Female household, no spouse present

28.7

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Policies to Reduce Poverty Poor families more likely to experience

• homelessness

• drug dependence

• health problems

• teen pregnancy

• illiteracy

• unemployment

Most people believe the government should provide a “safety net.”

We now consider a few such policies…

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1. Minimum-Wage Laws Arguments for:

• helps the poor without any cost to the government

• little impact on employment if demand for unskilled labor is relatively inelastic

Arguments against:

• In the long run, demand for unskilled labor is likely elastic, so minimum wage causes substantial unemployment among the unskilled.

• Those helped by minimum wage are more likely to be teens from middle-income families than low-income adult workers.

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2. Welfare

Welfare: government programs that supplement the incomes of the needy• Temporary Assistance for Needy Families (TANF)

• Supplemental Security Income (SSI)

Critics argue that such programs create incentives to become or remain needy

• argue that welfare contributed to the rise of the single-parent family

The severity of such incentive problems is unknown

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3. Negative Income Tax Negative income tax: a tax system that collects

revenue from high-income households and gives transfers to low-income households

Example: Taxes owed = (1/3 of income) – $10,000

• If earnings = $90,000, taxes owed = $20,000

• If earnings = $60,000, taxes owed = $10,000

• If earnings = $30,000, taxes owed = $0

• If earnings = $15,000, taxes “owed” = –$5,000i.e., would receive $5000 payment from gov’t

The Earned Income Tax Credit (EITC) is similar to a negative income tax.

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4. In-Kind Transfers

In-kind transfers are goods or services provided to the needy. Examples:

• homeless shelters

• soup kitchens

• food stamps

• Medicaid

An alternative: cash payments

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Anti-Poverty Programs andWork Incentives

Assistance from anti-poverty programs declines as income rises.

Poor families face high effective marginal tax rates (exceeding even 100% in some cases!)