Income Distribution and Poverty

Distribution of Household Income • In a market economy, income depends primarily on earnings, which depend on the productivity of one’s resources • The problem with allocating income according to productivity is that some people have difficulty earning income • Some have mental and physical disabilities • Others may face limited job choices and reduced wages because of age, poor education, discrimination, bad luck, or the demands of caring for small children

Income Distribution • Consider the distribution of income and see how it has changed over time, focusing on the household as the unit of measure • After dividing the total number of U.S. households into five groups of equal size – quintiles – ranked according to income, we have Exhibit 1 by decade since 1970

Exhibit 1: Share of Aggregate Household Income 49.9 46.6 43.7 43.3 Lowest Second Third Fourth Highest quintile quintile quintile quintile quintile • Households in the lowest, or poorest, fifth of the population received only 4.1% of the income in 1970 • Households in the highest, or richest, fifth received 43.3% of the income • U.S. Census Bureau measures income after cash transfer payments are received but before taxes are paid. increase The share of income going to the top 5% of households has grown since 1980, accounting for all the growth in the top 20% of households decrease • Share of income going to the top fifth has increased • Share going to the bottom fifth has decreased slightly Top 5 % Primary contributor to the larger share going to the highest group has been the growth of two-earner households in the top growth and the growth in single-parent households in the bottom group. Middle 60 percent

Lorenz Curve • The Lorenz curve is another way to picture the distribution of income in an economy • The Lorenz curve shows the percentage of total income received by any given percentage of households when incomes are arrayed from smallest to largest • Exhibit 2 provides the Lorenz Curve

Exhibit 2: Lorenz Curve Cumulative percentage of households is shown along the horizontal axis, and cumulative percentage of income is on the vertical axis. If income were equally distributed, each 20% of households would receive 20% of the total income  the Lorenz curve would be the straight line shown in blue. As distribution becomes more uneven, the Lorenz curve is pulled down and to the right, away from the line of equal distribution. . a . Line of equal distribution b Point aon the 1970 Lorenz curve (in red) indicates in that year the bottom 80% of families received 56.7% of the income and the top 20% received 43.3% of the income. Point b on the 2000 Lorenz curve (in green) shows the bottom 80% received 50.6% of the income and the top 20% received 49.4% of the income. Since the Lorenz Curve for 2000 is farther from the line of even distribution than it was for 1970, income has become more unevenly distributed.

A College Education Pays More • Contributing to the dominance of the top group is a growing premium paid those with a college education for a number of reasons • Trends such as industry deregulation, declining unionization, and freer international trade have reduced the demand for workers with less education • New computer-based information technologies have reduced the demand for low-skilled clerical workers • The supply of less-educated workers increased more than the supply of more-educated workers

Problems with Distribution Benchmarks • First is that there is no objective standard for evaluating income distributions • The usual assumption is that a more equal distribution is more desirable, but is a perfectly even distribution most preferred? • A second problem is that most distributions measure money income after cash transfers but before taxes, it omits the effects of taxes and in-kind transfers such as food stands and free medical care  understates the share of income going to lower income groups

Problems with Distribution Benchmarks • Third, focusing on the share of income going to each income quintile overlooks the fact that household size differs across quintiles • Households in the bottom quintile contain 39 million people • The top quintile contains 64 million people • So households at the top average two-thirds larger than those at the bottom

Problems with Distribution Benchmarks • Fourth, the two exhibits presented here include only reported sources of income • Finally, a better measure of household welfare might be the distribution of expenditures • Evidence on expenditures indicates that spending by quintiles is much more evenly distributed than income

Why Do Household Incomes Differ? • The median income of all households is the middle income when all incomes are ranked from lowest to highest • Thus, one reason household incomes differ is that the number of household members who are working differ • For example, over two-thirds of households in the bottom 20% are headed by unmarried females

Why Do Household Incomes Differ? • Incomes also differ for all the reasons labor incomes differ, such as differences in education, ability, job experience, and so on • Differences in earnings based on age and education reflect a normal life-cycle pattern of income • In fact, most income differences across households reflect the normal workings of resource markets, whereby workers are rewarded according to their productivity

Poverty and the Poor • Since poverty is such a relative concept, how do we measure it objectively and how do we ensure that our measure can be applied with equal relevance over time? • The benchmark for poverty analysis is based on the assumption that the poor spend about one-third of their income on food  the U.S. Department of Agriculture estimates the cost of a nutritionally adequate diet

Poverty and the Poor • This nutritionally adequate diet is then multiplied by three to generate the U.S. official poverty level • The poverty definition is based on pretax money income, including cash transfers, but it excludes the value of noncash transfers such as food stamps, Medicaid, subsidized housing, or employer provided health insurance • Exhibit 3 presents some basic poverty measures

Exhibit 3: Poverty Measures

Programs to Help the Poor • What should society’s response to poverty be? • Families with a full-time worker are nine times more likely to escape poverty than are families with no workers  a healthy economy remains the first line of defense in fighting poverty • However, even when the unemployment rate is low, some people remain poor

Programs to Help the Poor • Since the mid-1960s, social welfare expenditures at all levels of government have increased significantly • These programs can be divided into two broad categories • Social Insurance • Income assistance

Social Insurance • Social insurance programs are designed to help make up for the lost income of those who worked but are now retired, temporarily unemployed, or unable to work because of disability or work-related injury • Social Security is designed to supplement retirement income of those with a work history and a record of contributing to the program • Medicare provides health insurance for short-term medical care, mostly to the elderly, regardless of income

Social Insurance • Other social programs include unemployment insurance and worker’s compensation which supports workers injured on the job • Both programs require that beneficiaries have a prior record of employment • The social insurance system deducts insurance premiums from workers’ pay to provide benefits to others. However, most current Social Security beneficiaries receive far more than they paid into the system

Income Assistance • Income assistance programs – what we usually call “welfare” programs – provide money and in-kind assistance to the poor • Do not require the recipient to have a history of work or have contributed to the program • Income assistance programs are normally means tested

Income Assistance • Means-tested programs require that a household’s income and assets must fall below a certain level to qualify for benefits • Federal government funds two-thirds of welfare spending, and state and local governments the remaining one-third

Income Assistance • The two primary cash transfer programs which vary inversely with income are: • Temporary Assistance for Needy Families (TANF) which provides cash to poor families with dependent children, replaced Aid for Families with Dependent Children (AFDC) • Controlled by each state and carries no federal entitlement • Each state given a fixed grant program to help fund TANF programs

Income Assistance • Supplemental Security Income (SSI) provides cash to the elderly poor and the disabled • Is the fastest-growing cash transfer program with outlays quadrupling from $8 billion in 1980 to nearly $32 billion in 2000 • SSI coverage has been broadened to include those addicted to drugs and alcohol, children with learning disabilities, and, in some cases, the homeless • The federal portion of this program is uniform across states, but states can supplement federal aid • Most states also offer General Assistance aid to those who are poor but do not qualify for TANF or SSI

Income Assistance • The federal government also provides an earned-income tax credit which supplements wages of the working poor • In addition to cash transfer programs, a variety of in-kind transfer programs provide health care, food stamps, and housing assistance to the poor

Income Assistance • Medicaid pays for medical care for those with incomes below a certain level; by far the largest welfare program costing twice as much as all cash transfer programs combined • It has grown more than any other poverty program, quadrupling in the last decade and accounting for nearly a quarter of the typical state’s budget • Qualifying level of income set by each state • Proportion of poor covered varies by state

Income Assistance • Food stamps are vouchers that can be redeemed for food • Funded by the federal government • Uniform across states and is aimed at reducing hunger and providing nutrition to poor families • Housing assistance programs include direct assistance for rental payments and subsidized low-income housing • Has more than doubled since 1990

Income Assistance • Exhibit 4: In 1959, the elderly were the poorest group, with a poverty rate of 35%. Since then, poverty among the elderly has declined to a record low of 9.7% in 2000. • This decline stems from tremendous growth in spending for Social Security and Medicare. • In real terms those two programs grew tenfold from $62 billion in 1959 to over $620 billion in 2000, measured in 2000 dollars. • Thus, while not welfare programs in a strict sense, Social Security and Medicare have been extremely successful in reducing poverty among the elderly.

Exhibit 4: Poverty Rates by Age: 1959–2000

Poverty and Public Choice • In a democracy, public policies depend very much on the political power of the interest groups involved • In recent years, the elderly have become a powerful political force • Voter participation rate of those 65 and over is higher than that of any other age group • For example, they show up at the polls at triple the rate of those between 18 and 24 and four times that of welfare recipients

Poverty and Public Choice • Unlike most interest groups, this is a group we all expect to join one day • The elderly are actually represented by five constituencies • The elderly themselves • Those under 65 who are concerned about the current benefits to their parents & other elderly relatives • Those under 65 who are concerned about their benefits in the future • Those who earn a living by caring for the elderly • Those running for office who want the votes the elderly deliver

Feminization of Poverty • One way of classifying the incidence of poverty is by age • Another way is based on the marital status and race of the household head • Exhibit 5 compares, for black, non-Hispanic white, and Hispanic families, the poverty rates for married couples with the rates headed by females with no husband present

Exhibit 5: Percentage of U.S. Families in Poverty by Type of Household Three trends are unmistakable First, poverty rates among married couples average only one-third the rates among female households Second, Hispanic households have the highest poverty rates followed by black families, then non-Hispanic white families Third, since the middle of the 1990s, rates have trended down for all types of families

Feminization of Poverty • While the exhibit shows the poverty rate among female householders, it doesn’t show the growth in the number of such households • The number of families headed by women has nearly tripled since 1960, while married-couple households grew just 40 percent • The percentage of births to unmarried mothers is five times greater today than in 1960

Feminization of Poverty • Today, one in ten children lives with a single parent who has never married • The United States has the highest teenage pregnancy rate in the developed world • Since the father in such cases typically assumes little responsibility for child support, children born outside of marriage are likely to be poorer than other children

Feminization of Poverty • The divorce rate has also increased  even children born to married couples now face a greater likelihood of living in a one-parent household before they grow up • Thus, the growth in the number of poor families since 1969 resulted overwhelmingly from a growth in the number of female householders

Feminization of Poverty • Families with a female head are in the worst position to take advantage of job growth  children of female householders are five times more likely to live in poverty than are other children • Young, single motherhood is a recipe for poverty • Often the young mother drops out of school, which reduces her future earning possibilities when and if she seeks work outside the home

Feminization of Poverty • Worse yet, young, single mothers-to-be are less likely to seek adequate medical care  a higher proportion of premature, underweight babies • The lack of education and limited job skills leads to the fact that most unwed mothers go on welfare • Poverty has therefore become increasingly feminized, mostly because female householders have become more common

Poverty and Discrimination • To what extent has racial discrimination limited job opportunities and increased poverty among minorities? • Discrimination can occur in many ways: in school funding, in housing, in employment, in career advancement • Also, discrimination in one area can affect opportunities in another, e.g, housing discrimination may reduce job opportunities

Poverty and Discrimination • Consider the difference between the earnings of white and nonwhite workers • After adjusting for a variety of factors that could affect the wage – education and work experience – research shows that whites earn more than blacks, but the gap between the two has narrowed • Some research suggests that black workers received a lower quality of schooling than white workers

Poverty and Discrimination • Direct evidence of discrimination comes from audit studies where otherwise similar white and minority candidates are sent to the same source to seek jobs, rent apartments, or apply for mortgages • These studies find that employers are less likely to interview or offer a job to minority applicants and minority applicants tend to be treated less favorably by real estate agents and lenders

Affirmative Action • The Equal Employment Opportunity Commission, established by the Civil Rights Act of 1964, monitors cases involving unequal pay for equal work and unequal access to promotion • Research suggests that civil-rights legislation has played a role in narrowing the black-white earnings gap • State and local governments have also introduced set-aside programs to guarantee minorities a share of contracts

Affirmative Action • Since 1993 the median income of black families has risen faster than that of white families • The proportion of black families living below the poverty line has fallen to a record low • There is also a growing middle class among black householders

Unintended Consequences • On the plus side, antipoverty programs increase the consumption possibilities of poor families which is especially significant since children are the largest poverty group • But programs to assist the poor may have secondary effects that limit their ability to reduce poverty

Disincentives • Society, through government, tries to provide families with an adequate standard of living, but society also wants to ensure that only those in need receive benefits • Income assistance consists of a combination of cash and in-kind transfer programs, the benefits of which vary inversely with income from other sources  transfers decline sharply as earned income increases  high marginal tax rate on earned income

Disincentives • Over certain income ranges, the welfare recipient may lose more than $1 in transfer benefits for each additional $1 in earnings  the marginal tax rate on earned income could exceed 100% • Since holding even a part-time job involves additional expenses, the high marginal tax rate discourages employment and self-sufficiency

Disincentives • The longer people are out of the labor force, the more their job skills deteriorate  when they do look for work, their productivity and their pay are lower than when they were last employed • Some argue that in this way, welfare benefits can lead to long-term dependency  unfavorable consequences both for the family and for society

Disincentives • Welfare programs can cause other disincentives • For example, children may be eligible for Supplemental Security Income if they have a learning disability and there is some evidence that low-income parents encouraged poor behavior in school so their children would qualify for this program

Does Welfare Cause Dependency? • How could we examine such a question? • A relatively brief average stay on welfare would be evidence of little dependency • If, however, the same families were found on welfare year after year, this would be a matter of concern

Does Welfare Cause Dependency? • A University of Michigan study tracked 5,000 families over a number of years, paying particular attention to economic mobility from year to year, or dependency within a generation • It found that most recipients received welfare for less than a year, but about 30 percent remained on welfare for at least eight years  a core of long-term recipients

Does Welfare Cause Dependency? • A second and more serious concern is whether the children of the poor end up in poverty as well • Is there a cycle of poverty? • Why might we expect one? • Children in welfare households may learn the ropes about the welfare system and may come to view welfare as a normal way of life rather than as a temporary bridge

Income Distribution and Poverty