ECO 101 (Module 13 - Income Distribution)

There are a variety of government support programs focused specifically on the poor,

including TANF (the basic welfare program), SNAP (food stamps), Medicaid, and the earned income tax credit (EITC).

The United States does have an estate tax—

that is, a tax imposed on the value of an inheritance—which suggests a willingness to limit how much wealth can be passed on as an inheritance.

After all, if society does not make some effort toward reducing inequality and poverty,

the alternative might be that people would rebel against market forces.

The second major issue is that when the government phases out its support payments more slowly,

the antipoverty program costs more money.

The most plausible explanation is that while the explosion in new information and communications technologies over the last several decades has helped many workers to become more productive,

the benefits have been especially great for high-skilled workers like top business managers, consultants, and design professionals.

Poverty is what we call

the condition of people who do not earn enough income to be able to afford the necessities of life, which is measured by the poverty line.

estate tax:

a tax imposed on the value of an inheritance

Poverty is measured by the number of people who fall below a certain level of income—

called the poverty line—that defines the income needed for a basic standard of living.

quintile:

dividing a group into fifths, a method economists often use to look at distribution of income

Moreover, policies to diminish inequality and soften the hardship of poverty

may sustain political support for a market economy.

First, even if it does not eliminate the incentive to work by reducing government payments by $1 for every $1 earned, enacting such a program may still reduce the incentive to work.

At least some people who would be working 2,000 hours each year without this program might decide to work fewer hours but still end up with more income—that is, their choice on the new budget line would be like S, above and to the right of the original choice P. Of course, others may choose a point like R, which involves the same amount of work as P, or even a point to the left of R that involves more work.

We can view the market for high-skilled labor as a race between forces of supply and demand. Additional education and on-the-job training will tend to increase the high-skilled labor supply and to hold down its relative wage.

Conversely, new technology and other economic trends like globalization tend to increase the demand for high-skilled labor and push up its relative wage. We can view the greater inequality of wages as a sign that demand for skilled labor is increasing faster than supply.

However, the federal government imposed two key requirements.

First, if states are to keep receiving the TANF grants, they must impose work requirements so that most of those receiving TANF benefits are working (or attending school). Second, 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.

When you take into account the effects of inflation, the decline is even greater.

Moreover, there seemed little evidence that poor families were suffering a reduced standard of living as a result of TANF—although, on the other side, there was not much evidence that poor families had greatly improved their total levels of income, either.

The United States has often been called 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, especially for those who otherwise seem likely to start their lives in a disadvantaged position.

Such policy experiments need to be carried out in a spirit of open-mindedness, because some will succeed while others will not show positive results or will cost too much to enact on a widespread basis.

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, who are referred to as the near-poor.

Such programs are called the safety net, in recognition of the fact that they offer some protection for those who find themselves without jobs or income.

The earned income tax credit (EITC), first passed in 1975, is a method of assisting the working poor through the tax system.

The EITC is the second largest assistance program for low-income groups (after SNAP, described below), and projections for 2013 expected 26 million households to take advantage of it at an estimated cost of $50 billion. In 2013, for example, a single parent with two children would have received a tax credit of $5,372 up to an income level of $17,530.

Figure 2 presents an alternative way of showing inequality data in what is called a 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.

Alternatively, if the supply of lower skilled workers exceeds the demand, then average wages in the lower quintiles of the income distribution will decrease.

The combination of forces in the high-skilled and low-skilled labor markets leads to increased income disparity.

This program was often just called "welfare." In 1996, Congress passed and President Bill Clinton signed into law the Personal Responsibility and Work Opportunity Reconciliation Act, more commonly called the "welfare reform act." (TANF).

The new law replaced AFDC with Temporary Assistance for Needy Families

Which of the following is a potential source of income inequality?

Wage disparity (The demand for highly skilled workers has been increasing leading to even higher wages for those already high income groups and causing inequality to rise.)

As a consequence, market economies tend to result in inequality of income and wealth.

Whether this is good or bad depends at least in part on the degree of inequality.

Medicaid:

a federal-state joint program enacted in 1965 that provides medical insurance for certain (not all) low-income people, including the near-poor as well as those below the poverty line, and focusing on low-income families with children, the low-income elderly, and the disabled

Supplemental Nutrition Assistance Program (SNAP):

a federally funded program, started in 1964, in which each month poor people receive SNAP cards they can use to buy food

income:

a flow of money received, often measured on a monthly or an annual basis

Lorenz curve:

a graph that compares the cumulative income actually received to a perfectly equal distribution of income; it shows the share of population on the horizontal axis and the cumulative percentage of total income received on the vertical axis

earned income tax credit (EITC):

a method of assisting the working poor through the tax system

When anti-poverty programs from the government have declining benefits as people earn higher incomes, this has the possibility of leading to

a poverty trap (The issue of declining benefits as income rises is likely to discourage people from working and therefore keep them in poverty.)

These changes in family structure, including the growth of single-parent families who tend to be at the lower end of the income distribution, and the growth of two-career high-earner couples near the top end of the income distribution,

account for roughly half of the rise in income inequality across households in recent decades.

In turn, the rising impact of foreign trade in the U.S. economy has opened up greater opportunities for high-skilled workers to sell their services around the world,

and lower-skilled workers have to compete with a larger supply of similarly skilled workers around the globe.

poverty trap:

antipoverty programs set up so that government benefits decline substantially as people earn more income—as a result, working provides little financial gain

The wealth distribution is more unequal than the income distribution,

because differences in income can accumulate over time to make even larger differences in wealth.

Calculating a(n) ________ can help the government make antipoverty programs such as TANF (the basic welfare program), SNAP (food stamps), Medicaid, and the earned income tax credit (EITC) be more effective.

budget constraint line (By calculating a budget constraint line then the antipoverty programs can guarantee a certain amount of income inititally and then phase out the assistance at a rate that will lead to a higher budget set for the worker. the hope is that this program will provide incentives to work at least the same or more hours, depite receving income assistance.)

The poverty line defines the income needed for a basic standard of living and is determined by ________.

by tripling the inflation-adjusted cost of a minimum food diet from the 1960s and adjusting for other factors such as size of the family, composition and ages (Poverty is calculated by the government adjusting the dollar amounts to represent the same buying power over time and it is measured by the number of people who fall below a certain level of income.)

Governmental public policies have the potential to create a series of programs to assist people to transform the ________ under which they live.

circumstances (Governmental public policies aim to provide opportunities to all and level the playing field.)

Public policy can attempt to build a ladder of opportunities so that,

even though all children will never come from identical families and attend identical schools, each child has a reasonable opportunity to attain an economic niche in society based on their interests, desires, talents, and efforts. Some of those initiatives include those shown in Table 1.

Income is a

flow of money received, often measured on a monthly or an annual basis;

Under TANF, however, the federal government gives a fixed amount of money to each state. The state can then use the money for almost any program with an antipoverty component:

for example, the state might use the money to give cash to poor families, or to reduce teenage pregnancy, or even to raise the high school graduation rate.

Temporary Assistance for Needy Families (TANF):

government assistance program in which the federal government gives money to states to help provide assistance to those in poverty. People receiving assistance are required to find a job within two years and cannot receive benefits for more than five years.

The effects of a poverty trap can be reduced by ________.

initially decreasing the government payments by smaller amounts (This would allow for the incentives to work to remain.)

Since not everyone has the same job skills,

labor markets result in considerable income inequality.

In a market economy, labor markets work efficiently to match job seekers with employers needing their skills who, in turn,

pay wages and salaries based on the value that workers bring to firms.

poverty rate:

percentage of the population living below the poverty line

effective income tax:

percentage of total taxes paid divided by total income

Still, it may be preferable in the long run to spend more money on a program that retains a greater incentive to work,

rather than spending less money on a program that nearly eliminates any gains from working.

While income inequality can motivate people to work harder and improve their skills,

recent evidence suggests that if income inequality gets too extreme, it can adversely affect the functioning of the economy as a whole.

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.

Redistribution means

taking income from those with higher incomes and providing income to those with lower incomes.

The new technologies have also helped to encourage globalization,

the remarkable increase in international trade over the last few decades, by making it more possible to learn about and coordinate economic interactions all around the world.

The programs are paid for through the federal income tax, which is a progressive tax system designed in such a way that

the rich pay a higher percent in income taxes than the poor.

near-poor:

those who have incomes just above the poverty line

With such a program, every time a poor person earns $100, the person loses $100 in government support. As a result, the person experiences no net gain for working.

Economists call this problem the poverty trap.

No society should expect or desire complete equality of income at a given point in time, for a number of reasons.

First, most workers receive relatively low earnings in their first few jobs, higher earnings as they reach middle age, and then lower earnings after retirement. Thus, a society with people of varying ages will have a certain amount of income inequality. Second, people's preferences and desires differ. Some are willing to work long hours to have income for large houses, fast cars and computers, luxury vacations, and the ability to support children and grandchildren.

Here, the tradeoff between economic output and equality first slopes up, in the vicinity of choice C, suggesting that certain programs might increase both output and economic equality.

For example, the policy of providing free public education has an element of redistribution, since the value of the public schooling received by children of low-income families is clearly higher than what low-income families pay in taxes. A well-educated population, however, is also an enormously powerful factor in providing the skilled workers of tomorrow and helping the economy to grow and expand. In this case, equality and economic growth may complement each other.

Citizens might seek economic security by demanding that their legislators pass laws forbidding employers from ever laying off workers or reducing wages, or laws that would impose price floors and price ceilings and shut off international trade.

From this viewpoint, policies to reduce inequality may help economic output by building social support for allowing markets to operate.

Samantha is a single mother raising two young children. In 2015, she was let go from her assembly line job at the car plant where she had worked for 15 years. She has a 15 hr a week job which pays $12,000.00 a year. She qualifies for and receives the earned income tax credit. What will happen to her earned income credit if Samantha gets in increase in her pay and earns $17,350 now?

Her EITC will not be decreased. (Her EITC will be reduced when she earns more than $17,350.)

Poverty can change even when inequality does not move at all. Imagine a situation in which income for everyone in the population declines by 10%. Poverty would rise, since a greater share of the population would now fall below the poverty line.

However, inequality would be the same, because everyone suffered the same proportional loss. Conversely, a general rise in income levels over time would keep inequality the same, but reduce poverty.

Earlier in this module, we considered some of the key government policies that provide support for the poor: the welfare program TANF, the earned income tax credit, SNAP, and Medicaid.

If a reduction in inequality is desired, these programs could receive additional funding.

Even if they cannot answer the question of how much inequality is too much, economists can still play an important role in spelling out policy options and tradeoffs.

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; and a tax on inheritance.

Which of the following statements is the most accurate regarding government intervention to reduce economic inequality?

If society wishes a high level of economic output it must also accept a high degree of inequality. Conversely, if society wants a high level of equality, it must accept a lower level of economic output because of reducded incentives for production. (Society faces a trade-off where any attempt to move toward greater equality involves a reduction in economic output. It is possible to both increase equality and also to increase economic output. Itm ay also be possible to increase equality with little impact on economic output. However, at some point, too aggressive a push for equality will tend to reduce economic output.)

What are some of the causes of the poverty trap?

In the long run, working provides little financial gain. (If government benefits are reduced when earned income rises, overall income would not increase and work would not offer much benefit and so people stay poor.)

The tradeoff in Figure 1(b) then flattens out in the area between points D and E, which reflects the pattern that a number of countries that provide similar levels of income to their citizens—the United States, Canada, the nations of the European Union, Japan, Australia—have different levels of inequality. The pattern suggests that countries in this range could choose a greater or a lesser degree of inequality without much impact on economic output. Only if these countries push for a much higher level of equality, like at point F, will they experience the diminished incentives that lead to lower levels of economic output.

In this view, while a danger always exists that an agenda to reduce poverty or inequality can be poorly designed or pushed too far, it is also possible to discover and design policies that improve equality and do not injure incentives for economic output by very much—or even improve such incentives.

In the past, a common problem has been that many low-paying jobs pay enough to a breadwinner so that a family could lose its eligibility for Medicaid, yet the job does not offer health insurance benefits. A poor parent considering such a job might choose not to work rather than lose health insurance for his or her children.

In this way, health insurance can become a part of the poverty trap.

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, however, has to do with the distribution of that income, in terms of which group receives the most or the least income. Income inequality involves comparing those with high incomes, middle incomes, and low incomes—not just looking at those below or near the poverty line.

It is also possible for income inequality to change without affecting the poverty rate. Imagine a situation in which a large number of people who already have high incomes increase their incomes by even more.

Inequality would rise as a result—but the number of people below the poverty line would remain unchanged.

Another factor behind the rise in U.S. income inequality is that earnings have become less equal since the late 1970s. In particular, the earnings of high-skilled labor relative to low-skilled labor have increased.

It used to be that a man could find a well paid job—one that would put his family in the middle class—with only a high school diploma. Those jobs are increasingly hard to find. By contrast, more and more jobs require at least some post-secondary education, if not a 4-year degree.

Indeed, the poverty trap is even stronger than this simplified example shows, because a working mother will have extra expenses like clothing, transportation, and child care that a nonworking mother will not face, making the economic gains from working even smaller.

Moreover, those who do not work fail to build up job experience and contacts, which makes working in the future even less likely.

There is always a debate about inheritance taxes. It goes like this: 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? In particular, it would seem un-American if children were unable to inherit a family business or a family home. 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.

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.

Why give debit cards and not just cash?

Part of the political support for SNAP comes from a belief that since the cards must be spent on food, they cannot be "wasted" on other forms of consumption. From an economic point of view, however, the belief that cards must increase spending on food seems wrong-headed. After all, say that a poor family is spending $2,500 per year on food, and then it starts receiving $1,000 per year in SNAP aid. The family might react by spending $3,500 per year on food (income plus aid), or it might react by continuing to spend $2,500 per year on food, but use the $1,000 in food aid to free up $1,000 that can now be spent on other goods. So it is reasonable to think of SNAP cards as an alternative method, along with TANF and the earned income tax credit, of transferring income to the working poor.

n a market economy, your income depends on the resources you own (e.g. labor, land, etc.), and the value the market places on those resources.

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.

Which of the following statements is not accurate regarding distribution of income?

Poverty rates cannot change if inequality does not change (Poverty can change even when inequality does not move at all. Imagine a situation in which income for everyone in the population declines by 10%. Poverty would rise, since a greater share of the population would now fall below the poverty line. However, inequality would be the same, because everyone suffered the same proportional loss. Conversely, a general rise in income levels over time would keep inequality the same, but reduce poverty.)

SNAP can contribute to the poverty trap. For every $100 earned, the government assumes that a family can spend $30 more for food, and thus reduces its eligibility for food aid by $30. This decreased benefit is not a complete disincentive to work—but combined with how other programs reduce benefits as income increases, it adds to the problem.

SNAP, however, does try to address the poverty trap with its own set of work requirements and time limits.

Which of these types of government actions would aggravate a poverty trap?

Set a timed deadline to cut off assistance at a certain date whether extra work or income has been achieved or not. (This plan would further reduce the incentive to work and aggravate the poverty trap.)

Which of the following are considered anti-poverty government programs under the safety net grouping?

Tanf, EITC, SNAP, and Medicaid (These all represent the variety of government support programs avaiable to assist the poor and disadvantaged. Although the programs vary from state to state, it is generall a true statement that in man states from the 1960s into the 1980s, if poor people worked, their level of income barely rose-or did not rise at all-after the reduction in government support payments were factored in. 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, who are refered to as the near-poor. Such programs are called the safety net, in recognition of the fact that they offer some protection for those who find themselves without jobs or income. These expanded guarantees cost the government money, of course, but they also attempt to help encourage those on welfare to enter the labor force.)

Often called "food stamps," Supplemental Nutrition Assistance Program (SNAP) is a federally funded program, started in 1964, in which each month poor people receive a card like a debit card that they can use to buy food.

The amount of food aid for which a household is eligible varies by income, number of children, and other factors but, in general, households are expected to spend about 30% of their own net income on food, and if 30% of their net income is not enough to purchase a nutritionally adequate diet, then those households are eligible for SNAP.

Which of the following determinants are used to define the poverty line?

The cost of basic housing (The poverty line is based on basic needs versus income and basic housing is a basic need.)

The amount of the tax break increases with the amount of income earned, up to a point.

The earned income tax credit has often been popular with both economists and the general public because of the way it effectively increases the payment received for work.

Medicaid was created by Congress in 1965 and is 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, and determining eligibility. It provides medical insurance for certain low-income people, including those below the poverty line, with a focus on families with children, the elderly, and the disabled.

TANF brought several dramatic changes in how welfare operated. Under the old AFDC program, states set the level of welfare benefits that they would pay to the poor, and the federal government guaranteed it would chip in some of the money as well.

The federal government's welfare spending would rise or fall depending on the number of poor people, and on how each state set its own welfare contribution.

Which of the following accurately describes government food stamps?

There are time limits which are not completely a work hindrance. (The food stamp program does have time limits that provide some incentives to work.)

The federal government deploys a range of income security programs that are funded through departments such as Health and Human Services, Agriculture, and Housing and Urban Development (HUD) (see Figure 2).

These three departments provide billions of dollars of aid through programs such as supplemental feeding programs for women and children, subsidized housing, and energy assistance. The federal government also transfers funds to individual states through special grant programs.

One common way of measuring income inequality is to rank all households by income, from lowest to highest, and then to divide all households into five groups with equal numbers of people, known as quintiles.

This calculation allows for measuring the distribution of income among the five groups compared to the total. 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.

Firms hire workers because they value the workers' productivity. Employees get paid based on the value of their productivity to their employer. Labor productivity depends on a worker's talents, skills and abilities.

This means that people who lack marketable skills tend to be qualified only for low wage jobs, if they are employed at all.

Government policies to reduce poverty or to encourage economic equality, if carried to extremes, can injure incentives for economic output. The poverty trap, for example, defines a situation where guaranteeing a certain level of income can eliminate or reduce the incentive to work. An extremely high degree of redistribution, with very high taxes on the rich, would be likely to discourage work and entrepreneurship.

Thus, it is common to draw the tradeoff between economic output and equality, as shown in Figure 1(a). In this formulation, if society wishes a high level of economic output, like point A, it must also accept a high degree of inequality. Conversely, if society wants a high level of equality, like point B, it must accept a lower level of economic output because of reduced incentives for production.

Comparisons of high and low incomes raise two different issues:

economic inequality and poverty.

Potential causes of income inequality in a market economy include which of the following?

family structure, earings disparity, increased demand for high-skilled jobs (Family structure, earnings inequality, and increase demand for high-skilled jobs all represent potential causes for the shifting in the distribution of wages between the top and bottom earners in the economy. Family structures because of dual high earner couples and divorce rates creating single parent households. Earnings ineqality because of education creating an oversupply of skilled workers which is driving down wages and more educated workers setting the bar higher regarding minimum job requrements. Increased demand for high-skilled jobs because of the explosion in new information and communications technologies creating a need to support these new technologies. The high-skilled worker is better off while the low-skilled worker is replaced. Addition potential sources of income inequality include reducded influence in unions, tax policies that favor the wealthy, inceom disparity between high and low level employees, and race/gender inequality.)

The Lorenz curve presents an alternative way of showing inequality data. Which graphical description typically means a more unequal distribution of income?

farther down and away from the 45-degree line (A more unequal distribution of income will loop farther down and away from the 45-degree line ,while a more equal distribution of income will move the liner closer to the 45-degree line.)

The safety net includes a number of other programs:

government-subsidized school lunches and breakfasts for children from low-income families; the Special Supplemental Food Program for Women, Infants and Children (WIC), which provides food assistance for pregnant women and newborns; the Low Income Home Energy Assistance Program, which provides help with home heating bills; housing assistance, which helps pay the rent; and Supplemental Security Income, which provides cash support for the disabled and the elderly poor.

The allocation of income among members of society whether it is seen as equitable or inequitable, is called ________.

income distribution (Money allocation is not the correct term to describe the allocation of income among members of society.)

However, 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,

like quintile measurements. Data on wealth are collected once every three years in the Survey of Consumer Finance.

safety net:

the group of government programs that provide assistance to the poor and the near-poor

The poverty line is determined by ________.

the level of income needed to cover basic needs (The poverty line is the level of income below which an individual would not be able to cover basic needs such as food and housing.)

poverty:

the situation of being below a certain level of income one needs for a basic standard of living

poverty line:

the specific amount of income one requires for a basic standard of living

News stories occasionally report on a high-income person who has managed to pay very little in taxes, but while such individual cases exist, according to the Congressional Budget Office,

the typical pattern is that people with higher incomes pay a higher average share of their income in federal income taxes.

The effective income tax, which is

total taxes paid divided by total income (all sources of income such as wages, profits, interest, rental income, and government transfers such as veterans' benefits), was much lower.

The poverty rate is

what percentage of the population lives below the poverty line.

income inequality:

when one group receives a disproportionate share of total income or wealth than others

From the Great Depression of the 1930s until 1996, the United States' most visible antipoverty program was Aid to Families with Dependent Children (AFDC),

which provided cash payments to mothers with children whose income was below the poverty line.

Later we will take a closer look at income inequality,

which refers to the disparity between those with higher and lower incomes.