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Chapter 17
The Distribution of
Income
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
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Basics of income distribution
Measures of inequality
Changing income inequality
Reasons for rising inequality
Poverty
Debate over inequality
Taxes and redistribution
17-2
Basics of Income Distribution
• Data on the nation’s income distribution
is produced each year by the Census
Bureau.
• Each year, the Census surveys
households about how much money they
received from various sources.
• There seems to be a growing gap between
the people at the top of the income
distribution and everyone else.
17-3
The Distribution of Income in the
United States, 2006
17-4
Quintiles
• Economists look at income distribution in
terms of quintiles.
• A quintile represents 20% of households.
• Thus, the bottom quintile is the 20% of
families with the lowest income.
• The table on the following slide shows the
minimum income needed to get into each
quintile.
17-5
The Quintiles of Household Income,
2006
Quintiles
Lower limit
Top 5%
$174,012
Top quintile
$97,032
Fourth quintile
$60,000
Third quintile
$37,774
Second quintile
$20,035
Bottom quintile
$0
17-6
Measures of Inequality
• The income level that marks the dividing line
between the bottom quintile and the second
quintile is called the 20th percentile, because
20% of households fall below that level.
• The income level that marks the dividing line
between the top quintile and everyone else is
called the 80th percentile, because 80% of
households have incomes below that level.
17-7
Measures of Inequality
• The 80/20 ratio
(the 80th percentile
divided by the 20th
percentile)
measures the
spread between
high-income and
low-income
households.
17-8
Changing Income Inequality
• Most economists believe that the distribution of
income has widened over the past twenty five
years.
• But there is no consensus about whether the
increase in inequality has been large or small.
• It depends on which data source you look at,
and which measure of inequality you use.
– The 80/20 ratio shows a slow and gradual
rise.
17-9
The Rising 80/20 Ratio
17-10
Changing Income Inequality
• An alternative measure of income
inequality is obtained by examining tax
return data from the Internal Revenue
Service.
• Look at the share of income going to the
top 1% of taxpayers.
– A growing share of income going to this group
suggests an increase in inequality.
17-11
Share of Income Going to Top 1% of
Taxpayers
17-12
Reasons for Rising Inequality
• The increase in inequality is attributed to
a number of factors.
– First, rapid technological change tends to
favor highly educated workers.
– Another factor is foreign trade.
• The labor-pool effect of globalization has caused
wages for low-skilled workers to fall.
• At the same time, the market expansion impact of
globalization has benefitted high-skilled workers.
17-13
Reasons for Rising Inequality
– Another cause of inequality is the shift to what
is called the superstar economy.
• As the economy evolves from local to national and
even global markets, companies are reaching out
to the very best talent they can find. This means
that the top people in any field do well.
– Finally, there has been a lack of government
action.
• The minimum wage has not kept up with inflation.
17-14
Poverty
• Another measure of the distribution of
income is the poverty rate.
• The poverty rate measures the percent of
people living in households with incomes
below the poverty line.
– In 2006 the poverty line for a family of four
was $19,971.
• One problem with the poverty rate is that it
excludes in-kind transfers such as food
stamps and Medicaid payments.
17-15
The Poverty Rate
17-16
Poverty Rate by Age
Percent below poverty line
35
30
25
20
Under 18 years old
18-64 years old
15
65 and over
10
5
0
Data: Census Bureau
17-17
Global Poverty
17-18
The Debate Over Inequality
• There is considerable debate among
economists about the causes of inequality
and the role of government intervention.
• There are two competing notions of
fairness:
– Some argue that an economy with wide gaps
between rich and poor is inherently unfair and
immoral, so there is a need for government
programs.
– Others argue that taking money from those
who earned it is unfair and immoral.
17-19
The Pros and Cons of Government
Intervention
Arguments in favor of
government intervention to
reduce inequality
Arguments against government
intervention to reduce inequality
Fairness
A wide gap between rich and
poor is unfair and immoral.
Taking money away from individuals
who have earned it is unfair and
immoral.
Growth
More equal societies experience
stronger growth.
Allowing big rewards to go to the most
successful performers helps motivate
creativity, innovation, and hard work.
Politics
Big income differences cause
political strife and eventually
undermine support for a market
economy.
A policy devoted to reducing inequality
eventually leads to political control of
the economy and rent-seeking behavior.
Statistics
The income distribution statistics
understate inequality, because
they miss the really high income
house.
The income distribution statistics
overstate inequality, because they fail to
take economic mobility into account.
17-20
Taxes and Redistribution
• The most common form of government
intervention is through the use of the tax
system.
• Redistribution transfers money from
high-income to low-income households.
• Progressive taxes make the distribution of
income more equal.
– With a progressive tax, the after-tax income
distribution is more equal than the pre-tax
income distribution.
17-21
Taxes and Redistribution
• We call the share of income a household
pays in taxes the effective tax rate.
• An income tax is progressive if highincome households pay a higher share of
their income in taxes than low-income
households
– That is, high-income households have a
higher effective tax rate.
– The higher effective tax rate tends to narrow
the income distribution.
17-22
Taxes and Redistribution
• A tax is regressive if low-income households
pay a bigger share of their income than highincome households.
• An example of a regressive tax is the sales tax.
– Under the sales tax, only the portion of income
consumed is taxed, with savings not taxed.
– Low-income households consume virtually their entire
income, so they pay a high percentage of their
income in taxes.
– In contrast, high-income households save a high
percentage of the income which is not taxed.
17-23
Taxes and Redistribution
• It is difficult to determine whether the US
tax system is progressive or regressive
overall, since individuals pay a number of
different types of taxes.
• The federal tax system is only slightly
more progressive than in 1981.
– The effective tax rate on high income
individuals is essentially unchanged, but the
effective tax rate for the poor has gone down.
17-24
Effective Federal Tax Rate for the Top 1%
of Individuals
17-25
Earnings and Discrimination
• Discrimination occurs when one person
is paid less or treated worse on the job
than an equally qualified person, because
of his or her race, gender, or some other
characteristics.
– The role of government is to enforce
antidiscrimination laws.
– Despite the laws, some groups – notably
women, blacks, and Hispanics – consistently
earn less, on average, than others.
17-26
Earnings Differences By Gender and
Race for US, 2007
17-27
Women’s Median Weekly Earnings as a
Percentage of Men’s
17-28