Chapter 18
Income Distribution and
Poverty
© 2006 Thomson/South-Western
1
Distribution of Household Income
 In a market economy, income depends primarily
on the productivity of one’s resources
 The problem with allocating income according to
productivity is that some people have difficulty
earning income
Some have mental and physical disabilities
Others may face limited job choices and reduced
wages because of age, poor education,
discrimination, bad luck, or the demands of caring
for small children
2
Exhibit 1: Share of Aggregate
Household Income by Quintile
3
Lorenz Curve
The Lorenz curve is another way to
picture the distribution of income in an
economy
The Lorenz curve shows the percentage of
total income received by any given
percentage of households when incomes
are arrayed from smallest to largest
4
Median Wage
Median wage: the middle wage when
wages of all workers are ranked
from lowest to highest
5
As distribution becomes
more uneven, the Lorenz curve
is pulled down and to the right,
away from the line of equal
distribution
Point a indicates that the
bottom 80% of families
received 56.7% of the income
and the top 20% received
43.3% of the income
Point b shows that the
bottom 80% received 50.3%
and the top 20% received
49.7% of the income
Since the Lorenz Curve for
2002 is farther from the line of
even distribution than it was
for 1970, income has become
more unevenly distributed.
Cumulative percent of income
Exhibit 2: Lorenz Curve
100
80
1970
..
b
a
60
40
2002
20
0
0
20
40
60
80
100
Cumulative percent of households
6
College Education Pays More
Trends such as industry deregulation, declining
unionization, and freer international trade have
reduced the demand for workers with less
education
New computer-based information technologies
have reduced the demand for low-skilled clerical
workers
The supply of less-educated workers increased
more than the supply of more-educated workers
7
Problems with Distribution Benchmarks
There is no objective standard for
evaluating income distributions
Most distributions measure money income
after cash transfers but before taxes,
 But
omits the effects of taxes and in-kind
transfers such as food stamps and free medical
care
 And understates the share of income going to
lower income groups
8
Problems with Distribution Benchmarks
Focus on the share of income going to each
income quintile overlooks that household size
differs across quintiles
only reported sources of income are included
A better measure of household welfare might be
the distribution of expenditures, which are
more evenly distributed
9
Why Do Household Incomes Differ?
The median income of all households:
the middle income when all incomes are
ranked from smallest to largest
Household incomes differ because of the
number of household members who are
working differ
10
Why Do Household Incomes Differ?
Incomes also differ for all the reasons
labor incomes differ: differences in
education, ability, job experience, etc.
Differences in earnings based on age and
education reflect a normal life-cycle
pattern of income
11
Poverty and the Poor
Poverty is a relative concept
Benchmark for poverty analysis is based on
taking a nutritionally adequate diet and
multiplying it by three
Poverty definition is based on pretax money
income, including cash transfers, excluding the
value of non-cash transfers such as food stamps,
Medicaid, subsidized housing, or employer
provided health insurance
12
Programs to Help the Poor
Since the mid-1960s, social welfare
expenditures at all levels of government
have increased significantly
These programs can be divided into two
broad categories
 Social
insurance
Income assistance
13
Social Insurance
Designed to make up for lost income
of those who are retired, temporarily
unemployed, or unable to work
because of disability or work-related
injury
Deducts insurance premiums from
workers’ pay to provide benefits to
others
14
Income Assistance
Do not require the recipient to have a history of
work or to have contributed to the program
Income assistance programs are normally
means tested
 Require
that a household’s income and assets must
fall below a certain level to qualify for benefits
 Federal government funds two-thirds of welfare
spending, and state and local governments the
remaining one-third
15
Income Assistance
Temporary Assistance for Needy Families
(TANF) which provides cash to poor
families with dependent children,
replaced Aid for Families with Dependent
Children (AFDC)
Controlled by each state and carries no federal
entitlement
Each state given a fixed grant program to help
fund TANF programs
16
Income Assistance
Supplemental Security Income (SSI) provides cash
to the elderly poor and the disabled
 Is
the fastest-growing cash transfer program, with
outlays quadrupling from $8 billion in 1980 to nearly $31
billion in 2002
 The federal portion of this program is uniform across
states, but states can supplement federal aid
 Most states also offer General Assistance aid to those
who are poor but do not qualify for TANF or SSI
17
Income Assistance
The federal government provides an
earned-income tax credit to supplement
wages of the working poor
Medicaid pays for medical care for those
with incomes below a certain level
 It
has grown more than any other poverty
program, quadrupling in the last decade and
accounting for nearly a quarter of the typical
state’s budget
Qualifying level of income set by each state
Proportion of poor covered varies by state
18
Income Assistance
Food stamps are vouchers that can be
redeemed for food
Funded by the federal government
Uniform across states
Aimed at reducing hunger and providing
nutrition to poor families
Housing assistance programs include
direct assistance for rental payments and
subsidized low-income housing
19
Exhibit 3 Number and Percentage of U.S.
Population in Poverty, 1959-2002
20
Exhibit 4: Poverty Rates and
Unemployment Rates in the United States
21
Exhibit 5: Poverty Rates by Age
22
Poverty and Public Choice
The decline in the poverty rate of the
elderly stems from tremendous growth in
spending for Social Security and
Medicare
In a democracy, public policies depend
very much on the political power of the
interest groups involved
In recent years, the elderly have become
a powerful political force
23
Poverty and Public Choice
The elderly are actually represented by five
constituencies
The elderly themselves
Those under 65 who are concerned about the
current benefits to their parents & other elderly
relatives
Those under 65 who are concerned about their
benefits in the future
Those who earn a living by caring for the elderly
Those running for office who want the votes the
elderly deliver
24
Feminization of Poverty
Poverty rates among families headed by
females are much higher than rates among
other families
Poverty rates among female-headed families
have declined in the last decade
Families headed by women increased 148%
between 1965 and 2002
Percentage of births to unmarried mothers is
five times greater today than in the 1960s
Children born outside of marriage are likely to
be poorer than other children
25
Exhibit 6: Poverty Rates Are Much
Higher for Families Headed by Females
26
Exhibit 7: Percent of Population Living in
Poverty by State
27
Poverty and Discrimination
 Discrimination can occur in many ways

in school funding,
 in housing,
 in employment,
 in career advancement
 Discrimination in one area can affect opportunities
in another, e.g, housing discrimination may reduce
job opportunities
 Research shows that whites earn more than blacks,
but the gap between the two has narrowed
 Some research suggests that black workers receive
a lower quality of schooling than white workers
28
Poverty and Discrimination
Direct evidence of discrimination comes
from audit studies where otherwise
similar white and minority candidates are
sent to the same source to seek jobs, rent
apartments, or apply for mortgages
These studies find that

employers are less likely to interview or offer
a job to minority applicants
 minority applicants tend to be treated less
favorably by real estate agents and lenders
29
Affirmative Action
The Equal Employment Opportunity
Commission, established by the Civil Rights
Act of 1964, monitors cases involving unequal
pay for equal work and unequal access to
promotion
Research suggests that civil-rights legislation
has played a role in narrowing the black-white
earnings gap
State and local governments have also
introduced set-aside programs to guarantee
minorities a share of contracts
30
Affirmative Action
Since 1993 the median income of black families
has risen faster than that of white families
The proportion of black families living below
the poverty line has fallen to a record low
There is also a growing middle class among
black householders
31
Unintended Consequences
On the plus side, antipoverty programs increase
the consumption possibilities of poor families,
which is especially significant since children are
the largest poverty group
But programs to assist the poor may have
secondary effects that limit their ability to
reduce poverty
32
Disincentives
Income assistance consists of a combination of
cash and in-kind transfer programs, the
benefits of which vary inversely with income
from other sources
 transfers
decline sharply as earned income increases
 high marginal tax rate on earned income
 Since holding even a part-time job involves additional
expenses, the high marginal tax rate discourages
employment and self-sufficiency
33
Disincentives
The longer people are out of the labor force, the
more their job skills deteriorate
When they do look for work, their productivity
and pay are lower than when they were last
employed
Some argue that in this way, welfare benefits
can lead to long-term dependency
34
Does Welfare Cause Dependency?
Will the children of the poor end up in
poverty as well, e.g., is there a cycle of
poverty? Why might we expect one?
Children in welfare households may learn
the ropes about the welfare system and may
come to view welfare as a normal way of life
Research indicates that daughters from
welfare families are more likely than
daughters in other families to participate in
the welfare system themselves, and are more
likely to give birth outside of marriage
35
Welfare Reform
Some analysts believe one way to reduce
poverty is to provide welfare recipients
with job skills and make them find jobs
 workfare programs
Where tried, these state programs
indicate that they do save some money
because those in welfare-to-work left
welfare rolls sooner
36
Welfare Reform
Reforms at the state level set the stage for
federal reforms
Biggest reform came with the replacement of
Aid to Families with Dependent Children with
Temporary Assistance for Needy Families
AFDC set eligibility rules and left federal costs
open-ended through matching grants to the stats
TANF offers a block grant to the states to run their
welfare programs
37
Welfare Reform
Under the new system, states have wide
latitude to run their own welfare
programs
Concerns about welfare dependency
foster some special provisions
The act imposes a lifetime limit of five years
that a recipient can be on welfare
All able-bodied recipients on welfare for two
years must participate in welfare-to-work
programs
38
Exhibit 8: Welfare Recipients as a Percentage of the
U.S. Population Declined Sharply After 1994
39