Income redistribution
Today: Conceptual issues
Programs for the poor
Previously

Income redistribution through Social Security



Redistribution from young to old
Redistribution from rich to poor
Redistribution from those that die young to those
that die old
Today

More on income redistribution

Chapter 12

Conceptual issues




Distribution of income
Rationales for redistribution
In-kind versus cash transfers
Chapter 13

Various welfare programs for the poor

TANF, EITC, Supplemental Security Income, Medicaid,
Unemployment insurance, Nutrition programs, Housing
assistance, Education/Job training
Conceptual issues

How is income distributed?


Is there such a thing as “too much” income
inequality?
Why should there be redistribution?



Simple utilitarianism
Maximin criterion
In-kind versus cash transfers

When income is redistributed, should recipients be
forced to consume a minimum amount of certain goods?
Is there “too much” income inequality

Some people would argue yes



“Marginal utility of income is lower for somebody
with high incomes”
“Each person has a right to a minimum standard
of living”
“Social unrest may occur unless each person is
above the poverty line”
Is there “too much” income inequality

Some people would argue no

“When economic incentives to make a good living
go away, the economic pie becomes smaller”



Think about communist systems
“People that have a good work ethic and work
hard should make more money”
“There are plenty of opportunities for anybody
born today in the US to become successful”

Free K-12 education; subsidized colleges and
universities
Absolute income
Quintile
1980
1990
2000
Bottom 20 percent
$12,756
$12,625
$14,232
Second 20 percent
$27,769
$29,448
$32,268
Middle 20 percent
$41,950
$45,352
$50,925
Fourth 20 percent
$58,200
$65,222
$74,918
Top 20 percent
$97,991
$121,212
$155,527
Top 5 percent
$139,302
$190,187
$272,349



Real income growth, 1980-2000
 Bottom 20% has been flat
 Top 20% has seen huge growth (59%)
Note that the “economic pie” is getting bigger
See also Table 12.1, p. 259, for more on this topic
Source: “Principles of Microeconomics” 3rd edition, by Frank and Bernanke
Problems with annual income figures

Ignores number of workers in a household




In-kind transfers ignored
Taxes change over time


General trend from one earner to two
Expenses, such as child care, could be higher with in twoworker households
Disposable income changes over time (given the same
income)
Income changes over time

If a rich person earns no income in a calendar year, should
she be considered “poor?”
Different views of income redistribution

Some people believe that utility, not income,
should be maximized within a population


Additive social welfare function
W = U1 + U2 + … + Un
See Figure 12.2, p. 264, for a model of
optimal income distribution
Different views of income redistribution

Others believe that social welfare should be
the minimum of the utilities of each person in
society

“Veil of ignorance” argument developed by John
Rawls



Conceals knowledge and talents from people
Risk averse people will want to have income equality
under these conditions
No inferiority, jealousy or envy based on income
Different views of income redistribution

Commodity egalitarianism

Some things should be made available to
everyone without restrictions




Right to vote (if 18 or older)
Basic education
“Needed” items such as food, shelter, and clothing
Basic medical care

Recall issues presented in Chapters 9 and 10
Some other factors

Income redistribution does not directly take
into account other factors

Number of hours worked

If our goal is to maximize utility from income, why not
reduce leisure?



Not necessarily, since additional leisure likely increases
utility
Income depends on number of hours worked
Does relative income matter?

Does someone get a decrease in utility when his income
remains the same and someone else’s increase?
In-kind versus money transfers


With some views, such as commodity
egalitarianism, in-kind transfers have more
appeal than monetary ones
How does this affect individual utility?

See Figures 12.3, p. 272, and 12.4, p. 273
Summary: Conceptual issues



People have conflicting opinions as to
whether or not there is too much income
inequality
Most increases in income in recent decades
have gone to the wealthiest of Americans
Some arguments support the use of in-kind
transfers rather than monetary transfers
Welfare programs for the poor

Over $500 billion in expenditures in 2002








TANF
EITC
Supplemental Security Income
Medicaid
Unemployment insurance
Nutrition programs
Housing assistance
Education/Job training
TANF

Temporary Assistance for Needy Families



Federal government provides block grants to
states for welfare spending
Over 80% of recipients in every state must be on
TANF for five years or less
States face penalties if a substantial percentage
of recipients are not working or in work
preparation programs
TANF

TANF replaced Aid to Families with
Dependent Children (AFDC)

Under AFDC, some argued that many women on
AFDC had children out of wedlock to continue get
benefits and not have to work

If the mother had to work once the child reached
kindergarten, then there would be an economic incentive
to have another child
TANF and benefit reduction rates

TANF benefits are reduced when income
reaches a certain level


Example: In California, recipients can earn up to
$225 per month before benefits are reduced at a
rate of 50% of money earned
How do people respond to these incentives in
the short run?
Work incentives
The Basic Trade-offs
G – basic grant if not
working
t – rate at which grant
reduced when recipient
earns money
B – benefit received
B = G – tE
B = 0 if E = G/t
Analysis of work incentives

Figure 13.1, p. 281


Budget constraint for leisure and income
Figure 13.2, p. 282

Utility maximization based on the labor-leisure
options
Analysis of work incentives

Figure 13.4, p. 284




In this example, someone can get $100 in TANF
benefits if not working
Between point Q and point S, an implicit tax rate
of 25% is imposed
Note that there are some incentives to work while
still receiving benefits
Figure 13.6, p. 286

In this case, a 100% implicit tax rate is imposed
after a benefit of $338 is received
Income per month (= earnings + transfers)
Analysis of work incentives
This person is
indifferent
between
working and
receiving
benefits.
D
E2
R
G
P
See also
Figure 13.7, p.
286, for a case
in which an
individual
chooses to
work.
Hours worked
(if working)
0
M
T Hours of leisure per month
EITC

The earned income tax credit



A success story for the working poor
Provides credits to workers within low incomes
How it worked in 2006 for a family with 2 or
more kids




40% credit for first $11,340 earned
No additional credit for next $5,470 earned
Phased out at a 21.06% rate after $16,810 is
earned, until the credit is gone at $38,348 earned
See Figure 13.8, p. 289, for two graphs about this
What has the EITC done?

Households with nobody working


Encourages one person to work
Households with one person working

Additional work not encouraged once a family with
2+ kids earns $11,340


Does not encourage additional hours of work of the
person already working
Does not encourage a second worker in the household
to work
Supplemental Security Income (SSI)



Federal program that provides benefits for
the aged, blind, and disabled with little or no
assets
In 2003, average benefit was $342
SSI recipients can earn up to $65 per month
without loss in benefits

After $65 is earned, additional earnings have a
50% implicit tax rate
Medicaid

Medicaid affects incentives to work


Under old incentive structures, people
often lost eligibility once they earned
enough money to get off of welfare
This created a “Medicaid notch”

See Figure 13.9, p. 292

For main
details
about
Medicaid,
see
Chapter 10
Solving the Medicaid notch problem

In recent years, families that earn enough to
leave welfare can often stay on Medicaid


12 month coverage after leaving TANF
Low-income children and pregnant women
Unemployment insurance (UI)


States provides insurance for unemployment due to
adverse selection and moral hazard reasons
Benefits




Average weekly benefit in 2005: $266
Maximum length of benefits in most states: 26 weeks
Typically financed by a payroll tax on employers
Empirical studies find that increasing benefits
increases the duration of unemployment
Food stamps

Many poor households are eligible for food
stamps


Can only be used for purchasing domesticallyproduced food, excluding alcohol and animal food
2004 averages


Monthly benefit was about $200
23.9 million people on food stamps in a given
month
Housing assistance

Public housing projects




Largest program, currently about 1.3 million units
When kids see building with everyone with low
incomes, there are no role models for being
successful
Crime is a big problem
Section 8


Recipients rent a unit in the private market
Government provides subsidy if unit meets certain
requirements
Education and job training

Programs aimed at poor families

Head Start


Training programs


Results mixed, but mostly positive
Evidence shows that costs are higher than benefits
Job search programs

Not effective in increasing living standards of many
people
Overview

See Figure 13.10, p. 299

Estimates marginal tax rates for a one-parent,
two-child household residing in Wisconsin


Negative until about $10,000 per year
Over 40% from about $12,000-$31,000 per year
Future of social insurance?

Academics are starting to study alternate
ideas to help the poor



Providing benefits to those most in need, rather
than those that are already “in the system”
“One-stop shopping” for help
Faith-based support

Government provides cash to the faith-based
organization, and the organization provides the service
Summary: Welfare programs for the poor


Many programs exist to support poor people
Some programs give little economic incentive
to work

Exception: Earned income tax credit
End of Unit 3

Next lecture, begin Unit 4


Tax-related topics
Read Chapters 14 and 15