Income

WeaIth and Income InequaIity
Prof. OIeg PavIov
Econ 1110
Ìncome distribution in the USA
The measurement of inequality
· How much inequality is there in our society?
· How many people live in poverty?
· What problems arise in measuring the amount
oI inequality?
· How oIten do people move among income
classes?
Wealth
· We must distinguish between wealth and income
· Wealthy households do not necessarily have high income
· But typically households with the most wealth have the most income
· Wealth ('net worth¨ or 'marketable wealth¨) is
everything a person or household owns (assets) less
any debts (liabilities).
· Assets: owner-occupied housing, other real estate, stocks,
government bonds, corporate bonds, Ioreign bonds, cash and other
demand deposits, time and savings deposits, certiIicates oI deposit,
money market accounts, cash value oI liIe insurance plans, cash
value oI pension plans, mutual Iunds, equity in trust Iunds, net equity
oI unincorporated businesses, collectable art.
· Debts: mortgages, credit card debt, auto loans, business debt.
Financial wealth
· Financial wealth is marketable wealth less net
equity of owner-occupied housing
· Financial wealth is more liquid than wealth, i.e. you can
transIer Iinancial wealth into cash Iaster
· Financial wealth is nearly immediately available Ior
consumption or investment
Wealth is highly concentrated
· Top 1° own approximately
35° oI all privately held
wealth
· 20° oI the households own
85° oI all privately held
wealth
· The bottom 80° own only
15° oI all privately held
wealth
· Wealth distribution has been
rather stable
Source: WhoRulesAmerica.net, UCSC
Financial wealth is more concentrated than
all marketable wealth
· Financial wealth is net worth
less the owner-occupied
home
· Top 1° own 42° oI
Iinancial wealth
· Top 20° own 92.5°
· Bottom 80° own 7.5°
%he drop in ownership when
compared to net worth
indicates that for the majority
of Americans their homes are
their most significant wealth
asset
Ìf your wealth is not in your home.
From the practical standpoint it is important
whether or not your home is not your primary
asset
· This means that wealthy households do not borrow too much
relative to their Iortunes.
· Their Iinancial wealth is suIIicient to service the debt
· Wealthy are not likely to become homeless during a real
estate crisis
· Rich don`t go bankrupt as oIten as non-wealthy
· Very Iew people in the Forbes 400 ever Iiled Ior bankruptcy
(Bernstein and Swan: 66).
Global wealth distribution
· 10° oI world adults
own 85° oI global
household wealth
· 10° oI Americans
control 70° oI the
country`s wealth
· 10° in Switzerland
control 71° oI the
country`s wealth
Why do people care to be wealthy? Lifestyle
Why do people care to be wealthy? Ìnfluence
!ower is.
· The capacity to reach goals and realize wishes
· the ability oI !erson A (or group A) to aIIect !erson
B (or group B) in such a way that it is contrary to
B`s interests
Wealth leads to power
· Wealth is a resource that helps exercise power
· Think oI wealth given to political parties,
lobbyists, congressmen.
· Wealth shapes society in the interests oI the
wealthy. The wealthy can.
· Hire !R consultants to shape the public image oI an issue
· Hire experts such as lawyers and accountants to protect
their interests via legal channels.
· Donate money to universities, museums, Ioundations etc.
to shape the research and public discussion agendas
Wealth leads to corporate power
· Concentration oI stocks.
· Stock ownership allows control of corporations
· Should the workers be hired or fired
· Should productions we shipped to China
· Should production be increased or decreased
· What prices should be charged
· What compensation should be paid to the CEO and
workers
Power leads to wealth
· Wealth leads to power, but power also leads to
wealth
· Federal government contracts are given to
corporations with close government ties
· E.g. large engineering Iirms such as Bechtel and
Halliburton are hired by the Iederal government
Bechtel
· Bechtel is a large engineering Iirm
· Former efense Secretary Caspar Weinberger, Iormer
Secretary of State George Schult: and Iormer CIA
irector William Casey beIore they took their
government posts worked at Bechtel
· Bechtel gave $1.3 million in individual, !AC and soIt
money contributions between 1999 and 2002
Halliburton
· Halliburton is a large energy
company
· Vice !resident Dick Cheney was
the CEO oI Halliburton until 2000
· Halliburton contributed $709,000
to individuals and !ACs between
1999 and 2002
· Halliburton won a $600M contract
Ior initial repairs to Iraq`s oilIields
and a Iurther $600M contract Ior
the pumping oI oil
· Kellogg, Brown & Root (KB&R),
a subsidiary oI Halliburton until
2007, has a 10 year contract with
the US military to run bases in Iraq
worth more than $830m
Ìncome
Income (earnings) is what the household earns
Irom wages, dividends, interest, rents, royalties,
etc.
A person`s income Irom wages depends on the supply and
demand Ior that person`s labor, which in turn depend on
natural ability, human capital, compensating diIIerentials,
discrimination, and so on.
Ìncome is less concentrated than wealth
· Top 1 ° earned 17° oI
income in 2003
· Top 20° earned 58° oI
income
· Bottom 80° earned 42° oI
income
· In 2004, top 0.1° had more
combined pre-tax income
than the poorest 120 million
people
CEO's annual pay as a multiple of
the average factory worker's pay
· 42:1 in 1960
· 531:1 in 2000 (technology bubble)
· 411:1 in 2005
Ìncome Equality around the World
The Poverty Rate
· The poverty rate is the percentage oI the
population whose Iamily income Ialls below an
absolute level called the poverty line.
The poverty line is an absolute level oI income set by the Iederal government
Ior each Iamily size below which a Iamily is deemed to be in poverty.
Poverty line for 2007-2008
opyright © 2004 South-Western
The Poverty Rate
opyright©2003 Southwestern/Thomson Learning
Percent of the
PopuIation
beIow Poverty
Line
1960 1965 1970 1975 1980 1985 1990 1995 2000
Poverty rate
5
10
15
20
25
opyright © 2004 South-Western
Who Ìs Poor?
opyright©2004 South-Western
Three Findings About Poverty
· !overty is correlated with race.
· !overty is correlated with age.
· !overty is correlated with Iamily composition.
Problems in Measuring Ìnequality
· Data on income distribution and the poverty
rate give an incomplete picture oI inequality in
living standards because oI the Iollowing:
· In-kind transIers
· LiIe cycle
· Transitory versus permanent income
Problems in Measuring Ìnequality
· In-Kind TransIers
· TransIers to the poor given in the Iorm oI goods and
services rather than cash are called in-kind
transfers.
· Measurements oI the distribution oI income and the
poverty rate are based on Iamilies` money income.
· The Iailure to include in-kind transIers as part oI
income greatly aIIects the measured poverty rate.
Problems in Measuring Ìnequality
· The Economic LiIe Cycle
· The regular pattern oI income variation over a
person`s liIe is called the life cycle.
· A young worker has a low income at the beginning oI his
or her career.
· Income rises as the worker gains maturity and
experience.
· Income peaks at about age 50.
· Income Ialls sharply at retirement, around age 65.
Problems in Measuring Ìnequality
· Transitory versus !ermanent Income
· Incomes vary because oI random and transitory
Iorces.
· Acts oI nature
· Temporary layoIIs due to illness or economic conditions,
etc.
· A Iamily`s ability to buy goods and services depends
largely on its permanent income, which is its normal, or
average, income.
· !ermanent income excludes transitory changes in
income.
Economic Mobility
economic mobility: the movement oI people
among income classes
· Economic mobility is substantial in the U.S.
economy.
· Movements up and down the income ladder can
be due to:
· Ability
· Good or bad luck
· Hard work or laziness
· !ersistence oI economic success Irom generation to generation
· Entrepreneurship
Ìnheritance
Inheritance is wealth transIerred Irom a deceased
individual to beneIiciaries (heirs)
· 1.6° oI Americans inherit $100,000¹
· Another 1.1° inherit $50,000 - $100,000
· 91.9° oI Americans inherit nothing
· There are two types oI taxes that are paid on
inheritance: Estate tax (Iederal, by estate) and
Inheritance tax (state, by beneIiciaries)
Estate tax
The estate tax is collected by the Iederal
government on the total monetary value oI the
estate
· !aid by the estate
· %he federal government gets the money first. Estate
tax is paid before beneficiaries receive their shares
eath tax
Inheritance tax ('death tax¨) is a tax that beneIiciaries
(individuals) oI an inheritance have to pay
· In the U.S., inheritance tax is collected by the states
· ot all states collect the inheritance tax
· !roponents: inheritance should be taxed just like income or
giIts
While the 'death tax¨ is a hot political topic during elections, in reality elimination oI the
inheritance tax would beneIit only about 1° oI the population
Ìnherited wealth vs. self-made wealth
· The easiest way to become
rich is to inherit a Iortune.
· In 1982, the percentage oI
people in the Forbes 400
who inherited their wealth
was 47°. In 2006, it was
30°.
· The share oI selI-made
wealthy individuals in the
Forbes 400 is increasing








0
50
100
150
200
250
300
1982 1992 2002 2006
Source: Bernstein, !. and Swan A. "All the Money in the World." KnopI, NY. 2007: 65
Inherited
SelI-made
Case: u Pont ÷ an entrepreneur
· Eleuthere Irenee du !ont de
Nemours immigrated to the
U.S. Irom France in 1799
· The Iortune started in 1802,
when Eleuthere Irenee du
!ont de Nemours started the
Du!ont company to
manuIacture gunpowder
· Now, Du!ont is one oI the
largest chemical companies
in the world
Eleuthere Irenee du !ont de Nemours
Wealth is fluid
· 24 Du !ont heirs were on the Forbes 400 in
1982
· No Du !onts were on the Forbes 400 list in
1999
· Du !onts still control a lot oI wealth
· Du !onts are still very inIluential in Delaware
where the company headquarters are even
though they are not on the Forbes 400
Should the government do anything
about economic inequality?
· Economic analysis alone cannot give us the
answer.
· The question is a normative one Iacing
policymakers.
· !olitical philosophies oI redistributing income:
· Utilitarianism
· Liberalism
· Libertarianism
Utilitarianism
Utilitarianism is the political philosophy according to
which the government should choose policies to
maximize the total utility oI everyone in society.
The Iounders oI utilitarianism are the English philosophers
Jeremy Bentham and John Stuart Mill.
The utilitarian case Ior redistributing income is
based on the assumption oI diminishing marginal
utility: An extra dollar oI income to a poor person provides that person with
more utility (aka beneIit, well-being), than does an extra dollar to a rich person.
Liberalism
iberalism is the political philosophy according to which
the government should choose policies deemed to be just,
as evaluated by an impartial observer behind a 'veil oI
ignorance¨
This view was originally developed by the philosopher John Rawls
· !ublic policy should be based on the maximin criterion, which seeks to
maximize the utility or well-being oI the worst-off person in society.
That is, rather than maximizing the sum oI everyone`s utility, one should maximi:e the
minimum utility
· This idea would allow Ior the consideration oI the redistribution of income
as a Iorm oI social insurance
Libertarianism
ibertarianism is the political philosophy
according to which the government should punish
crimes and enIorce voluntary agreements, but
should not redistribute income.
· Libertarians argue that equality of opportunity is
more important than equality oI income.
Reduction of Poverty
· !olicies
· Minimum-wage laws
· WelIare
· Negative income tax
· In-kind transIers
· WorkIare
· Entrepreneurship
Minimum-Wage Laws
· Advocates view the minimum wage as a way oI
helping the working poor.
· Critics view the minimum wage as hurting those it is
intended to help.
· The magnitude oI the eIIects oI the minimum wage
depends on the elasticity of the demand Ior labor.
· Advocates argue that the demand Ior unskilled labor is
relatively inelastic, so that a high minimum wage depresses
employment only slightly.
· Critics argue that labor demand is more elastic, especially in
the long run when Iirms can adjust employment more Iully.
Welfare
· The government attempts to raise the living
standards oI the poor through the welIare
system.
· Welfare is a broad term that encompasses
various government programs that supplement
the incomes oI the needy.
· Temporary Assistance Ior Needy Families (TANF)
· Supplemental Security Income (SSI)
egative Ìncome Tax
A negative income tax collects tax revenue Irom
high-income households and gives transIers to
low-income households.
· High-income Iamilies would pay a tax based on
their incomes.
· Low-income Iamilies would receive a subsidya
'negative tax.¨
Advantage oI the schema: !oor Iamilies would
receive Iinancial assistance without having to
demonstrate need.
Example of a negative income tax
Tax owed ÷ 1/3 income -$10,000
Income Tax owed
$60,000 $10,000
$30,000 0
$15,000 -$5,000
Ìn-Kind Transfers
In-kind transIers are transIers to the poor given in
the Iorm oI goods and services rather than cash.
Food stamps, Medicaid, school lunches, rent vouchers, etc.
· Advocates oI in-kind transIers argue that such
transIers ensure that the poor get what they
most need.
· Advocates oI cash payments argue that in-kind
transIers are ineIIicient and disrespectIul.
Unintended consequences of antipoverty programs
Many policies aimed at helping the poor can have
the unintended eIIect oI discouraging the poor
Irom escaping poverty on their own.
E.g.: An antipoverty program can aIIect work
incentives:
· A Iamily needs $15,000 to maintain a reasonable standard oI living.
· The government promises to guarantee every Iamily a $15,000
income.
· Any person making under $15,000 has no incentive to work due to
the eIIective marginal tax rate oI 100 percent.
WelIare policies may create the 'culture oI poverty¨
Workfare
WorkIare reIers to a system that would require
any person collecting beneIits to accept a
government-provided job.
WorkIare attempts to eliminate the negative
incentives associated with welIare
Government acts as the Employer oI Last Resort