3% per year means growing income inequality in dollar terms.
Employers are $4k/day better off with EITC and $4K/day tax than with $7 minimum wage
Attraction of government jobs is job security and perceived lighter work load.
Income Inequality and WealthRedistributionMay20, 2013
Announcements• Homework due Wednesday (May 22).• New Homework posted to website before nextclass, due the following Wednesday (May 29).
Last Class• Human capital theory of marginal value of laborto production• Imperfections in wage determination– Unions– Discrimination– Wage differentials• Both free-market principles and imperfectionsdetermine wages.
Learning Goals for Today• Summarize the trends in US income inequalitysince 1980.• Substantiate the argument underlying JohnRawls’s ``Veil of Ignorance.’’• Describe three methods of incomeredistribution.– Argue why one (which?) is better than the othertwo, and why.
Trends in Inequality After 1980Source: Inequality.org
Trends in Inequality Prior to 1980Source: Inequality.org
Recent Trends in Inequality• In 1980, CEOs earned 42 times the salary of average the worker.• In 2000, CEOs earned more than 500 times the salary of theaverage worker.• Dick Fuld (CEO of Lehman Brothers circa 2008) had a three-story cargarage with a car elevator.
What About Income Mobility?• Some people argue that income inequality is not a problem in theUnited States because of the high degree of economic mobilityacross generations.• US income mobility across generations is low and there’s noevidence that it’s increasing.
Correlations in the Earnings of Fathers andSonsCountry CorrelationUnited States .41-.54Sweden .14Canada .17-.19Finland .22Germany .10-.36Malaysia .33-.37Source: Bjorkland and Jantti, 2000
John Rawls and the Veil of Ignorance• The "right" income distribution is a normative matter.• Rawls proposed a "fair" income distribution is one that peoplewould accept before they know their position in thedistribution– Equality of distribution is favored by anyone who is riskaverse.– Strong disincentive to investing in human capital, takingrisk, working hard.• Less liberal slant: See Robert Nozick, Anarchy, State, andUtopia (free market perspective on “fairness.”)
Acceptable Income Distributions• If income is distributed equally, total output is smaller than in acountry with earnings incentives.• Rawls argued that inequality would be acceptable if it increasestotal output by "enough”.• Rawls also argued that market systems produce more inequalitythan acceptable– Fairness requires some attempt to reduce income inequalityproduced by the market
The Challenge of IncomeRedistribution• Raising incomes of the needy reduce incentives to work and makeprudent decisions.– Difficulty distinguishing between needy and others• Example: Hurricane victims• No perfect solution– Choose among imperfect alternatives
Methods of Redistributing Income• There is substantial and growing income inequality in theUnited States.• The problem is that redistribution can lead to inefficientoutcomes.• Methods for redistributing income– How does each work?– What are the costs and benefits of each?
In-kind Transfers and Cash Transfers• In-kind transfers: direct transfers of goods or services– Food stamps– Medicaid– Public housing– Free schools lunches• Cash transfers: direct transfers of cash (“welfare”).– AFDC (60’s-1996)– TANF (1996-present)
Aid to Families with Dependent Children(AFDC)• AFDC: Aid to Families with Dependent Children– Targeted to single-parent families– Provided monthly benefits that depended on family size andfamily income– Administered by the Federal government• Potential problems– Discourages marriage.– Creates a work disincentive.– Fear that people would become “dependent” on AFDC.
Temporary Assistance to Needy Families(TANF)• Created as part of the Personal Responsibility and WorkOpportunity Act of 1996 (PRWORA)– Replaced AFDC with TANF– Provided cash grants from federal government to states– States determine details of how policy implemented– Five-year lifetime limit on benefits for each recipient• Some evidence that it has reduced welfare rolls.• May aggravate the condition of the poorest during economicrecessions
Means-Tested Benefit Programs• A means-tested program:– A benefit program whose benefit level declines as the recipient earnsadditional income. The intention is to avoid paying benefits to those who cansupport themselves.• Administrative structure discourages work– If benefits are reduced by $1 for each $2 earned, participants inmultiple programs may lose more benefits than the income theyearn.• Administrative costs are high– Extremely expensive to administer.
The Negative Income Tax (NIT)• Negative income tax:– a system under which the government would grant each citizen a cashpayment each year, financed by a tax on earned income.• With NIT, low income families receive a cash transfer while highincome families pay tax.• Family with no income would receive the federal povertythreshold
The Negative Income Tax (NIT)After-Tax IncomePre-Tax IncomeNo TaxesNITtaxtransfer$5,000$5,000 for everyone, tax=10%$50,000
Negative Income Tax• Advantages– Incentive to work is greater than with current mean-testedprograms because people are guaranteed to keep at least someportion of what they earn.– Lower administrative cost because a single programadministered through IRS.• Disadvantages– Creates an incentive to not work because the NIT guaranteesincome to all who do not work.– The political cost is high.
Minimum Wages• Effect on total earnings (w*L) is ambiguous because wages increasebut employment falls. Whether total earnings increase or decreasewill depend on the elasticity of demand for labor.• Studies show little effect of minimum wage on employment, and ifso the loss in total surplus may be small.
L (work-hours/day)W($/hour)SD105,00050No Minimum WageMinimum Wages and Total SurplusL (work-hours/day)SW($/hour)D5,0005100Minimum Wage ($7)33,0007
L (work-hours/day)W($/hour)SD105,00050No Minimum WageMinimum Wages and Total SurplusL (work-hours/day)SW($/hour)D5,0005100Minimum Wage ($7)33,0007Consumer Surplus
L (work-hours/day)W($/hour)SD105,00050No Minimum WageMinimum Wages and Total SurplusL (work-hours/day)SW($/hour)D5,0005100Minimum Wage ($7)33,0007Producer Surplus
L (work-hours/day)W($/hour)SD105,00050No Minimum WageMinimum Wages and Total SurplusL (work-hours/day)SW($/hour)D5,0005100Minimum Wage ($7)33,0007Deadweight Loss
Earned Income Tax Credit (EITC)• Clearly, minimum wage increases CS, butdecreases TS=CS+PS through decreasing PS.• An EITC directly transfers cash from employersto workers.• The form of a rebate on tax return to laborers.
EITC Is a Better Option• Without minimum wageconsumer surplus is $12,500/day.• Minimum wage increases this to $16,500/day.• Goal: bring worker surplus to $16,500/day using EITC– Introduce an earned-income tax credit of $0.80/hr for 5,000person hours/day (total of $4000).– Finance with a $4000/day tax on employers.• Efficient– Worker surplus– Firm surplus– Both at least as well off as under a minimum wage
Public Employment for the Poor• Overcomes the shortcomings of the EITC and NIT– EITC does not help the unemployed– NIT reduces the incentive to work• Problems– “Make-work” programs are not productive– Increases government bureaucracy
A Combination of Methods• No single method is perfect.• In reality, we have a combination of programs.• The social safety net in the United States is complex—Food stamps, TANF, EITC, minimum wage, SSI (disability),Medicaid, etc.
Federal Government Outlays, 2011Billions ofCurrent Dollars % of TotalNational Defense 705.6 19.6%Individual Payments 2,345.6 65.1%Social Security 730.6 20.3%Federal Employees Retirement 181.4 5.0%Unemployment Insurance 118.6 3.3%Medicare, Medicaid & Other Medical 913.0 25.3%Assistance to Students 58.6 1.6%Housing Assistance 45.9 1.3%Food Stamps and Other Food Assistance 103.1 2.9%Public Assistance 188.4 5.2%SSI 49.6 1.4%TANF 21.3 0.6%EITC 55.7 1.5%Other Public Assistance 61.8 1.7%Other Individual Payments 6.0 0.2%Other 551.9 15.3%TOTAL OUTLAYS 3,603.1 100.0%