Income Distribution • Household Income Percentage of Total Group Money Income • Lowest 20% 3.4% • Second 20% 8.7% • Third 20% 14.8% • Fourth 20% 23.4% • Highest 20% 49.7% Economic Mobility • There is significant economic mobility in the U.S. economy. • Over a typical ten year period, most of the households in the Lowest Income 20% will move up to one of the four higher Income Groups. Lorenz Curve • The degree of income inequality can be expressed with a Lorenz curve. • A Lorenz curve contrasts the actual distribution of income with perfect equality. Lorenz Curve 100% - Perfect 80% - Equality 60% - % of Income 40% - 20% - 0% ׀ ׀ ׀ ׀ ׀ 0% 20% 40% 60% 80% 100% % of Households Lorenz Curve 100% - Perfect 80% - Equality 60% - % of Actual Income Distribution 40% - 20% - 0% ׀ ׀ ׀ ׀ ׀ 0% 20% 40% 60% 80% 100% % of Households Lorenz Curve 100% - Perfect 80% - Equality 60% - % of Actual Income Distribution 40% - Degree of 20% - Inequality 0% ׀ ׀ ׀ ׀ ׀ 0% 20% 40% 60% 80% 100% % of Households Increasing Income Inequality • The distribution of income has been growing more unequal in recent decades. • See Example 1 on page 31-3. • The increase in income inequality was due largely to increased immigration. Overstating the Degree of Income Inequality • The distribution of money income overstates the degree of inequality: • 1. It does not take into account the effect of taxes paid or of in-kind transfer payments received. • Higher income households pay a higher percentage of income in taxes, and receive a smaller proportion of in-kind transfer payments. Overstating the Degree of Income Inequality • The distribution of money income overstates the degree of inequality: • 2. It focuses on income distribution at a point in time rather than over the course of a lifetime. • Income is distributed more equally over the course of a lifetime than at a point in time. Distribution of Wealth • The distribution of wealth is much more unequal than the distribution of income. • See Example 2 on page 31-4. • The greater inequality in the distribution of wealth is caused by differences in savings rates and by measuring wealth distribution at a point in time. • See Examples 3 and 4 on page 31-4. Overstating the Inequality in Wealth Distribution • The inequality of wealth distribution is overstated because: • 1. Wealth distribution compares persons at different career stages. • 2. Human capital is not included in measuring wealth. • See Example 5 on page 31-4. Causes of Continuing Income Inequality • 1. Natural ability. • 2. Human capital. • 3. Work and leisure choices. • 4. Risk taking. • 5. Wrongful employment discrimination • 6. Luck. Human Capital • Human capital – developed ability that increases a person’s productivity. • Human capital is developed primarily through education and training and through work experience. • See Example 6 and the tables on pages 31-5 and 31-6. Work and Leisure Choices • People differ in the work and leisure choices that they make. • Example 7: In 2006, for households in the Lowest Income 20%, only 15% of households included a full-time, year- round worker. 75% of households in the Highest Income 20% had at least two earners in the household. Risk Taking • People differ in their willingness to take risks. • Risk takers are more likely to rise to the top of the income scale or to sink to the bottom. • Example 8: Less than 20 percent of the American labor force is self-employed. But nearly 70 percent of American millionaires are (or were) self-employed. Wrongful employment Discrimination • Wrongful employment discrimination occurs when employers make hiring, promotion, and pay decisions based on factors unrelated to worker productivity. • One viewpoint holds that wrongful employment discrimination can be reduced by making markets more competitive. • See Examples 9A and 9B on page 31-6. Wrongful employment Discrimination • Another viewpoint contends that increased government regulation of labor markets is necessary to reduce wrongful employment discrimination. • This viewpoint assumes that markets will not be competitive enough or that employers will be so biased against certain employee characteristics that they will willingly put themselves at a competitive disadvantage. Standards of Income Distribution • 1. Marginal productivity standard (market). • a. Provides maximum incentive for productivity. • b. Provides maximum individual freedom. • c. Does not redistribute income to attempt to achieve greater total utility. Standards of Income Distribution • 2. Equality standard. • a. May increase total utility for society. • b. The quantity of total production is likely to fall since the equality standard breaks the market link between effort and reward. • c. The government intervention to redistribute income will decrease individual freedom. Income Redistribution • The basic justification for income redistribution is to increase total utility for society. • Redistribution to achieve greater equality may increase total utility up to a point. • At some point, the disincentive effect of income redistribution will decrease the total quantity of production so much that total utility decreases. Ideal Income Redistribution • An ideal income redistribution system would: • 1. Transfer most from those with the highest income. • 2. Transfer most to those with the lowest income. • 3. Interfere with private market decisions as little as possible. Ideal Income Redistribution • An ideal income redistribution system would: • 4. Interfere with the incentive for productivity as little as possible. • 5. Provide as little opportunity for rent seeking as possible. • 6. Be as simple and inexpensive to administer as possible. Actual Income Redistribution • The actual income redistribution program in the U.S. is badly flawed: • 1. The income that funds income redistribution is not necessarily transferred from those with the highest income. • 2. Most income redistribution transfers are not received by those with the lowest income. Actual Income Redistribution • 3. Income redistribution policies often interfere strongly with private market decisions. • 4. Income redistribution efforts have a strong disincentive effect on both taxpayers and transfer recipients. Actual Income Redistribution • 5. Income redistribution policies often are subject to rent seeking. • 6. The income redistribution program is very complex. Negative Income Tax • A negative income tax would transfer income to low income households. • A basic support amount would be set and then the support would be reduced by a fraction of income earned. • At some level of income, support would be eliminated. • See Example 11 on page 31-10. Poverty • Poverty – a family whose income falls below a minimum necessary for an adequate standard of living is classified as living in poverty. • Poverty rates tend to be higher for minority groups, single parent families, the young, and the poorly educated. • See the table on page 31-11. Poverty and Economic Mobility • In an average ten year period, about a quarter of households will have income below the poverty line in at least one year. • Fewer than 3% of households will have income below the poverty line for eight or more of the ten years. Four Keys to Achieving Financial Security • 1. Believe that you can achieve financial security. • 2. Invest in your human capital. Investing in human capital pays an even higher return today than it did in the past. • See Example 13 on page 31-12. Four Keys to Achieving Financial Security • 3. Make good personal choices; • a. Health. • b. Marriage. • c. Self-control. • 4. Get on the good side of compound interest. Compound Interest • Compound interest refers to interest paid on interest. • Compound interest is the saver’s best friend and the borrower’s worst enemy. • See Examples 14A, 14B, 14C, and 15 on page 31-13. Gini coefficient • The Gini coefficient is a measure of income inequality based on the Lorenz curve. • See the graph and the formula on page 31-14. Gini coefficient • The higher the Gini coefficient, the greater the degree of income inequality. • See the comments about various countries on page 31-14.