CHAPTER 12

Income Redistribution: Conceptual Issues

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

12-2

The Distribution of Income Among Households

Source: US Bureau of the Census [2008bNote: These figures do not include the value of in-kind transfers.

12-3

Who is Poor?

GroupPoverty

Rate GroupPoverty

Rate

All persons 12.5%Under 18 years 17.0%

White 8.265 years and older 9.7

Black 24.5 Female households, no husband present

Hispanic origin 21.5 28.3

Source: US Bureau of the Census, [2008a] Figures are for 2007.

12-4

Poverty Rate (1960-2007)

Source: US Bureau of the Census [2008a]

12-5

Measuring Poverty

• Poverty line

• A fixed level of real income considered enough to provide a minimally adequate standard of living.

12-6

Interpreting the Distributional Data

• Census income consists only of family’s cash receipts– In-kind(ayni in turkish) transfers, household production

• Official figures ignore taxes

• Income measured annually– Lifetime income would be more accurate

• Consumption data may provide better assessment of well-being

• Problems defining unit of observation

12-7

Simple Utilitarianism

• Utilitarian Social Welfare Function:W = F(U1, U2, ,,,, Un)

• “Promote Greatest Good for Greatest Number”• Additive Social Welfare Function

W = U1 + U2 + … + Un

– Assume• Individuals have identical utility functions that depend only on

their incomes

• Utility functions exhibit diminishing marginal utility of income

• Total amount of income is fixed

12-8

Implications for Income InequalityP

aul’

s m

argi

nal u

tili

ty

Pet

er’s

mar

gina

l uti

lity

Paul’s income Peter’s income

0 0’

MUPaulMUPeter

a

e

c

d

f

I*b

Paul’s income

Peter’s income

Take ab from Peter and give

to Paul

Paul gains this much

utility

Peter loses this much

utility

This is the net gain to

society

Social welfare

maximized

12-9

Evaluating the Assumptions

• Assumption 1– Individuals have same identical utility functions.

• Assumption 2– Marginal utility of individuals is decreasing.

• Assumption 3– The size of pie is fixed and won’t change with

income redistribution.

12-10

The Maximin Criterion

• Social Welfare FunctionW = Minimum(U1, U2, …, Un)

• Maximin criterion - No inequality acceptable unless it works to the advantage of the least well off

• Original position – “behind the veil of ignorance” (insurance against being at the bottom of the income distribution.

– Original position refers to the time when wealth is not distributed yet.

• Critique of Rawls (some people can take the risk)

12-11

Pareto Efficient Income Redistribution

• Will redistribution always make someone worse off?• Utility Function

Ui = F(X1, X2, …, Xn, U1, U2, …, Ui-1, Ui+1, …, Um)

• Redistribution if gain in utility from charity exceeds loss from reduced consumption

• Government reduces cost of redistribution• Income distribution as a Public Good• Social safety net• Social stability

12-12

Non-individualistic Views

• Fundamental principles specifying income distribution derived independent of tastes– Incomes distributed equally as matter of principle– Plato’s 4:1 ratio of highest to lowest income

• Commodity Egalitarianism

12-13

Other Considerations

• Processes versus Outcomes– Fairness of distribution of income judged by fairness of

process that generated it– Robert Nozick

• Society cannot redistribute income because society has no income to redistribute

• Good set of rules to govern society’s operation.

• Mobility

• Corruption

• Positive correlation between inequality and corruption across countries.

12-14

Expenditure Incidence

• Relative price effects– When government uses spending program for the

poor it might change relative price of goods.

• Public goods– Do rich receive more benefit form public goods.

• Valuing in-kind transfers

12-15

In-Kind Transfers

Pounds of cheese per month

Oth

er

go

od

s p

er

mo

nth

300

260

20 150

B

A

D

21060

F

E1

U

E3

420

340

H

12-16

In-Kind Transfers

Pounds of cheese per month

Oth

er

go

od

s p

er

mo

nth

300

136

82 150

B

A

D

210

F

E4

E5

420 H

168

126

12-17

Reasons for In-Kind Transfers

• Commodity egalitarianism

• Reduce welfare fraud

• Political factors– In kind transfers not only help the recipient but

also producer of the good. – Construction companies support housing benefits.– Farmers support food stamp programs.