Inequality and Poverty1 INEQUALITY AND POVERTY ECO 2023 Principles of Microeconomics Dr. McCaleb

Inequality and Poverty 1

INEQUALITY AND POVERTY

ECO 2023Principles of Microeconomics

Dr. McCaleb


TOPIC OUTLINE

I. Income Inequality in the United States

II. Income Distribution and Economic Status

III. Poverty and Income Redistribution


Inequality in the United States


Income Distribution in the U.S., 2005

Household money income

The following chart illustrates the distribution of household money income in the U.S. in 2005.

Each slice of the pie shows the percent of total income received by the respective quintile. For example, the first, or bottom, quintile received 3.4% of total money income and the fifth, or top, quintile received 50.4% of total money income.

A quintile is 20% of all households. Therefore, each quintile contains the same number of households, approximately 22,876,800.

INEQUALITY IN THE UNITED STATES


INEQUALITY IN THE UNITED STATESDistribution of U.S. Household Money Income, 2005

1st3.4%

2nd8.6%

3rd14.6%

4th23.0%

5th50.4%


Income Distribution in the U.S., 2005

Household money income statistics

Median household income $ 46,326

Mean household income $ 63,344

Lowest and mean household income by quintileLowest Mean

– First $ 0 $ 10,665– Second $ 19,179 $ 27,357– Third $ 36,001 $ 46,301– Fourth $ 57,661 $ 72,825– Fifth $ 91,706 $ 159,583



The Skewed Distribution of Income

The median, or middle, income is greater than the mode, or most common income, . . .


and the mean, or average, income is greater than the median*.

There are many more people with incomes below the mean than above it, but the distribution has a long, thin upper tail representing a small number of people with very large incomes.

The distribution of income is highly skewed toward higher incomes.

*Data for 2000



Share (Percent) of Aggregate Household Income Received by Each Quintile

Year First Quintile

Second Quintile

Third Quintile

Fourth Quintile

Fifth Quintile

2005 3.4 8.6 14.6 23.0 50.4

2000 3.6 8.9 14.8 23.0 49.6

1990 3.9 9.6 15.9 24.0 46.6

1980 4.3 10.3 16.9 24.9 43.7

1970 4.1 10.8 17.4 24.5 43.3

1967 4.0 10.8 17.3 24.2 43.8

• Historical Trends in Inequality


Historical Trends in Inequality


Since the mid-1970’s, income inequality measured by household money income has increased.

Between 1967, when the data series begins, and the mid-1970’s, income inequality measured by household money income narrowed.


Historical Trends in Mean Household Income


Real income—mean household income adjusted for inflation—has increased in every quintile.

Although inequality has increased, the average household in every quintile had more purchasing power in 2005 than in 1967.



Share of Aggregate Individual Income Received by Lowest and Highest Quintiles in Selected Countries (World Development Report, 2005)

Country First Quintile Fifth QuintileRatio

5th/1st

Japan 10.6 35.7 3.4

Germany 8.5 36.9 4.3

Canada 7.0 40.4 5.8

UK 6.1 44.0 7.2

U.S. 5.4 45.8 8.5

Russia 4.9 51.3 10.5

China 4.7 50.0 10.6

Mexico 3.1 59.1 19.1

Brazil 2.0 64.4 32.2

• International Comparisons


Income Mobility

The income distribution is characterized by income mobility

An estimated 20-40 percent of Americans move into a different income quintile each year.

Primary reasons for changes in income are changes in marital status, changes in the number of workers in the household, and moving into or out of full-time, year-round employment.



The chart shows the percentage of individuals in families in each income quintile in 1968 who were in a different quintile in 1991.

For example, 48.2% of individuals in families in the third quintile in 1968 had moved to a higher quintile in 1991 and 31.3% had moved to a lower quintile.

Income Mobility, 1968-1991

24.2 31.3

53.7 58.446.9

24.820.5

20.4

41.653.1 51.0 48.2

25.9

0%

10%20%

30%40%

50%

60%70%

80%90%

100%

1st 2nd 3rd 4th 5th

Moved to higher quintileStayed sameMoved to lower quintile



Demographic and Economic Characteristics

Differences between high-income and low-income households and families

Demographic, education, and employment differences between high-income and low-income households and families explain much of the inequality in the distribution of income.

While some of these differences are inherent to individuals, many are a result of people’s own choices.




Demographic Differences between High-Income and Low-Income Households

First Quintile Fifth Quintile

Location - Non-metro 21.2% 9.2%

Region - South 40.2% 32.0%

Race of householderBlackHispanic

20.6%13.4%

5.8%5.9%

Family StatusMarried coupleFemale-headed familyNon-family household

17.9%19.7%59.0%

79.0%4.8%

12.5%

Age of householderUnder 35Over 65

23.5%37.1%

14.8%8.3%



Education and Employment Differences between High-Income and Low-Income Households

First Quintile Fifth Quintile

Education of householder*High school dropoutHigh school graduateSome collegeBachelor’s degreeAdvanced degree

34.4%35.9%21.6%5.7%2.5%

2.6%16.2%23.1%32.9%25.1%

Employment of householderFull-timePart-timeNo work during year

23.2%12.7%64.2%

79.6%9.1%

11.3%

Mean number of income earners 0.48 2.10

*Data for 2000


True (T) or false (F): Between 1967 and the mid-1970’s, household money income became more equally distributed but since the mid-1970’s inequality has increased.


True (T) or false (F): Mean household income adjusted for inflation has increased in every quintile since 1967.


Income Distribution and Economic Status


INCOME DISTRIBUTION AND ECONOMIC STATUS

Problems in Measuring Inequality

Annual money income is not a good measure of standard of living or economic status

Living standards depend on ability to consume. Annual money income exaggerates inequality in ability to consume because of

• taxes and transfers• the economic life cycle• transitory income• household size.



Taxes and Transfers

Disposable income is more equally distributed than annual money income

Consumption depends on disposable income, after payment of taxes and receipt of transfers, not on annual money income.

To measure ability to consume, taxes should be deducted from annual money income and the value of non-cash transfers (public housing and Medicaid, for example) should be added to annual money income.



First Quintile

Second Quintile

Third Quintile

Fourth Quintile

Fifth Quintile

Annual Money Income 3.4 8.6 14.6 23.0 50.4

Disposable Income* 4.4 9.9 15.3 23.1 47.3

Adjusting Annual Money Income for Taxes and Transfers

The distribution of disposable income is more equal than the distribution of annual money income. The ratio of the fifth quintile to the first quintile decreases from 14.82 to 10.75.

*Annual money income minus taxes plus non-cash transfers



The Economic Life Cycle

Consumption is influenced more by lifetime income than annual money income

There is a predictable pattern to lifetime income called the life cycle pattern of income.

While income levels may differ widely between lower-income and upper-income households, the income of households at all income levels follows the life cycle pattern.


Life Cycle Pattern of Income


Median household income by age of householder in 2005 clearly displays the life cycle pattern of income.

Income rises from age 15-24 to the peak earning years of 44-55 and then decreases, falling sharply after age 65. $28,770

$47,379

$58,064

$62,424

$52,260

$26,036

$0 $15,000 $30,000 $45,000 $60,000

15-24

25-34

35-44

45-54

55-64

65 and over




Lifetime income and consumption are more equally distributed than annual money income

• Younger households borrow, enabling them to consume more than their incomes.

• Older households use up accumulated savings, enabling them to consume more than their incomes.

• Households in their peak earning years pay off their debts and accumulate savings, consuming less than their annual incomes.




Using annual money income creates apparent inequality where there is none

Two households at different stages of the life cycle may have very different annual money incomes in one year but have the same lifetime income, the same consumption, and the same economic status or standard of living.



Transitory Income

Consumption depends more on permanent income than on transitory income

Transitory income refers to changes in income that are are not expected to last for more than one or a few years at most.

Transitory income can be either positive, raising a household’s annual money income above its long-term average, or permanent income, or negative, reducing a household’s annual money income below its permanent income.


Transitory Income

Common reasons for transitory income

• Unemployment• Time out of the labor market for domestic responsibilities or

education or training or illness• Short-term business losses or successes• Sales commissions and bonuses• Irregular and fluctuating incomes characteristic of certain

occupations and businesses• Gambling winnings or losses, random events, “lucky breaks”,

“bad breaks”




Transitory Income

Transitory income and inequality

When annual money income is below the household’s expected long-term average, or permanent, income, the household reduces consumption but not by as much as the decrease in income.

When annual money income is above permanent income, the household increases consumption but not by as much as the increase in income.

Transitory income is an additional reason that consumption and living standards are more equally distributed than annual money income.



Household Size

Household income is not adjusted for household size

A household’s standard of living depends on the number of individuals who depend on the household’s income for consumption.

Household size increases as household income increases. Higher income households have more individuals to support so individual income and consumption is more equally distributed than household income.

First Quintile

Second Quintile

Third Quintile

Fourth Quintile

Fifth Quintile

Mean Household Size (2000) 2.90 2.99 3.22 3.33 3.41


The distribution of annual money income is not a good measure of inequality in economic living standards because

i. the distribution of disposable income is more equal than the distribution of annual money income.

ii. consumption is determined by average expected lifetime or permanent income which is more equally distributed than annual money income.

iii. low income households are on average smaller than high income households.

1. i and ii

2. i and iii

3. ii and iii

4. i, ii, and iii


Poverty and Income Redistribution


POVERTY AND INCOME REDISTRIBUTION

Poverty

Measuring poverty

Poverty rate: The percentage of families whose annual money income is below the poverty income threshold.

If income falls below the threshold, all individuals in the family are officially classified as poor.

The poverty rate in 2005 for families was 9.9 percent. The poverty rate for individuals was 12.6 percent. About 37 million people were officially classified as poor.



Poverty

Poverty income threshold

Defining the poverty income threshold is not a scientific endeavor.

The threshold is three times the estimated cost of a nutritionally adequate diet as determined by the U.S. Department of Agriculture. It varies by family size and composition and has been updated annually for inflation.

In 2005, the average poverty income threshold for an individual was $9,973 and for a four-person family it was $19,806.


The white poverty rate fell during the 1960’s and has been constant since then.

The black poverty rate is higher than the white poverty rate but it has fallen more and continued falling over the past 30 years.


Trends in Poverty Rates

The Hispanic poverty rate is similar to the black poverty rate but it increased during the 1980’s before falling during the 1990’s.



Characteristics of Poor Families 2005

Percent of poor families headed by:

FemaleBlack

50.5%27.5%

Percent of poor people in:Married-couple familiesFemale-headed familiesWhite familiesBlack familiesFamilies with no workers

5.9%31.1%8.7%

23.6%27.3%

Percent of people in poor families:

Under 18Over 65

17.1%13.9%

Who Are the Poor?

50.5% of poor people lived in female-headed families.

27.5% of poor people lived in families headed by a black person.

Poverty rates are highest for people in families with no workers and in female-headed families.

Poverty rates are lowest for people in married couple families and in white families.



Poverty Is Not PermanentThere is a high degree of income mobility in the population, even among the poor.

More than half of poor people are in poverty for less than 6 months at a time, but many move into and out of poverty frequently.

Only about one-third of the poor are in poverty for more than a year and fewer than 10% for more than 3 years.


Income Redistribution

Three kinds of anti-poverty programs

• Cash transfers to the poor such as Temporary Assistance to Needy Families (TANF) and Supplemental Security Income (SSI)

• Non-cash transfers such as food stamps, Medicaid, and public housing

• Regulatory policies such as rent controls and minimum wage laws.




Non-cash transfers are inefficient

Most anti-poverty programs provide non-cash transfers to the poor. Non-cash transfers are less efficient than cash.

For the same dollar expenditure of taxpayer money, the poor would be as well off or better off if they received cash. With cash they could consume goods that provide the greatest marginal benefit.

Non-cash benefits may not change the poor’s consumption patterns. The transfer replaces cash they would have spent on their own. They use their own cash for goods that provide greater marginal benefit.




Regulatory policies are inefficient

Regulatory policies are inefficient and often ineffective.

A regulatory policy is like a tax on producers with the proceeds used to finance a subsidy to consumers. But the subsidy is provided to all consumers, non-poor as well as poor. Therefore, the cost of providing $1 of benefit to the poor is much greater than $1.

Regulatory policies also give rise to a deadweight loss that reduces the aggregate income of the economy.



Why is the mother in the video unhappy about receiving the house?i. Her welfare payment isn’t enough to pay the mortgage.ii. She would have preferred cash to a house.iii. Her welfare payment will be reduced because she has the house.

1. i only2. ii only3. iii only4. i and ii5. i and iii6. ii and iii7. i, ii, and iii


An Anti-Poverty Impossibility Theorem

Three goals of an ideal poverty program

High guaranteed minimum income: Raise the incomes of all poor above the poverty line.

Low break-even income level: Keep costs low by targeting redistribution to the poor.

Low benefit reduction rate (or marginal tax rate): Provide positive incentives for the poor to help themselves by working and earning income.




Ideal policy is an impossibility

The three goals are mutually inconsistent. It is impossible to achieve all three.

The trade-off among the goals is illustrated by the negative income tax.

The negative income tax has never been adopted but it is often proposed as a single cash program to replace the many current cash and in-kind transfer programs.




Illustration: Negative income tax

A negative income tax provides every household with a guaranteed minimum annual income and taxes all market income at a fixed marginal tax rate.

The negative income tax is the simplest possible anti-poverty program. Individuals whose income exceeds a specified amount pay tax. The higher the income, the larger the tax.

Individuals whose income is below the specified amount receive a transfer from the government. The lower the income, the larger the transfer.



Negative Income Tax (1)


With no income redistribution, income after redistribution equals market income. Households are located along the blue 45o line.

With a negative income tax, households are located along the red line.

Families below the breakeven income receive transfers. Families above pay taxes.

0

20

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0 20 40 60 80 100

Market Income ($000)

0

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0 20 40 60 80 100


0

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0

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Breakeven

income




Suppose the guaranteed minimum income equals the poverty income threshold.

Suppose the marginal tax rate equals the rate currently imposed on middle and upper income families.

The breakeven income must be 2.5 times the poverty income threshold. More than half of all families receive transfers.

0

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Breakeven

income

0

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Breakeven

income

Guaranteed minimum

income=$17,603

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Breakeven

income

Guaranteed minimum

income=$17,603

Marginal tax

rate=35.65%

0

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40

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0 20 40 60 80 100


Breakeven

income=$44,831

Guaranteed minimum

income=$17,603

Marginal tax

rate=35.65%




Suppose the cost of the program is reduced by reducing the breakeven income to $26,405.

Retain the guaranteed minimum at the poverty income threshold.

The marginal tax rate must be 66.67%, higher than the highest rate imposed on the highest income families.

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$44,831

Guaranteed minimum

income=$17,603

Marginal tax

rate=35.65%

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60

80

100

0 20 40 60 80 100


Guaranteed minimum

income=$17,603

0

20

40

60

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0 20 40 60 80 100


Guaranteed minimum

income=$17,603

0

20

40

60

80

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0 20 40 60 80 100


Guaranteed minimum

income=$17,603

0

20

40

60

80

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0 20 40 60 80 100


Breakeven

income=$26,405

Guaranteed minimum

income=$17,603

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$26,405

Guaranteed minimum

income=$17,603

Marginal tax

rate=66.67%




To improve work incentives for the poor, reduce the benefit reduction rate back to 35.65%, but keep the breakeven income at $26,405.

Now, the guaranteed minimum income must be $9,413, only about half the poverty income threshold, leaving the poorest families in poverty.

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$26,405

Guaranteed minimum

income=$17,603

Marginal tax

rate=66.67%

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$26,405

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$26,405

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$26,405

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$26,405

Marginal tax

rate=35.65%

0

20

40

60

80

100

0 20 40 60 80 100


Breakeven

income=$26,405

Guaranteed minimum

income=$9,413

Marginal tax

rate=35.65%



Every anti-poverty program faces the trade-off among the three goals

The three elements of the negative income tax—guaranteed minimum income, breakeven income, and benefit reduction rate—are features of every anti-poverty program.

The trade-off among these three elements exists in every anti-poverty program. Disagreement and debate about welfare is really disagreement and debate about which of the three goals of the ideal anti-poverty program is more important.



According to the statements in the video, why are these poor people standing in line for food?

1. They are hungry and have no money to buy food.

2. They are homeless.

3. They have no transportation to the grocery store.

4. The food is free (except for the opportunity cost of their time).


What Does It Mean To Be Poor Today in America?


Housing

41% of poor households own their own homes.

The average home has 3 bedrooms, 1.5 baths, a garage and a porch or patio.

More than 750,000 poor people own homes worth more than $150,000; nearly 200,000 own homes worth more than $300,000.

Nearly 60% of poor households have two or more rooms per person.

The average poor American has one-third more living space than the average Japanese and four times as much as the average Russian.


Nutrition

84% of the poor say they have enough to eat; 13% say they sometimes do not have enough to eat; 3% say they often do not have enough to eat.

Average consumption of protein, vitamins, and minerals is virtually the same for poor and non-poor children.

Average protein consumption of poor children is 100% above recommended levels.

Poor children consume more meat than higher-income children.

Most poor children today grow up to be one inch taller and 10 pounds heavier than the average World War II soldier.




Possessions


Two-thirds have A/C compared with 36% of all Americans 30 years ago.


25%Automatic dishwasher

50%Stereo system

64%Microwave oven

20%Two or more VCR’s

75%One VCR

50%Two or more color TV’s

97%One color TV

27%Two or more cars

70%One car

ApproximatelyItem

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Inequality and Poverty1 INEQUALITY AND POVERTY ECO 2023 Principles of Microeconomics Dr. McCaleb