Income, Poverty, and Healthcare
15 c h a p t e r
The ultimate purpose of producing goods and services is to satisfy the material wants of people. Up to this point, we have examined the process by which society decides which wants to satisfy in a world characterized by scarcity; we have examined the question of how goods are produced; and we have examined the question of how society can fully utilize its productive resources. We have not, however, looked carefully into two equally important questions: For whom does society produce consumer goods and services? Why are some people able to consume much more than others? Exhibit 1 shows a breakdown of average annual family income by groups of five (or quintiles): the bottom fifth, the second fifth, the third fifth, the fourth fifth, and the top fifth.
THE RECORD SINCE 1935
Exhibit 2 illustrates the changing distribution of measured income in the United States since 1935.
As you can see in this table, the proportion of income received by the richest Americans (top 5 percent) declined sharply after 1935 but has been edging back up since the 1980s. The proportion received by the poorest Americans (the lowest 20 percent) has remained virtually unchanged since 1935. Most of the observed changes occurred between 1935 and 1950, probably reflecting the impact of the Great Depression and new government programs in the 1930s, as well as World War II.
From 1950 to 1980, there was little change in the overall distribution of income. Two significant changes have occurred since the 1980s: The lowest one-fifth of families have seen their share of measured income fall from 5.3 percent to 4.2 percent of all income, and the top one-fifth of families have
Income Distribution
s e c t i o n
15.1
_ What has happened to income distribution since 1935?
_ Are income distribution statistics accurate?
_ How significant is income mobility?
_ How much income inequality exists in other countries?
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Income Distribution of the United States, 2002
SECTION 15.1
EXHIBIT 1
Household Income Group (Average)
Bottom Fifth $9,990 Second Fifth $25,400 Third Fifth $42,802 Fourth Fifth $67,326 Top Fifth $143,743 Median Household Income = $42,409
SOURCE: U.S. Bureau of the Census, September 2003.
Lowest Second Third Fourth Highest Highest Year Fifth Fifth Fifth Fifth Fifth 5%
1935 4.1% 9.2% 14.1% 20.9% 51.7% 26.5% 1950 4.5 12.0 17.4 23.4 42.7 17.3 1960 4.8 12.2 17.8 24.0 41.3 15.9 1970 5.4 12.2 17.6 23.8 40.9 15.6 1980 5.3 11.6 17.6 24.4 41.1 14.6 1990 4.6 10.8 16.6 23.8 44.3 17.4 2001 4.2 9.7 15.4 22.9 47.7 21.0
SOURCE: U.S. Bureau of Census.
Income Inequality in the United States SECTION 15.1
EXHIBIT 2
seen their share of measured income rise from 41.1 to 47.7 percent of all income.
ARE WE OVERSTATING THE DISPARITY IN THE DISTRIBUTION OF INCOME?
Failing to take into consideration differences in age, certain demographic factors, institutional factors, and government redistributive activities have all been identified as elements that influence income distribution data and may suggest that we might be overstating inequality.
Differences in Age
At any moment in time, middle-age people tend to have higher incomes than both younger and older people. Middle age is when most people are at their peak in terms of productivity and participate in the labor force to a greater extent than do the very old or very young. Put differently, if every individual earned exactly the same total income over his or her lifetime, there would still be some observed inequality at any given moment in time simply because people usually earn more in middle age.
Inequality resulting from this demographic difference overstates the true inequality in the lifetime earnings of people. A typical 50-year-old male earns nearly twice the income of a male in his early 20s and nearly one-third more than workers over 65. Since 1950, the proportion of individuals who are either very young or very old has grown, meaning that in a relative sense, more people are in lower-income age groups.
Other Demographic Trends
Other demographic trends, like the increased number of divorced couples and the rise of two-income families, have also caused the measured distribution of income (which is measured in terms of household income) to appear more unequal. For example, in the 1950s, the overwhelming majority of families had single incomes. Today, many households have two breadwinners instead of one. Suppose their incomes rise from $50,000 a year to roughly $100,000; thus, these households move into a higher-income quintile and create greater apparent income inequality. At the same time, divorces create two households instead of one, lowering income per household for divorced couples; thus, they move into lower-income quintiles, also creating greater apparent income inequality.
Government Activities
Some economists have argued that the impact of increased government activity should be considered in evaluating the measured income distribution.
Government-imposed taxes burden different income groups in different ways. Also, government programs benefit some groups of income recipients more than others. For example, it has been argued that state subsidized higher education has benefited the high- and middle-income groups more than the poor (because far more students from the higher income groups go to college), as have such things as government subsidies to airports and airlines, operas, and art museums. Some programs, though, clearly aid the poor more than the rich. Food
Income Distribution 311
What impact do you think higher divorce rates will have on income inequality?
As you would probably imagine, when one family with two incomes turns into two families with one income each, there will be more families reporting and less income per family. Often this causes one high-income household to become two middle-income households in the data. However, the most dramatic changes in the distribution of income may occur in households with one male breadwinner. When the breakup occurs, the woman, who may have little previous job experience, is forced to look for a job. And if she receives custody of the children, her search might be limited to part-time jobs or low-paying jobs with flexible hours. Her new household income will undoubtedly be far lower, also increasing measured income disparities between families.
DEMOGRAPHIC FACTORS AND INCOME DISTRIBUTION
USING WHAT YOU'VE LEARNED
A Q
stamps, school lunch programs, housing subsidies, Medicaid, and several other programs provide recipients with in-kind transfers. In-kind transfers are given in the form of goods and services rather than money. When in-kind transfers are included in income distribution data, many economists conclude that they have served to reduce levels of inequality significantly from the levels suggested by aggregate income statistics.
On balance, the evidence suggests that inequality of money income in the United States declined from 1935 to 1950 and then remained rather stable until 1980. Since then, the distribution of income has become less equal. However, if we consider age distribution, institutional factors, and in-kind transfer programs, it is safe to say that the income distribution is more equal than it appears in Exhibit 2.
HOW MUCH MOVEMENT IS THERE ON THE ECONOMIC LADDER?
A study of income mobility during the decade of 1985–1995 found that less than 50 percent of individuals who began in the poorest quintile ended up there a decade later, and almost 30 percent of those in the poorest quintile moved up to the top three quintiles. Although, roughly 80 percent of individuals in the richest quintile were still there a decade later, the research does not show that people moving into the top quintile tended to stay there. In the middle quintiles, there appeared to be considerable movement up and down the income ladder. Generational studies also suggest that there is a considerable income mobility—that is, there tends to be only slight positive correlation between income of fathers and sons. If a father had lifetime income earnings 20 percent above his generation, his son could expect to earn income about 8 percent above his generation. There was virtually no positive correlation between the earnings of grandchildren and grandparents. In short, high-income and lowincome earners will always be with us, but more than likely they will be different people.
In sum, most Americans experience significant fluctuations in their economic well-being from one year to the next. According to a Census Bureau study in the mid-1990s, about three-fourths of the population see their economic well-being go either up or down by at least 5 percent from one year to the next. Economic well-being can be affected by changes in personal and family circumstances, such as work experience, marital status, and household composition, as well as changes in earnings.
WHY DO SOME EARN MORE THAN OTHERS?
There are many reasons why some people earn more income than others. Some reasons for income differences include differences in age, skill, human capital (education and training), and preferences toward risk and leisure.
Age
The amount of income people earn varies over their lifetimes. Younger people with few skills tend to make little income when they begin their working careers. Income rises as workers gain experience and on-the-job training. As productivity increases, workers can command higher wages. These wage earnings generally increase up to the age of 50 and fall dramatically at retirement age, around 65.
Skills and Human Capital
Some workers are just more productive than others and therefore earn higher wages. Greater productivity can be a result of innate skills or of improvements in human capital, such as training and education. In Exhibit 3, we see that college graduates’ average earnings are 81% greater than high school graduates.
The financial rewards for attending college are higher than ever. Why is there a widening gap between skilled and unskilled workers? One possibility is that with international trade increasing over the last thirty years, there has been an increase in domestic demand for skilled workers and a decrease in demand for domestic unskilled workers (unskilled workers are relatively cheap and plentiful in developing countries). That is, the U.S. tends to import goods produced with unskilled workers and export goods produced with skilled workers. In addition, technological changes to more sophisticated equipment can lead to an increase in demand for skilled workers. Other workers, like star athletes and rock stars, have specialized talents that are in huge demand, so they make more money than those with fewer skills or with skills that are in less demand.
Worker Preferences
Aside from differences in age, skills, education, and training, people have different attitudes about and preferences regarding their work. Because worka-
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holics (by definition) work longer hours, they earn more than others with comparable skills. Some workers earn more because they work more intensely than others. Still others may choose jobs that pay less but have more amenities—flexible hours, favorable job locations, generous benefit programs, child care, and so on. Some people choose to work less and spend more time pursuing leisure activities, like traveling, hobbies, or spending time with family and friends. It is not for us to say that one preference is better than another but simply to recognize that these choices lead to differences in earnings.
Job Preferences
Finally, some of the differences in income are the result of the risks or undesirable features of some occupations.
Police officers and firefighters are paid higher wages because of the dangers associated with their jobs. The same would be true for window washers on skyscrapers and painters on the Golden Gate bridge. Coal miners and garbage collectors are paid more than other workers with comparable skill levels because of the unpleasantness of the jobs. In short, some workers have higher earnings because they are compensated for the difficult, risky, or unappealing nature of their jobs.
Income Distribution 313
$0 $20,000 $40,000 $60,000 $80,000 $100,000
Mean Earnings of Year-Round Full-Time Workers, 2001 Schooling
$120,000 Doctoral Degree $94,963 Master’s Degree $74,133 Bachelor’s Degree $59,683 Some College (no degree) $38,809 High School $32,906 Less Than High School $27,340 Professional Degree $113,725
Education and Earnings, 2001 SECTION 15.1
EXHIBIT 3
Earnings increase with additional education.
SOURCE: U.S. Department of Commerce, Current Population Reports, P-60 Series. Money Income in the United States: 2002. Table P-26.
© Jerry Scott and Jim Borgman, ZITS. Reprintedwith permission, King Features Syndicate
INCOME DISTRIBUTION IN OTHER COUNTRIES
Is the United States typical of advanced, industrial nations with respect to the distribution of income among its population? This is a difficult question to answer with absolute certainty, given international differences in defining income, difficulties in measuring the impact of taxes, the problem of nonmonetary payments, and so on. Despite these hurdles, international comparisons of income distribution have been made.
Exhibit 4, constructed with data from the World Bank, shows that income inequality is greater in the United States and United Kingdom than in Sweden and Japan. However, the table also shows that some of the greatest disparities in income are found in developing countries such as Mexico, South Africa, and Brazil.
Although income inequality within nations is often substantial, it is far less than income inequality among nations. A majority of income inequality on Earth reflects differences in living standards among countries rather than disparities within nations.
This is borne out by statistics.
314 CHAPTER FIFTEEN | Income, Poverty, and Healthcare
The contrasts between rich and poor are more extreme in Brazil than in almost any other country in the world.
According to the UN Development Program, nearly half of Brazil's population lives in absolute poverty. Those who are unable to make a living as vendors of newspapers or lottery tickets, shoeshine boys, guards for parked cars or the like are often forced to earn a living illegally. The number of children who work on the streets, or even live there permanently, is estimated to have reached 10 million.
Global Income Inequalities
EXHIBIT 4
Lowest Highest Country 10% 10%
Japan 4.8% 21.7% Sweden 3.7 20.1 Germany 3.3 23.7 India 3.5 33.5 Canada 2.8 23.8 France 2.8 25.1 United Kingdom 2.3 27.7 China 2.4 30.4 United States 1.8 30.5 Russia 1.7 38.7 Mexico 1.3 41.7 Chile 1.3 45.6 South Africa 1.1 45.9 Brazil 0.7 48.0
SOURCE: World Bank, World Development Report 2003
NOTE: The income inequality differences are approximations, because the data vary according to survey year and different methods are used for computing the distribution of income in different countries.
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The emphasis to this point has been on describing the amount of income inequality present in the United States and the rest of the world. Little has been said about the impact that inequality has on human welfare. Because of the difficulty of measuring welfare or of comparing the welfare of one person with another, it is impossible to “prove” that a given income distribution is better than another.
At the same time, however, it is clear that political and social changes in the past century or two have generally worked to reduce income inequality.
In some cases, revolutions have been fought with income redistribution as a paramount motive—such was the case with the Russian Revolution and probably the French Revolution, not to mention many more recent upheavals in less-developed countries.
Why is it generally felt that justice, fairness, and happiness would all be improved by increasing the income of the poor relative to the well-to-do or rich?
THE CASE FOR INCOME REDISTRIBUTION
The economic theory supporting policies of income redistribution is derived from the principle of diminishing marginal utility. According to this principle, increases in income generate less additional happiness (utility) at higher levels of income.
Consider Exhibit 1. Suppose a family with an income of $300,000 a year has $30,000 taken from it in the form of a tax on income. The family accordingly reduces its consumption spending, forcing it to cut out some spending on luxuries—perhaps taking less-expensive vacations, forgoing a vacation home, and so on. This lowers the family’s daily utility, say, from 27 utils to 25 utils. The marginal utility of the income given up is 2 utils (27 – 25). Now, suppose the income of some family making $10,000 a year is increased by the $30,000 taken from the first, well-to-do family. The poor family was formerly unable to purchase cars or appliances or take vacations. Now their utility is positively influenced by the transfer payment of $30,000, as it increases from 6 to 15 utils a week.
The marginal utility to the poor family of the $30,000 in transfer payments is 9 utils (15 – 6). Using the Robin Hood approach—taking from the rich and giving to the poor—could possibly increase society’s total utility in this case, because the
The Pros and Cons of Income Equality 315
1. From 1935 to 1980, the distribution of income became more equal. However, since 1980, there has been increased inequality.
2. Nonmonetary income and privileges to the well-to-do may understate the disparity in income inequality, while demographics, institutional factors, and government programs may overstate the disparity in income inequality.
3. High-income and low-income earners will always be with us, but they will likely be different people.
4. Income inequality between nations is substantial.
1. Why might patterns in the measured income distribution give an inaccurate impression?
2. Why might income distribution statistics understate the degree of income inequality?
3. Why might measured income shares overstate the degree of income inequality?
4. How does the fraction of the population that is middle aged, rather than young or old, affect measurements of income inequality?
5. How does the growth of both two-earner families and divorced couples increase measured income inequality?
6. Why is it important to take account of the substantial mobility of families within the income distribution over time when evaluating the degree of income inequality in America?
s e c t i o n c h e c k
The Pros and Cons of Income Equality
15.2
_ What is the case for income redistribution? _ What is the case against income redistribution?
rich family loses only 2 utils a week while the poor family gains 9 utils.
Thus, there is a theoretical argument favoring income redistribution. Note, however, that the argument is based on the critical assumption that people are alike in how they experience diminishing marginal utility from increasing income, a proposition impossible to prove (economists assume that interpersonal utility comparisons are not possible).
Many people believe it is a plausible assumption, but it is merely an assumption nonetheless. It is possible, however, that someone making $20 million a year after taxes would lose little utility if that income was cut to $17 million compared with the gains of the many poor families who could have their income doubled or tripled by receiving a portion of that income.
From time to time, groups have conducted polls asking people, “Are you happy?” Evidence from these polls suggests that, at a moment in time within a country, happiness is positively correlated with income—rich people are generally happier than poor people. This does not necessarily support the existence of diminishing marginal utility, but it might be evidence used by those who argue that income ought to be redistributed simply on the grounds of economic justice and fairness. Many people are able to command high incomes simply because of some inherited physical or mental talents that they develop or because they were, in some other way, “lucky.” Why should these people be happier than others simply because of fate? If you believe society should try to equalize happiness among its members, you could argue that some income redistribution makes sense.
THE CASE AGAINST INCOME REDISTRIBUTION
What are the arguments against a radical redistribution of income that would eliminate virtually all differences? The first argument is based on the principle of equity. Is it “fair” to take most of the income of hard-working, talented people who earn high incomes, particularly when some of it is given to people who perhaps may be perceived as shiftless and lazy? Not all poor people are automatically good and deserving, nor are all rich people greedy and selfish. Related to that, some income inequality would seem desirable, because consumption needs may well vary with family size, age of family members, and other factors. Total equality of family income, for example, would penalize those who choose to have big families, while total equality in
individual incomes would perhaps penalize those who choose to have small families or live alone.
Indeed, it is possible that the rich are rich largely because of their high marginal utility of income, while many poor may be poor because they
316 CHAPTER FIFTEEN | Income, Poverty, and Healthcare
Income per Year (thousands of dollars)
0 10 40 270 300 MU
Marginal Utility
Utility gain from receiving $30,000 Low – Income Groups High – Income Groups Utility loss from losing $30,000
Diminishing Marginal Utility of Income SECTION 15.2
As income rises, the happiness associated with that income also rises, but the principle of diminishing marginal utility of income means it rises by diminishing amounts. Assuming the two groups have identical marginal utility curves, the decrease in utility that results from taking some income from high-income groups may be less than the increase in utility generated by giving this income to low-income groups. Such redistribution would enhance total utility in society if people have similar preferences for income. The exact utility-income relationship is impossible to state, however, because of our inability to measure utility or to make utility comparisons among individuals.
care less about goods relative to nonwork activities.
As you can see by comparing the shaded areas in Exhibit 2, if this is indeed the case, the rich lose more than the poor gain from the transfer of income.
In this situation, then, transferring income from rich to poor actually makes society worse off!
When a worker is denied employment on the basis of some biological feature, such as sex or race, without any regard to productivity, it is called jobentry discrimination. Wage discrimination occurs when a worker is given employment at a wage lower than that of other workers, based on something other than productivity.
JOB-ENTRY DISCRIMINATION
In a world where sex and race have absolutely no bearing whatsoever on the employment circumstances of people (e.g., talent, education, willingness and ability to work, move, etc.), every occupation would, apart from random variations, have a workforce with the same sex and race proportions as the population at large. Thus, on average, 51 percent of employees in each occupation would be expected to be female, if women comprised 51 percent of the population, and approximately 12 percent or so would be blacks and other racial minorities, reflecting the proportion of nonwhites to the total population.
The Economics of Discrimination 317
Income ( Y ) per Year
0 YPOOR Y Œ
POOR YRICH Y Œ
RICH
MURICH
MUPOOR
Marginal Utility of Income
Utility loss from losing $30,000 Utility gain from gaining $30,000
Differences in Marginal Utility of Income
SECTION 15.2
The rich may have a higher marginal utility of income. Therefore, transferring income from rich to poor could make society worse off.
The Economics of Discrimination
15.3
_ What is job-entry discrimination?
_ What is wage discrimination?
_ Do earnings differences reflect discrimination or differences in productivity?
_ How can we remedy discrimination?
1. If the happiness or utility derived from additional income is subject to diminishing marginal utility, then it is possible that income taken from the very rich and given to the very poor might increase total utility. However, this argument is based on the assumption that people are alike in how they experience diminishing marginal utility from increasing income, a proposition that is impossible to prove.
2. Some income redistribution may lead to greater economic growth, but massive redistri...
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