Next Discussion Session

1. Next Discussion Session Choices Mon, June 7th Wed, June 9th Mon, June 14th Also, review for exam on June 9th, exam June 11th. Covers Chapters 1-9 in Rosen, lecture material through next Monday. Practice exam will be posted by 5pm this Friday. Answers posted by 5pm Sunday. I will answer questions during office hours and review session.

2. Special Interest Groups Recall from last time: Community/Group voting pressure. People are more likely to vote if they are part of a group that actively encourages voting (ie. unions) Further, these people tend to vote the same way (unions traditionally vote Democratic in the USA) This implies that these groups exercise a level of power that individual voters cannot. As such, there is an incentive to form special interest groups.

3. Special Interest Groups (SIG�s) SIG members generally share a common trait. SIG�s generally form to encourage politicians to make policy decisions that benefit the shared interests of their members. Example: NRA and gun control.

4. What are these common traits? Level of income: people at different income levels may have different ideas on what programs to fund. Industry of Employment: Unions, Firm Owners Region: People in the �breadbasket� (Kansas, Oklahoma, etc) have preferences for the level of farm subsidies Personal Characteristics: AARP, religious groups, ethnic groups, even gender.

5. Lobbyists SIG�s may hire lobbyists to meet with politicians. These lobbyists may attempt to provide information (could it be biased?) on the state of the world, or they may attempt to offer campaign contributions or bribes in exchange for favors.

6. SIG�s: continued These groups may engage in rent-seeking behavior, in order to win favorable outcomes for their members. It is to be noted that SIG�s with opposing interests may be operating at the same time in the same legislative body Tobacco lobbyists spend millions each year attempting to limit the level of cigarette taxes imposed by states. �Non-smoker rights� groups spend millions each year trying to promote healthier lifestyles through banning public smoking and raising cigarette taxes.

7. Who are some of the big SIG�s? National Rifle Association (NRA) � a group that seeks to protect the constitutional right to bear arms. Outspoken opponents of gun control. Pay for pro 2nd amendment publications, lobby, organize congressional letter campaigns. Members receive discounts at hotels such as Best Western and Ramada, rental car companies Hertz and Avis. 4.3 million members.

8. Mothers Against Drunk Driving (MADD) Group dedicated to ending drunk-driving through legislative and grassroots action, and victim-counseling. $47 million dollars of funding in the 2002-2003 fiscal year. Frequently called to testify before congressional subcommittees. Instrumental in helping legislators propose and enact tougher drunk-driving legislation, etc.

9. Chapter 7 Conceptual Issues in Income Redistribution

10. Introduction Will provide framework for thinking about the normative and positive aspects of government income redistribution policy.

11. Introduction Some questions whether economists should be concerned with distributional issues. Value judgments embodied in the �right� income distribution. No scientific basis for the �right� distribution.

12. Introduction Focus on efficiency alone has problems. That focus, too, is a value judgment. Multiple equilbria. Decision makers do care about the income distribution; economic analysis ineffective if it doesn�t consider this policy-maker constraint.

13. Distribution of Income Can analyze household income, and see how equally or unequally the �pie� is distributed. Table 7.1 shows the percentage of money income among households for more than 30 years.

14. Table 7.1

15. Distribution of Income Richest 20% receives about 50% of total income. Poorest 20% receives about 4% of total income. Inequality has increased over time.

16. Are the rich getting richer and the poor getting poorer? Most of you have heard this at some point or another. Half true. The rich are getting richer. But the poor are also getting richer. Inequality is increasing because the rich are getting more as a % of income, relative to the poor. Note that using our current definition of the poverty line, almost everyone in the US would have been below the line in 1880. Economists predict that almost nobody will be below this line in the year 2090.

17. Distribution of Income:Poverty The poverty line is a fixed level of real income which is considered enough to provide a minimally adequate standard of living. Inherently arbitrary, but still a useful benchmark. Trends over time Differences across groups

18. Quick digression on the poverty line Created in 1965 by Mollie Orshansky for the SSA. Based on food requirements. Dept. of Ag. (1955) found that poor families spend 1/3 income on food. Orshansky estimated the cost of providing a basic level of nutrition and multiplied by 3. Note: poverty line increases with size of family, but at a decreasing rate (due to the belief that there are certain fixed costs in households)

19. Absolute vs. Relative poverty lines Some debate as to whether or not our poverty line is appropriate. Poor families now spend about 1/5 income on food. Others have proposed relative poverty lines. Victor Fuchs (1967) proposed setting the line at 45-50% of the median household�s income. US still uses a version of Orshansky�s poverty line.

20. Distribution of Income:Poverty Poverty line for a family of 4 was $18,244 in 2001. Median household income more than double that, $42,228. Table 7.2 shows poverty rates for selected groups in 2001.

21. Table 7.2

22. Distribution of Income:Poverty Poverty rates in U.S. in 2001 might be considered surprisingly high � 11.7% for population as whole. Concentrated among certain groups, such as female headed households, children, and minorities. Elderly have lower poverty rates than the U.S. average.

23. Distribution of Income:Poverty Can also look at trends over time. See Table 7.3 Poverty considerably lower than in 1960�s, but not much progress since 1970.

24. Table 7.3

25. Interpretation Problems Poverty line (& poverty rate) is subject to a number of criticisms. When interpreting the numbers, it is useful to know the conventions and limitations.

26. Interpretation Problem #1 �Income� consists only of cash receipts. Excludes in-kind transfers like health insurance, food stamps, and housing. Would reduce poverty rate by more than 20%. Excludes non-market work such as childcare or housework. Ignores income flow from durable goods.

27. Interpretation Problem #2 Income is before-tax. It ignores cash refunds from the Earned Income Tax Credit, which has grown dramatically in the last decade, and now amounts to more than $31 billion annually. Ignoring this overstates poverty rates, and also affects the trends over time.

28. Interpretation Problem #3 Income is measured annually. Not obvious what the correct time frame should be. Income does fluctuate from year-to-year. Lifetime income considerations seem relevant. Consider a �starving� college student, for example. Not really �poor� in a lifetime sense.

29. Interpretation Problem #4 Unit of observation Person, family, household? People often make decisions as an economic unit, and there are economies of scale in household production. Classifications can matter for poverty numbers Bauman (1997) calculates that including the income of non-family members (such as nonmarried cohabitors) would reclassify 55% of people who are poor out of official definition.

30. Upshot It is quite likely that the official poverty rate is overstated. This is not to say that there is no real reason for income distribution. Also, just because one�s family is officially above the poverty line isn�t to say his family is doing well for itself. A family of 4 with $19,000 annual income is still in some sense struggling.

31. Rationales for Income Redistribution Different kinds of social welfare functions Utilitarian Maximin criterion (Rawlsian) Pareto efficient Non-individualistic

32. Simple Utilitarianism The utilitarian social welfare function is:

33. Simple Utilitarianism With the additive SWF that was given, also assume: Identical utility functions that depend only on income Diminishing marginal utility of income Society�s total income is fixed Implication: government should redistribute to obtain complete equality.

34. Simple Utilitarianism This can be illustrated with 2 people. See Figure 7.1 Any income level other than I* does not maximize the SWF. I* entails equal incomes.

35. Figure 7.1

36. Numerical Example 2 identical individuals (Betty and Al), diminishing marginal utility of income. $40 in economy. Additive social welfare function For example. If Al has 30 dollars and Betty has 10, Social welfare: W =21 +9 = 30. Total Utility is maximized when each individual receives $20. W = 16+16 = 32.

37. Simple Utilitarianism Striking result is that full income equality should be pursued, but some scrutiny required. Assumes identical utilities Assumes decreasing marginal utility Assumes total income fixed E.g., no disincentives from this kind of redistributive policy.

38. The Maximin Criterion The Rawlsian social welfare function is:

39. Original Position Rawls proposed a thought experiment: Individuals start from a position of knowing nothing about themselves. They then choose how to organize society. The Maximin criterion is what Rawls believes people would choose for themselves.

40. The Maximin Criterion These ethical claims are controversial: Still selfish view in original position Individuals extremely risk averse here All that is relevant is the welfare of the worst-off person, even if a policy is extremely detrimental to everyone else.

41. Pareto Efficient Income Redistribution as Justification for Income Redistribution Suppose that utility of richer person does depend on poorer person�s utility. That is:

42. Pareto Efficient Income Redistribution Altruism plays a role in this example, but private market could conceivably give charity. But not just altruism. Self-interest could play a role. Suppose there is a possibility that, for circumstances beyond your control, you become poor. When well-off, pay �premiums.� When bad times hit, collect �payoff.� Motivation of some social insurance programs.

43. Nonindividualistic views In previous cases, social welfare derived from individual�s utilities. Some specify what the income distribution should look like independent of individual preferences. One example: commodity egalitarianism. Right to vote, food, shelter, education, perhaps health insurance.

44. Processes versus Outcomes All the above examples are concerned with outcomes of distribution (who ends up with what) Some argue that a just distribution of income is defined by the process that generated it. For example, �equal opportunity� in U.S. Ensuing outcome would be considered fair, regardless of the income distribution it happened to entail. Fair bit of income mobility (Gottschalk, 1997). Does raise problem of how to evaluate social processes.

45. Expenditure Incidence- the impact of expenditure policy on distribution of real income Relative Price Effects Public Goods Valuing In-Kind Transfers

46. Relative Price Effects Suppose government subsidized housing of the poor. As a first pass, redistribution from rich to poor. May have overall effects on housing prices Landlords may reap part of gain. Affects wages of construction workers Generally, any government program sets off a chain of price changes, and the incidence is unclear.

47. Public Goods Do rich and poor benefits similarly from the provision of public goods? Difficult to measure, sensitive to assumptions that are made.

48. Valuing in-kind transfers Government provides many benefits to the poor in-kind � that is, direct provision of goods rather than cash. Food stamps Medicaid Public Housing Estimating value is difficult. Not always valued at dollar-for-dollar (if resale is difficult).

49. Valuing in-kind transfers Consider how the provision of an in-kind benefit changes the budget constraint in transparency. In this case, giving an in-kind benefit lowers utility relative to an equally costly cash transfer. Although the person is better off by having the in-kind transfer than not having it, she would be even happier with the cash transfer.

50. Valuing in-kind transfers A person can never be made better off with an in-kind transfer that is equal in cost to a cash transfer. There are instances, however, when a person is indifferent between the two transfer schemes. See overhead.

51. Valuing in-kind transfers Why give in-kind transfers if they tend to be inefficient? Commodity egalitarianism/ tax-payer sovereignty. Congress (or taxpayers) may only want to provide health-care or housing, rather than just give cash. May reduce welfare fraud (especially if the in-kind transfer is an inferior good) Politically viable because they help the producer of the in-kind good.

52. Recap of Income Redistribution: Conceptual Issues Distribution of income Poverty line Social welfare functions Valuing In-Kind transfers