INEQUALITY AND POVERTY
ECO 2023
Principles of Microeconomics
Dr. McCaleb
Inequality and Poverty
1
TOPIC OUTLINE
I.
Income Inequality in the United States
II. Income Distribution and Economic Status
III. Poverty and Income Redistribution
Inequality and Poverty
2
Inequality in the United States
Inequality and Poverty
3
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 and Poverty
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INEQUALITY IN THE UNITED STATES
Distribution of U.S. Household Money Income, 2005
1st
3.4%
2nd
8.6%
3rd
14.6%
5th
50.4%
4th
23.0%
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INEQUALITY IN THE UNITED STATES
 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 quintile
Lowest
–
–
–
–
–
First
Second
Third
Fourth
Fifth
$
$
$
$
$
0
19,179
36,001
57,661
91,706
Inequality and Poverty
Mean
$ 10,665
$ 27,357
$ 46,301
$ 72,825
$ 159,583
6
INEQUALITY IN THE UNITED STATES
The Skewed Distribution of
Income
The distribution of income is highly
skewed toward higher incomes.
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.
*Data for 2000
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INEQUALITY IN THE UNITED STATES
• Historical Trends in Inequality
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
Inequality and Poverty
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INEQUALITY IN THE UNITED STATES
Historical Trends in
Inequality
Between 1967, when the data series
begins, and the mid-1970’s, income
inequality measured by household
money income narrowed.
Since the mid-1970’s, income
inequality measured by household
money income has increased.
Inequality and Poverty
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INEQUALITY IN THE UNITED STATES
Historical Trends in Mean
Household Income
Although inequality has increased,
the average household in every
quintile had more purchasing power
in 2005 than in 1967.
Real income—mean household
income adjusted for inflation—has
increased in every quintile.
Inequality and Poverty
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INEQUALITY IN THE UNITED STATES
• International Comparisons
Share of Aggregate Individual Income Received by Lowest and Highest
Quintiles in Selected Countries (World Development Report, 2005)
Country
First Quintile
Fifth Quintile
Ratio
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
Brazil
3.1
2.0
59.1
64.4
19.1
32.2
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INEQUALITY IN THE UNITED STATES
 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.
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INEQUALITY IN THE UNITED STATES
Income Mobility, 1968-1991
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.
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Inequality and Poverty
25.9
53.1
51.0
41.6
48.2
20.4
24.8
20.5
46.9
24.2
1st
2nd
53.7
58.4
4th
5th
31.3
3rd
Moved to higher quintile
Stayed same
Moved to lower quintile
13
INEQUALITY IN THE UNITED STATES
 Demographic and Economic Characteristics
Differences between high-income and low-income
households and families
Demographic, education, and employment differences between highincome 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.
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INEQUALITY IN THE UNITED STATES
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 householder
Black
20.6%
5.8%
Hispanic
13.4%
5.9%
Family Status
Married couple
17.9%
79.0%
Female-headed family
19.7%
4.8%
Non-family household
59.0%
12.5%
Age of householder
Under 35
23.5%
14.8%
Over 65
37.1%
8.3%
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INEQUALITY IN THE UNITED STATES
Education and Employment Differences between High-Income and LowIncome Households
First Quintile
Fifth Quintile
Education of householder*
High school dropout
34.4%
2.6%
High school graduate
35.9%
16.2%
Some college
21.6%
23.1%
Bachelor’s degree
5.7%
32.9%
Advanced degree
2.5%
25.1%
Employment of householder
Full-time
23.2%
79.6%
Part-time
12.7%
9.1%
No work during year
64.2%
11.3%
Mean number of income earners
0.48
2.10
*Data for 2000
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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.
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True (T) or false (F): Mean household income adjusted for
inflation has increased in every quintile since 1967.
Inequality and Poverty
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Income Distribution and Economic Status
Inequality and Poverty
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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.
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
 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.
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
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.
First
Second Third Fourth
Fifth
Quintile Quintile Quintile Quintile 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
*Annual money income minus taxes plus non-cash transfers
Inequality and Poverty
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
 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.
Inequality and Poverty
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
Life Cycle Pattern of
Income
$26,036
65 and over
55-64
Median household income by age of
householder in 2005 clearly
displays the life cycle pattern of
income.
$52,260
45-54
$62,424
35-44
Income rises from age 15-24 to the
peak earning years of 44-55 and
then decreases, falling sharply after
age 65.
$58,064
25-34
$47,379
$28,770
15-24
$0
Inequality and Poverty
$15,000
$30,000
$45,000
$60,000
24
INCOME DISTRIBUTION AND
ECONOMIC STATUS
 The Economic Life Cycle
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.
Inequality and Poverty
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
 The Economic Life Cycle
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.
Inequality and Poverty
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
 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.
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
 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”
Inequality and Poverty
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
 Transitory Income
Transitory income and inequality
When annual money income is below the household’s expected longterm 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.
Inequality and Poverty
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INCOME DISTRIBUTION AND
ECONOMIC STATUS
 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
Second Third Fourth Fifth
Quintile Quintile Quintile Quintile Quintile
Mean Household Size (2000)
2.90
2.99
Inequality and Poverty
3.22
3.33
3.41
30
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
Inequality and Poverty
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Poverty and Income Redistribution
Inequality and Poverty
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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.
Inequality and Poverty
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POVERTY AND INCOME
REDISTRIBUTION
 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.
Inequality and Poverty
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POVERTY AND INCOME
REDISTRIBUTION
Trends in Poverty Rates
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.
The Hispanic poverty rate is similar
to the black poverty rate but it
increased during the 1980’s before
falling during the 1990’s.
Inequality and Poverty
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POVERTY AND INCOME
REDISTRIBUTION
Who Are the Poor?
Characteristics of Poor Families 2005
50.5% of poor people lived in
female-headed families.
Percent of poor families
headed by:
Female
Black
50.5%
27.5%
Poverty rates are highest for people
in families with no workers and in
female-headed families.
Percent of poor people in:
Married-couple families
Female-headed families
White families
Black families
Families with no workers
5.9%
31.1%
8.7%
23.6%
27.3%
Poverty rates are lowest for people
in married couple families and in
white families.
Percent of people in poor
families:
Under 18
Over 65
27.5% of poor people lived in
families headed by a black person.
Inequality and Poverty
17.1%
13.9%
36
POVERTY AND INCOME
REDISTRIBUTION
Poverty Is Not Permanent
There 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.
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37
POVERTY AND INCOME
REDISTRIBUTION
 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.
Inequality and Poverty
38
POVERTY AND INCOME
REDISTRIBUTION
 Income Redistribution
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.
Inequality and Poverty
39
POVERTY AND INCOME
REDISTRIBUTION
 Income Redistribution
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.
Inequality and Poverty
40
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.
2.
3.
4.
5.
6.
7.
i only
ii only
iii only
i and ii
i and iii
ii and iii
i, ii, and iii
Inequality and Poverty
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POVERTY AND INCOME
REDISTRIBUTION
 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:
redistribution to the poor.
Keep costs low by targeting
Low benefit reduction rate (or marginal tax rate): Provide positive
incentives for the poor to help themselves by working and earning
income.
Inequality and Poverty
42
POVERTY AND INCOME
REDISTRIBUTION
 An Anti-Poverty Impossibility Theorem
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.
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43
POVERTY AND INCOME
REDISTRIBUTION
 An Anti-Poverty Impossibility Theorem
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.
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44
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.
Income after Redistribution ($000)
POVERTY AND INCOME
REDISTRIBUTION
100
80
60
40
Breakeven
income
20
0
Inequality and Poverty
0
20
40
60
80 100
Market Income ($000)
45
Negative Income Tax (2)
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.
Income after Redistribution ($000)
POVERTY AND INCOME
REDISTRIBUTION
100
80
Marginal tax
rate=35.65%
60
40
Breakeven
income=$44,831
income
20
Guaranteed minimum
income=$17,603
0
Inequality and Poverty
0
20
40
60
80 100
Market Income ($000)
46
Negative Income Tax (3)
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.
Income after Redistribution ($000)
POVERTY AND INCOME
REDISTRIBUTION
100
80
Marginal tax
rate=35.65%
Marginal
tax
rate=66.67%
60
40
Breakeven
Breakeven
income=$44,831
income=$26,405
20
Guaranteed minimum
income=$17,603
0
Inequality and Poverty
0
20
40
60
80
100
Market Income ($000)
47
Negative Income Tax (4)
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.
Income after Redistribution ($000)
POVERTY AND INCOME
REDISTRIBUTION
100
80
60
Marginal tax
rate=66.67%
rate=35.65%
40
Breakeven
income=$26,405
20
Guaranteed minimum
income=$17,603
income=$9,413
0
Inequality and Poverty
0
20
40
60
80 100
Market Income ($000)
48
POVERTY AND INCOME
REDISTRIBUTION
 An Anti-Poverty Impossibility Theorem
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.
Inequality and Poverty
49
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).
Inequality and Poverty
50
POVERTY AND INCOME
REDISTRIBUTION
 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.
Inequality and Poverty
51
POVERTY AND INCOME
REDISTRIBUTION
 What Does It Mean To Be Poor Today in America?
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.
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52
POVERTY AND INCOME
REDISTRIBUTION
 What Does It Mean To Be Poor Today in America?
Possessions
Item
Approximately
One car
70%
Two or more cars
27%
One color TV
97%
Two or more color TV’s
50%
One VCR
75%
Two or more VCR’s
20%
Microwave oven
64%
Stereo system
50%
Automatic dishwasher
25%
Two-thirds have A/C compared with 36% of all Americans 30 years ago.
Inequality and Poverty
53