Income Inequality and Poverty

Income Inequality

  • The highest-earning 20% of families made more than half of all U.S. income in 2018.
  • Income inequality has increased more rapidly in the U.S. than in Europe between 1980 and 2016.

Measuring Income Inequality

  • Inequality is often measured using income.
  • Gini Coefficient
    • Measures how equally income is distributed across the population.
    • 0 = perfectly equal (everyone receives an equal share).
    • 1 = completely unequal (100% of income goes to only one person).

Impact of Government Taxes and Transfers

  • The federal income tax is a progressive tax, meaning that the marginal tax rates increase as income increases.
    • A wealthy individual will have a higher tax rate than a lower-income individual.
  • Government transfers are money payments by the government to individuals.
    • Include social security payments, welfare payments, and unemployment compensation.
    • These adjustments make the income distribution more equal.
  • Taxes and transfer payments both decrease the degree of income inequality.

Impact of Capital Gain Tax

  • The tax applies to the realization of capital gains, not the accrual of capital gains.
  • Example:
    • Bought a second home as an investment for 100,000, and years later you sold it for 500,000.
    • While it was accruing in value over the years, you did not have to pay taxes on that accrued value.
    • When you sold it, you realized a capital gain of 400,000 (500,000 minus your initial investment of 100,000).
    • When the capital gains tax rate was temporarily lowered to 15%, it provided an incentive for people to sell assets so they could benefit from the lower tax rate.
  • The wealthiest 10% of taxpayers enjoyed 90% of the capital gains eligible for this special tax break.
  • The poorest sixty percent of Americans collectively received just 2% of the capital gains eligible for the lower capital gains rates.
  • Lowering of the capital gains tax rate had a much greater impact on increasing income inequality.

Measurement Problems

  • More people are filing Income Tax Returns because the refundable tax credits (e.g., Earned Income Tax Credit) available to the poor motivate the poor to file.
  • Later marriages and fewer marriages also affect measurements.
  • Changes in Capital Gains Tax Rates.
    • Taxed on realization, not accrual.
  • Money in private retirement accounts is not included in the income and wealth inequality statistics mainly because the government does not have access to that data.
  • In 2019, less than 40% of families in the bottom half of the income distribution were in a retirement plan.
  • More than 80% of upper-middle-income families, and more than 90% of families in the top decile of income were in a retirement plan.

Causes of Household Income and Wealth Inequality

  • Decline of American manufacturing sector.
    • Steel and auto production in the 1970s and 1980s.
    • Consumer durables (TVs, appliances, etc.) in the 1990s and 2000s).
    • Good paying middle-class jobs requiring little education were replaced by robotics and international competition.
  • Fewer jobs require physically challenging labor, so demand (and wages) for non-skilled labor fell, while demand (and wages) for skilled labor rose.
  • Movement of global capital.
    • Capital markets have become much more profitable which benefits the rich.
  • American savings rates have fallen dramatically.
    • Mortgages require less down payment.
    • Autos which had earlier been paid for largely in cash are now financed or leased.
  • Savers are more likely to come from the higher end of the income scale.
  • Public policy changes since 1980.
    • Inheritance taxes have fallen.
    • Lower capital gains taxes.
    • Changes in marginal tax rates.
  • The impact of the increasing number of women in the labor force has run its course.

Benefits and Costs of Income Inequality

  • Benefits
    • Capitalism requires that the individual be motivated by money and that if hard-working or innovative people are not rewarded, they will be less likely to be productive.
    • Higher potential income increases the incentive to get a good education.
    • Higher take-home pay increases the incentive to work.
    • Higher after-tax return increases the incentive to invest.
  • Costs
    • Social Instability when low income is viewed (correctly or incorrectly) as permanent and unchangeable by the individual.
    • Lowers motivation to get ahead if attempting to do so is viewed as futile.

Wage Inequality Reversal

  • Remote work, deglobalization, and stalled technology have started eroding some advantages of higher-skilled workers.
  • The pandemic also changed the nature of work.
  • Employees love remote work because it saves on time and money for commuting, eases child and eldercare, and lets them live where they want.
  • The demand for remote jobs exceeds the supply.
  • Employers have to pay more to fill in-person positions and less to fill remote positions, which is compressing the wage gap.
  • Artificial intelligence could compress wages by undercutting people who make their living manipulating words and data rather than physical objects.
  • Globalization widened inequality in past decades as millions of good-paying blue-collar jobs were lost to China and other low-wage countries, but deglobalization is now in vogue as the U.S. seeks to insulate its supply chains from China’s influence.
  • Immigration fell sharply after 2016 and that has exacerbated labor shortages in industries long dependent on immigrant labor, such as nursing homes, trucking, and construction, bolstering the wages of its workers.

Income Mobility

  • Up: The ability to rise out of your current economic circumstance.
  • Down: The vulnerability to falling from your current economic circumstance.

Measures of Mobility

  • Percentage of the Population moving from one income quintile to the next.
  • What percentage of the population who are in the bottom/top X% in one year are also in the bottom/top X% ten years later.
  • Intergenerational Elasticity: The predictive power of parents' earnings in explaining a child’s earnings.

Poverty

  • Poverty is a state or condition in which a person or community lacks the financial resources and essentials for a minimum standard of living.

Poverty in the United States

  • A report from the U.S. Census Bureau released in September 2022 stated that poverty continued to decline nationwide to 11.6% in 2021.
  • Child poverty has fallen in every state, and it has fallen by about the same degree among children who are white, Black, Hispanic and Asian, living with one parent or two, and in native or immigrant households.
  • In 1993, nearly 28% of children were poor.
  • By 2019, before temporary pandemic aid drove it even lower, child poverty had fallen to about 11%.

Measuring Poverty

  • Poverty Line: that level of income sufficient to provide a family with a minimally adequate standard of living as defined by the government.
    • Established in the 1960s via calculating the cost of a minimally adequate diet and multiplied by 3.
    • Surveys indicated that, in the 1960s, poor families of four spent an average of one-third of their income on food.
    • The figure is updated annually for inflation using the CPI.
  • Poverty rates: percentage of the population living below the poverty line, selected years 1960–2020.

Problems with Poverty Measures

  • Concerns that suggest the poverty rate is understated:
    • Childcare costs are a bigger issue with today’s poor than those who were poor when the original poverty line was established.
    • It is estimated that today poor families of four spend an average of one-seventh of their income on food.
  • Concerns that suggest the poverty rate is overstated:
    • Americans under the poverty line consume more protein, have more living space, and are more likely to have air conditioning than the average European.
    • Updates are based on the CPI which has consistently overstated the increase in the cost of living.
    • The measure only counts income and not wealth. There are nearly a million “poor” who own homes worth more than 150,000.
  • Concerns that suggest the poverty rate is overstated:
    • The measure only counts cash income and does not count the non-cash amounts people get from programs such as food stamps and Medicaid.
    • The method of calculation misses a large proportion of income that we know exists; e.g., having a job, but getting paid “under the table.”
  • Concerns that suggest the poverty rate is overstated for some and understated for others:
    • The measure treats as equal the incomes of residents of high-cost cities and low-cost towns. This overstates rural poverty and understates urban poverty.
    • The measure uses the overall CPI, which includes goods the poor cannot afford. In some years, the prices of goods bought by the poor rise more than the CPI, and in other years it rises less.

In Cash Programs for the Poor

  • Temporary Aid to Needy Families (TANF):
    • Gives money to states for them to give to the poor, “Welfare checks.”
  • Supplemental Security Income (SSI):
    • Gives money to widows, orphans, and the disabled.
  • Earned Income Tax Credit (EITC):
    • Gives money in the form of a tax refund that is much greater than the taxes they had withheld.

In Kind Programs for the Poor

  • In-Kind transfers: provisions of goods and services in forms other than cash.
  • Women, Infants, and Children (WIC): basic food products for pregnant women, new mothers, and their children.
  • Food Stamps: enhance the ability to buy food.
  • Medicaid: free health insurance.
  • Section 8 or Housing Authority housing: subsidized housing.
  • Head Start: subsidized day care and preschool.
  • School Lunch: free breakfasts and lunches at school.

Cash vs. In-Kind Programs

  • Cash transfers would cost government less.
  • Much of the benefit of Medicaid goes to children in households just above the poverty line.
  • Giving cash does not serve the goals of those helping the poor because Americans generally believe poor would waste the money, would not spend the money on their children and feel better giving people what they need rather that what they like.

Welfare Reform

  • An optimal welfare program would be sufficiently funded to solve the problem of poverty, provide an incentive to leave the program and be politically sustainable by not putting an excessive burden on taxpayers.
  • Much of the variation in adult income in US is related to family background in childhood.
    • 1/3 to 1/2 of children who are poor in childhood will be poor as adults.
    • Welfare participation correlated across generations.
  • Widening income inequality in the U.S. has been accompanied by a widening achievement gap between children living in high- vs. low-income families.

Conservative versus Liberal Approaches

  • Liberals:
    • See a need for government involvement in anti-poverty efforts.
    • Believe there are equity issues that are not dealt with by the market economy.
    • Prefer extensive federal involvement in poverty programs.
    • Favor a direct approach to dealing with the problem of poverty.
  • Conservatives:
    • Are leery of government involvement.
    • Are concerned that too many programs or too much assistance creates inefficiencies and disincentives for work effort.
    • Prefer greater responsibility by private charities and by state governments.
    • Favor an indirect, trickle-down approach.