Distribution of Income

ECO 230

J.F. O’Connor

Assessing an Economic System

• Two Major questions concerning the outcome: Is it efficient? Is it fair or just?

• We have studied a market system with private ownership and have seen that, with some government intervention, it is socially efficient.

• Is the outcome of such a system just or fair?

Alternative Views of Justice

• Utilitarianism - maximize the sum of the well-being of the members of society. Reduce inequality but watch for the effect on incentives

• Liberalism (John Rawls)- focus on the condition of the least well-off

• Libertarianism - government should provide law and order but not redistribute income

Judging Fairness

• Distribution of income is a major indicator of the fairness of the outcome of an economic system

• Determined to a large extent by the distribution of labor earnings which are 75% of personal income in U.S.

• Can look at a person’s absolute position or a person’s relative position. Poverty measures in the U.S look at absolute position. Most other discussion uses relative position.

U.S. Distribution

• Next slide gives the percentage of the total personal income in the U.S that is received by each fifth or quintile and by the top five percent.

• In 2001, bottom 20% received less than 5% while the top 20% received 47% and top 5% received 21% of aggregate family income.

T a b l e F - 2 . S h a r e o f A g g r e g a t e I n c o m e R e c e i v e d b y E a c h F i f t h

a n d T o p 5 P e r c e n t o f F a m i l i e s ( A l l R a c e s ) : 1 9 4 7 t o 2 0 0 1

Y e a r L o w e s t S e c o n d T h i r d F o u r t h H i g h e s t T o p 5T o p 5

f i f t h f i f t h f i f t h f i f t h f i f t h p e r c e n tp e r c e n t

2 0 0 1 4 . 2 9 . 7 1 5 . 4 2 2 . 9 4 7 . 7 2 1

2 0 0 0 4 . 3 9 . 8 1 5 . 4 2 2 . 7 4 7 . 7 2 1 . 1

1 9 9 0 4 . 6 1 0 . 8 1 6 . 6 2 3 . 8 4 4 . 3 1 7 . 4

1 9 8 0 5 . 3 1 1 . 6 1 7 . 6 2 4 . 4 4 1 . 1 1 4 . 6

1 9 7 0 5 . 4 1 2 . 2 1 7 . 6 2 3 . 8 4 0 . 9 1 5 . 6

1 9 6 0 4 . 8 1 2 . 2 1 7 . 8 2 4 4 1 . 3 1 5 . 9

1 9 5 0 4 . 5 1 2 1 7 . 4 2 3 . 4 4 2 . 7 1 7 . 3

1 9 4 7 5 1 1 . 9 1 7 2 3 . 1 4 3 1 7 . 5

Comments• Some modest improvement in distribution of

family income in U.S. between 1947 and 1970 followed by some deterioration since then, especially in the proportion going to the top 5%.

• Why? Rise in DINC (dual incomes, no children) families, divorce rate, and lack of growth in blue collar jobs are some of the factors.

• Next slide shows what has happened to mean income of each quintile in constant dollars since 1966.

Table F-3. Mean Income ($000s) Received by Each Fifth and Top 5 Percent of Families (All Races): 1966 to 2001

TopTopYear Lowest Second Third Fourth Highest 5

fifth fifth fifth fifth fifth percentpercent

2001 14.0 32.5 51.5 76.6 159.6 280.3 2000 14.5 33.2 52.2 76.9 161.3 285.8 1990 12.9 30.1 46.4 66.7 124.0 194.5 1980 13.0 28.4 42.9 59.5 100.2 142.5 1970 12.1 26.7 38.7 52.2 89.7 136.6 1966 10.9 24.1 34.5 46.2 78.8 121.0

Comments

• The mean income of the bottom 40% of families has increased by about 33% while the income of the top 5% has increased by 133%. The actual dollar changes are $3,000 compared to $159,000. Much if divergence occurred from 1980 to 2000.

Income Redistribution

• All modern industrial societies modify both the initial endowments and the outcome of the market system.

• They modify the initial endowment through free and subsidized education, nutrition, and health care for children

• They redistribute income. Why?

Income Redistribution Methods

• Temporary Assistance to Needy Families (TANF). Replaced welfare in 1996 reform

• Negative Income Tax - Earned Income Tax Credit (EITC)

• In-Kind Transfers - food stamps, rent subsidies, Medicaid

• Public or subsidized employment for the poor

• Progressive taxation

Costs and Benefits

• Government programs to redistribute income have costs as well as benefits

• Policymakers must use the cost-benefit principle to compare an imperfect status quo with the practical consequences of imperfect government remedies

Poverty Rate

• An absolute measure based on family size, essentially three times the cost of an adequate diet.

• See Fig. 20-1 for historical data. Declined until mid-70s. Has tended to move up and down a little since then.

• Poverty rate does not take account of in-kind transfers such as food stamps and Medicaid