Microeconomics Module 13 Income Distribution Why It Matters
Microeconomics Module 13: Income Distribution
Why It Matters: Income Distribution • • Since not everyone has the same job skills, labor markets result in considerable income inequality • • Income inequality can motivate people to work harder and improve their skills If income inequality gets too extreme, it can adversely affect the functioning of the economy as a whole Market forces do not: • • • take into account how much income a family needs for food, shelter, clothing, and health care worry about what happens to families when a major local employer goes out of business take time to contemplate whether those who are earning higher incomes should pay an even higher share of taxes
Drawing the Poverty Line • • • Poverty is measured by the number of people who fall below a certain level of income The poverty line is the income needed for a basic standard of living Income inequality compares the share of the total income (or wealth) in society that is received by different groups
The Poverty Trap • • • When people are provided with food, shelter, healthcare, income, and other necessities, assistance may reduce their incentive to work A person in poverty may receive government assistance, but if they earn money, they may no longer receive assistance • • As a result the person would gain nothing for working Economists call this problem the poverty trap Possible solutions: • • • using a program where government payments are reduced by a smaller amount as more income is earned imposing requirements for work as a condition of receiving benefits setting a time limit on benefits
Addressing the Poverty Trap • • • The graph illustrates a government program that guarantees $18, 000 in income, even for those who do not work at all, but then reduces this amount by 50 cents for each $1 earned Enacting such a program may still reduce the incentive to work When the government phases out its support payments more slowly, the antipoverty program costs more money
The Safety Net • • • The near-poor are those who have an income that is just above the poverty line The U. S. government has implemented a number of programs to assist those below the poverty line and those who have incomes just above the poverty line called the safety net From the Great Depression of the 1930 s until 1996, the United States’ most visible antipoverty program was Aid to Families with Dependent Children (AFDC) • This program provided cash payments to mothers with children whose income was below the poverty line
Temporary Assistance for Needy Families • • • The AFDC was often called “welfare” In 1996, Congress passed the Personal Responsibility and Work Opportunity Reconciliation Act • More commonly called the “welfare reform act” The new law replaced AFDC with Temporary Assistance for Needy Families (TANF) • • • TANF brought several dramatic changes in how welfare operated Under TANF, the federal government gives a fixed amount of money to each state The state can use the money for almost any program with an antipoverty component
T. A. N. F • The federal government imposed two key requirements for TANF: • • • States must impose work requirements so that most of those receiving TANF benefits are working (or attending school) No one can receive TANF benefits with federal money for more than a total of five years over his or her lifetime The old AFDC program had no such work requirements or time limits TANF attempts to avoid the poverty trap by requiring that welfare recipients work and by limiting the length of time they can receive benefits TANF benefits vary considerably across states
The Earned Income Tax Credit (EITC) • • • The earned income tax credit (EITC) is a method of assisting the working poor through the tax system The EITC is the second largest assistance program for low-income groups To minimize the problem of the poverty trap, the earned income tax credit is phased out slowly
Supplemental Nutrition Assistance Program (SNAP) • • • Often called “food stamps, ” Supplemental Nutrition Assistance Program (SNAP) is a federally funded program The amount of food aid for which a household is eligible varies by income, number of children, and other factors If 30% of their net income is not enough to purchase a nutritionally adequate diet, then those households are eligible for SNAP can contribute to the poverty trap Anyone eligible for TANF is also eligible for SNAP In some states, where TANF welfare spending is relatively low, a poor family may receive more in support from SNAP than from TANF
Expenditure Comparison of TANF, SNAP, HUD, and Others
Medicaid • • Medicaid- a joint health insurance program entered into by both the states and the federal government The federal government helps fund Medicaid, but each state is responsible for: • • • administering the program determining the level of benefits determining eligibility It provides medical insurance for certain low-income people, those below the poverty line Focuses on families with children, the elderly, and the disabled
Medicaid cont. • The program ensures that a basic level of benefits is provided to Medicaid participants • Because each state sets eligibility requirements and provides varying levels of service, it differs from state to state
Measuring Income Inequality • • People who own a lot of resources and people who own resources that are highly valued will tend to earn higher incomes than people who do not • As a consequence, market economies tend to result in inequality of income and wealth Poverty levels can be subjective based on the overall income levels of a country • • Typically a government measures poverty based on a percentage of the median income Income inequality has to do with the distribution of income, in terms of which group receives the most or the least income • Involves comparing those with high incomes, middle incomes, and low incomes, not just below or near the poverty line
How Do You Separate Poverty and Income Inequality? • • Poverty levels can be subjective based on the overall income levels of a country Measuring income inequality means dividing up the population into various groups and then comparing the groups
Measuring Income Inequality cont. • • Poverty can change even when inequality does not move at all If the income of the population declined by 10%, poverty would rise but inequality would not It is also possible for income inequality to change without affecting the poverty rate If a large amount of people who already had high incomes had an increased amount of income then inequality would rise • The poverty line, however would remain the same
Measuring Income Distribution by Quintiles • • Measure income inequality by ranking households by: • • income, lowest to highest then dividing all households into five groups with equal amounts of people (known as quintiles) The first quintile is the lowest fifth or 20%, the second quintile is the next lowest, and so on We can measure income inequality by comparing what share of the total income each quintile earns It can also be useful to divide the income distribution in ways other than quintiles
Lorenz Curve • The Lorenz curve shows the cumulative share of population on the horizontal axis and the cumulative percentage of total income received on the vertical axis • • Change the shares of income for each specific quintile The Lorenz curve is a useful way of presenting the quintile data that provides an image of all the quintile data at once
Causes of Growing Inequality: the Changing Composition of American Households • Prior to the 1970 s, most American families were supported by one wage earner, typically the husband, while the wife stayed home • • It has become more common for one high earner to marry another high earner This pattern of households with two high earners tends to increase the proportion of highearning households According to data in the National Journal, even as two-earner couples have increased, so have single-parent households • The poverty rate among single-parent households tends to be relatively high These changes in family structure account for roughly half of the rise in income inequality across households in recent decades
Causes of Growing Inequality: A Shift in the Distribution of Wages • Another factor behind the rise in U. S. income inequality is that earnings have become less equal since the late 1970 s • • • For example, the earnings of high-skilled labor relative to low-skilled labor have increased A well paid job that only required a high school diploma are increasingly hard to find Economists use the demand supply model to reason through the most likely causes of this shift
Government Policies to Reduce Income Inequality • No society should expect or desire complete equality of income at a given point in time • • • Most workers receive relatively low earnings in their first jobs • • Higher earnings as they reach middle age Lower earning after retirement People’s preferences and desires differ • Some are willing to work long hours, for luxuries or to support family If a society decides to reduce the level of economic inequality, it has three main sets of tools: • • • Redistribution from those with high incomes to those with low incomes Trying to assure that a ladder of opportunity is widely available A tax on inheritance
How Do You Measure Wealth vs. Income Inequality? • • • Income is a flow of money received, often measured on a monthly or an annual basis Wealth is the sum of the value of all assets, including money in bank accounts, financial investments, a pension fund, and the value of a home The wealth distribution is more unequal than the income distribution The differences in income can accumulate over time to make even larger differences in wealth The degree of inequality in the wealth distribution can be measured with the same tools we use to measure the inequality in the income distribution (quintile measurements)
Redistribution • • • Redistribution means taking income from those with higher incomes and providing income to those with lower incomes Key government policies such as TANF, the earned income tax credit, SNAP, and Medicaid are examples • The programs are paid for through the federal income tax A progressive tax system designed in such a way that the rich pay a higher percent in income taxes than the poor The effective income tax, which is total taxes paid divided by total income Just because some degree of redistribution occurs through taxes, it doesn’t settle the question of much is appropriate or whether is should even occur
The Ladder of Opportunity • Public policy can attempt to build a ladder of opportunities so that children has reasonable opportunity to attain an economic niche in society based off their interests, desires, talents, and efforts • • • Is the United States a land of opportunity? Although the general idea of a ladder of opportunity for all citizens continues to exert a powerful attraction, specifics are often quite controversial Society can experiment with a wide variety of proposals for building a ladder of opportunity
Inheritance Taxes • • There is always debate about inheritance taxes On the one hand, why should people who have worked hard all their lives and saved up a substantial nest egg not be able to give their money and possessions to their children and grandchildren? On the other hand, many Americans are far more comfortable with inequality resulting from high-income people who earned their money by starting innovative new companies than they are with inequality resulting from high-income people who have inherited money from rich parents The United States does have an estate tax, a tax imposed on the value of an inheritance
Quick Review • • How is the poverty line determined? What is the poverty trap, noting how government programs impact it? What are the antipoverty government programs that compromise the safety net? What is the distribution of income? How can you use the Lorenz Curve to analyze the distribution of income and wealth Analyze the sources of income inequality and its effect on a market economy What are arguments for and against government intervention to reduce economic inequality?
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