INCOME REDISTRIBUTION
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
1

Virtually every important political issue involves the
distribution of income. This part presents a framework
for thinking about the normative and positive aspects of
government income redistribution policy.
(1)
The theory of welfare economics indicates that efficiency
by itself cannot be used to evaluate a given situation.
Criteria other than efficiency must be considered when
comparing alternative resource allocations.
(2)
Decision-makers care about the distributional
implications of policy. The economist who systematically
takes distribution into account can keep policymakers
aware of both efficiency and distributional issues.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
2
I. DISTRIBUTION OF INCOME

Poverty line: a fixed level of real income considered
enough to provide a minimally adequate standard
of living.

In contemplating policies that might alleviate
poverty, it is sometimes helpful to know how far the
poverty population lies below the poverty line.

The poverty gap measures how much income
would have to be transferred to the poverty
population to lift every household’s income to the
poverty line (assuming the transfers has no effect
on the recipients’ work efforts).
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
3

A family’s income consists not only of the cash it
receives but also in-kind receipts (payments to
individuals in commodities or services).

The TÜİK measure of income underestimates
income by the amount of in-kind receipts. One
major form of in-kind income is the value of time
adults devote to their households.

All of the income data are before-tax. The fact that
the income tax system takes a larger share of
income from high than from low income families is
not reflected in the numbers.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
4

Income should be measured over some time period. But
it is not obvious what the time frame should be.

It is better to measure the flow of income over a year.
However, even annual measures may not reflect on
individual’s true economic position due to unexpected
fluctuations in income from year to year. Theoretically,
lifetime income would be ideal but it is not possible.

Should income distribution be measured over individuals
or households ? Especially when distributional
comparisons are being made across time, changes in
household composition must be considered.

One should be careful when making comparisons over
time about the standard measures of income distribution
and poverty levels.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
5
II. RATIONALES FOR INCOME REDISTRIBUTION

While there is no doubt that income is distributed
unequally, people disagree about whether the
government should undertake redistributional policies.
1) Simple Utilitarianism
W = f (U1, U2, ..., UN) utilitarian social welfare function.
 Ui; W A change that makes someone better off
without making anyone worse off, increases social
welfare.
Ex: W = U1 + U2 + ... + UN  additive social welfare
function
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
6

We assume:
1) Individuals have identical utility functions based on incomes.
2) There is diminishing marginal utility of income.
3) Total amount of income available is fixed.

With these assumptions and additive social welfare
function, government should redistribute income so as to
obtain complete equality.

As long as incomes are unequal, marginal utilities (MU)
must be unequal and the sum of utilities can be increased
by distributing income to the poorer individual.

At I*, social welfare is maximized.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
7

Problems:

1) It is impossible to determine whether individuals have
identical utility functions, and whether they derive the
same utility from equal amounts of income.

2) Although the MU of any given good may decrease with
its consumption, this may not be true for income as a
whole. If MU is constant, government redistributive policy
cannot change social welfare.

3) Individual’s utility may depend on leisure, also.
Government tries to maximize total utilities by distribution
but to do so, takes taxes and reduces the fixed income
possible. The optimal income distribution must take into
account the cost of achieving more equality.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
8
2) The Maximin Criterion


W = min (U1, U2, ..., UN)
Social welfare depends only on the utility of the person who has
the lowest utility. The objective is to maximize utility of person with
the minimum utility.

The income distribution should be perfectly equal, except to the
extent that departures from equality increase the welfare of the
worst-off person.

Rawl (1971)’s idea relies on the original position notion :an
imaginary situation in which people have no knowledge of what
their place in society is to be.

In the original position, people adopt the maximin social welfare
function because of the insurance it provides against disastrous
outcomes. People are afraid that they may end up at the bottom
of income distribution and therefore want the level at the bottom
as high as possible. These decision-makers are so risk-averse
that they are unwilling to take any chances.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
9
III. PARETO EFFICIENT INCOME REDISTRIBUTION

The previous discussions of additive and maximin social
welfare functions assume that redistribution makes some
people better off and others worse off.

Redistribution was never a Pareto improvement – a
change that allowed all individuals to be at least as well
off as under status quo. This is a consequence of the
assumption that each individual’s utility depends on
his/her income only.

If high-income individuals are altruistic, so their utilities
depend on own and poor’s incomes, redistribution can
actually be a Pareto improvement.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
10

Thurow (1971) argues that the income distribution can
be regarded as a public good, because everyone’s utility
is affected by the degree of inequality.

There is always some chance that through situations
beyond your control, you will become poor. An income
distribution policy is like insurance. When you are welloff, you pay premiums in the form of tax payments to
those who are currently poor. If bad times hit, policy pays
off and you receive relief.

Some believe that income distribution programs help
purchase social stability. If poor become too poor, they
may engage in antisocial activities like crime, rioting etc.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
11
IV. NONINDIVIDUALISTIC VIEWS

Some thinkers have approached the problem by
specifying what the income distribution should look
like independent of individuals’ tastes.

Tobin (1970) suggested that only special
commodities should be distributed equally, which is
called commodity egalitarianism.

Most people believe that the right to vote should be
distributed equally to all, as should the consumption
of certain essential foodstuffs during times of war.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
12
V. OTHER CONSIDERATIONS

No attention is given to fairness of either
processes by which the initial income distribution
is determined or of the procedures used to
redistribute it.

If “equal opportunity” (somehow defined) were
available to all, then the ensuing outcome would
be fair, regardless of the particular income
distribution it happened to entail. If the process
generating income is fair, there is no scope for
government-sponsored income redistribution.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
13
VI. EXPENDITURE INCIDENCE

The impact of expenditure policy on the distribution of real
income is referred to as expenditure incidence.

Any government program sets off a chain of price changes
that affect incomes of people both in their roles as consumers
and goods and as suppliers of inputs.

A spending program that raises the relative price of a good
you consume intensively makes you worse off, ceteris
paribus. A program that raises the relative price of a factor
you supply makes you better off.

The problem is that it is very hard to trace all the price
changes generated by a particular policy. Practically,
assumptions that a given policy benefits the recipients only
and the effects of other price changes on income distribution
are minor are made.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
14
1) Public goods:

Substantial government expenditure is for public goods. But
we have to know how much each family values a public good
to determine its impact on the income distribution.
2) In-kind transfers:

Not only lower-income individuals but also middle and upper
income people benefit from in-kind transfers, ex. education.

Unlike pure public goods, in-kind transfers are not consumed
by everyone. Estimating their value to beneficiaries is difficult.

A useful consumption is that 1 TL on in-kind transfer 1 TL
 in income.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
15
Conclusions:
(1) Under cash transfer program, individual may consume less X
and more all other goods than under in-kind transfer program.
(2) In-kind transfer of X2 does not make the individual as well off
as equivalent income.

These conclusions are not general.

Because the individual is happy to consume more than X2, he
is happy in both caser (in-kind transfer and cash transfer)

It cannot be known for certain whether an in-kind transfer will
be valued less than a direct income transfer.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
16

In-kind transfer programs often entail substantial
administrative costs. The costs may be so large that some
communities choose not to participate.

In-kind transfers may also help curb welfare fraud. People
who do not qualify are sometimes able to obtain benefits.

In-kind transfers may discourage ineligible persons from
applying because some middle-class people may be quite
willing to lie to receive cash but less willing to commit
fraud to obtain a commodity they do not really want.

In-kind transfers are attractive politically because they
help not only the beneficiary but also the producers of the
favored commodity.
Assoc. Prof. Y.Kuştepeli
ECN 242 PUBLIC ECONOMICS
17