Average Income to Support a Family of 4

Chapter 14. Poverty and Economic Inequality

14.5 Government Policies to Reduce Income Inequality

Learning Objectives

By the end of this department, you will be able to:

• Explain the arguments for and confronting government intervention in a marketplace economy
• Place benign means to reduce the economic inequality in a guild
• Show the tradeoff between incentives and income equality

No society should wait or desire complete equality of income at a given indicate in time, for a number of reasons. First, virtually workers receive relatively depression earnings in their starting time few jobs, higher earnings equally they reach middle age, and and so lower earnings after retirement. Thus, a society with people of varying ages will take a certain amount of income inequality. 2d, people'southward preferences and desires differ. Some are willing to work long hours to have income for large houses, fast cars and computers, luxury vacations, and the ability to support children and grandchildren.

These factors all imply that a snapshot of inequality in a given year does not provide an accurate picture of how people'southward incomes rise and autumn over fourth dimension. Fifty-fifty if some degree of economic inequality is expected at any signal in fourth dimension, how much inequality should there be? There is likewise the deviation between income and wealth, as the post-obit Articulate It Upward feature explains.

How do y'all measure wealth versus income inequality?

Income is a flow of money received, ofttimes measured on a monthly or an annual basis; wealth is the sum of the value of all assets, including money in bank accounts, financial investments, a pension fund, and the value of a domicile. In calculating wealth all debts must exist subtracted, such equally debt owed on a home mortgage and on credit cards. A retired person, for example, may have relatively little income in a given year, other than a pension or Social Security. Notwithstanding, if that person has saved and invested over fourth dimension, the person's accumulated wealth tin be quite substantial.

In the United states of america, the wealth distribution is more diff than the income distribution, considering differences in income can accrue over time to brand even larger differences in wealth. However, the caste of inequality in the wealth distribution tin can be measured with the same tools we utilise to measure the inequality in the income distribution, similar quintile measurements. Information on wealth are collected once every 3 years in the Survey of Consumer Finance.

Even if they cannot answer the question of how much inequality is besides much, economists can nonetheless play an important function in spelling out policy options and tradeoffs. If a society decides to reduce the level of economic inequality, it has iii main sets of tools: redistribution from those with high incomes to those with low incomes; trying to assure that a ladder of opportunity is widely available; and a tax on inheritance.

Redistribution

Redistribution means taking income from those with higher incomes and providing income to those with lower incomes. Earlier in this affiliate, we considered some of the key government policies that provide support for the poor: the welfare program TANF, the earned income revenue enhancement credit, SNAP, and Medicaid. If a reduction in inequality is desired, these programs could receive boosted funding.

The programs are paid for through the federal income tax, which is a progressive revenue enhancement system designed in such a manner that the rich pay a college percentage in income taxes than the poor. Information from household income tax returns in 2009 shows that the top 1% of households had an average income of $1,219,700 per twelvemonth in pre-tax income and paid an average federal revenue enhancement charge per unit of 28.ix%. The effective income tax, which is total taxes paid divided past full income (all sources of income such as wages, profits, involvement, rental income, and government transfers such as veterans' benefits), was much lower. The constructive tax paid by the summit 1% of householders was 20.4%, while the bottom two quintiles actually paid negative effective income taxes, because of provisions like the earned income tax credit. News stories occasionally report on a high-income person who has managed to pay very little in taxes, merely while such individual cases exist, co-ordinate to the Congressional Budget Office, the typical pattern is that people with college incomes pay a higher average share of their income in federal income taxes.

Of form, the fact that some degree of redistribution occurs at present through the federal income tax and regime antipoverty programs does not settle the questions of how much redistribution is appropriate, and whether more than redistribution should occur.

The Ladder of Opportunity

Economic inequality is perhaps well-nigh troubling when information technology is not the result of attempt or talent, but instead is determined by the circumstances under which a kid grows upward. One kid attends a well-run grade schoolhouse and loftier schoolhouse and heads on to college, while parents assist out by supporting education and other interests, paying for college, a beginning auto, and a first house, and offering piece of work connections that lead to internships and jobs. Some other child attends a poorly run grade schoolhouse, barely makes it through a low-quality loftier school, does not go to higher, and lacks family and peer support. These two children may exist similar in their underlying talents and in the attempt they put forth, but their economic outcomes are likely to be quite different.

Public policy tin can attempt to build a ladder of opportunities so that, fifty-fifty though all children will never come from identical families and attend identical schools, each kid has a reasonable opportunity to attain an economic niche in club based on their interests, desires, talents, and efforts. Some of those initiatives include those shown in Tabular array 13.

Children	College Level	Adults
• Improved mean solar day intendance	• Widespread loans and grants for those in financial need	• Opportunities for retraining and acquiring new skills
• Enrichment programs for preschoolers	• Public support for a range of institutions from ii-year customs colleges to large research universities	• Prohibiting bigotry in job markets and housing on the basis of race, gender, historic period, and disability
• Improved public schools	–	–
• After school and customs activities	–	–
• Internships and apprenticeships	–	–
Table 13. Public Policy Initiatives

The United States has often been called a country of opportunity. Although the full general thought of a ladder of opportunity for all citizens continues to exert a powerful attraction, specifics are often quite controversial. Society tin experiment with a broad variety of proposals for building a ladder of opportunity, specially for those who otherwise seem likely to starting time their lives in a disadvantaged position. Such policy experiments need to be carried out in a spirit of open-mindedness, because some will succeed while others will non show positive results or will cost too much to enact on a widespread basis.

Inheritance Taxes

In that location is always a contend about inheritance taxes. It goes like this: On the i hand, why should people who have worked difficult all their lives and saved up a substantial nest egg not be able to give their money and possessions to their children and grandchildren? In particular, information technology would seem united nations-American if children were unable to inherit a family business organization or a family domicile. On the other hand, many Americans are far more comfortable with inequality resulting from high-income people who earned their money by starting innovative new companies than they are with inequality resulting from high-income people who have inherited money from rich parents.

The United States does have an estate tax—that is, a tax imposed on the value of an inheritance—which suggests a willingness to limit how much wealth tin be passed on every bit an inheritance. However, according to the Centre on Budget and Policy Priorities, in 2015 the estate tax applied but to those leaving inheritances of more $v.43 million and thus applies to merely a tiny percent of those with high levels of wealth.

The Tradeoff between Incentives and Income Equality

Government policies to reduce poverty or to encourage economic equality, if carried to extremes, can hurt incentives for economical output. The poverty trap, for case, defines a situation where guaranteeing a certain level of income can eliminate or reduce the incentive to piece of work. An extremely high caste of redistribution, with very high taxes on the rich, would be likely to discourage work and entrepreneurship. Thus, it is common to draw the tradeoff between economical output and equality, as shown in Figure i (a). In this formulation, if society wishes a high level of economic output, similar point A, it must also accept a loftier degree of inequality. Conversely, if guild wants a high level of equality, similar betoken B, it must accept a lower level of economic output because of reduced incentives for production.

This view of the tradeoff betwixt economic output and equality may be too pessimistic, and Figure 1 (b) presents an alternate vision. Here, the tradeoff between economic output and equality commencement slopes up, in the vicinity of choice C, suggesting that certain programs might increase both output and economic equality. For instance, the policy of providing gratuitous public education has an element of redistribution, since the value of the public schooling received past children of low-income families is clearly higher than what low-income families pay in taxes. A well-educated population, however, is also an enormously powerful factor in providing the skilled workers of tomorrow and helping the economic system to abound and expand. In this case, equality and economic growth may complement each other.

Moreover, policies to diminish inequality and soften the hardship of poverty may sustain political support for a market economy. After all, if society does not make some effort toward reducing inequality and poverty, the alternative might be that people would rebel against market place forces. Citizens might seek economic security by demanding that their legislators laissez passer laws forbidding employers from ever laying off workers or reducing wages, or laws that would impose cost floors and cost ceilings and close off international merchandise. From this viewpoint, policies to reduce inequality may help economical output by building social back up for allowing markets to operate.

Figure 1. The Tradeoff betwixt Incentives and Economical Equality. (a) Society faces a trade-off where any attempt to motion toward greater equality, similar moving from selection A to B, involves a reduction in economic output. (b) Situations can arise like betoken C, where it is possible both to increase equality and also to increase economic output, to a choice like D. It may also be possible to increment equality with little affect on economical output, like the movement from choice D to E. Nevertheless, at some bespeak, too aggressive a push for equality will tend to reduce economical output, as in the shift from Due east to F.

The tradeoff in Figure ane (b) then flattens out in the surface area between points D and E, which reflects the design that a number of countries that provide similar levels of income to their citizens—the United States, Canada, the nations of the European union, Japan, Australia—have unlike levels of inequality. The design suggests that countries in this range could cull a greater or a lesser degree of inequality without much impact on economic output. Only if these countries push for a much higher level of equality, similar at point F, will they feel the macerated incentives that lead to lower levels of economic output. In this view, while a danger always exists that an agenda to reduce poverty or inequality can exist poorly designed or pushed also far, it is also possible to find and design policies that improve equality and practice non injure incentives for economic output by very much—or even amend such incentives.

Occupy Wall Street

The Occupy movement took on a life of its own over the last few months of 2011, bringing to light bug faced by many people on the lower terminate of the income distribution. The contents of this chapter indicate that there is a significant amount of income inequality in the United States. The question is: What should be done about it?

The Smashing Recession of 2008–2009 caused unemployment to rise and incomes to fall. Many people aspect the recession to mismanagement of the financial system by bankers and fiscal managers—those in the 1% of the income distribution—merely those in lower quintiles bore the greater burden of the recession through unemployment. This seemed to present the picture show of inequality in a dissimilar light: the group that seemed responsible for the recession was not the group that seemed to carry the burden of the pass up in output. A burden shared tin bring a society closer together; a brunt pushed off onto others tin polarize it.

On one level, the trouble with trying to reduce income inequality comes downwards to whether you lot still believe in the American Dream. If you believe that ane day you lot will have your American Dream—a large income, large firm, happy family, or any else you would like to have in life—then y'all practise non necessarily desire to prevent anyone else from living out their dream. Yous certainly would non want to run the risk that someone would desire to take function of your dream away from you. So there is some reluctance to engage in a redistributive policy to reduce inequality.

Nonetheless, when those for whom the likelihood of living the American Dream is very pocket-sized are considered, there are sound arguments in favor of trying to create greater remainder. As the text indicated, a fiddling more income equality, gained through long-term programs similar increased education and chore training, tin can increase overall economic output. Then everyone is made better off. And the 1% will not seem similar such a small grouping any more.

Key Concepts and Summary

Policies that can affect the level of economical inequality include redistribution between rich and poor, making it easier for people to climb the ladder of opportunity; and manor taxes, which are taxes on inheritances. Pushing also aggressively for economic equality can run the risk of decreasing economic incentives. However, a moderate push button for economical equality tin increase economic output, both through methods like improved pedagogy and by building a base of political support for market forces.

Self-Check Questions

1. Here is 1 hypothesis: A well-funded social safety net can increase economical equality but will reduce economic output. Explain why this might be so, and sketch a production possibility curve that shows this tradeoff.
2. Hither is a 2nd hypothesis: A well-funded social condom net may lead to less regulation of the marketplace economy. Explicate why this might be so, and sketch a production possibility curve that shows this tradeoff.
3. Which set of policies is more probable to cause a tradeoff between economic output and equality: policies of redistribution or policies aimed at the ladder of opportunity? Explain how the product possibility frontier tradeoff between economic equality and output might look in each case.
4. Why is there reluctance on the part of some in the United States to redistribute income so that greater equality tin be achieved?

Review Questions

1. Identify some public policies that tin reduce the level of economical inequality.
2. Draw how a push for economical equality might reduce incentives to piece of work and produce output. Then describe how a push button for economic inequality might not have such effects.

Critical Thinking Questions

1. What practise you lot think is more important to focus on when considering inequality: income inequality or wealth inequality?
2. To reduce income inequality, should the marginal tax rates on the top i% exist increased?
3. Redistribution of income occurs through the federal income revenue enhancement and government antipoverty programs. Explain whether or not this level of redistribution is appropriate and whether more than redistribution should occur.
4. How does a society or a country make the decision about the tradeoff betwixt equality and economic output? Hint: Call up well-nigh the political system.
5. Explain what the long- and short-term consequences are of not promoting equality or working to reduce poverty.

References

Lath of Governors of the Federal Reserve System. "Research Resource: Survey of Consumer Finances." Last modified December 13, 2013. http://www.federalreserve.gov/econresdata/scf/scfindex.htm.

Congressional Budget Office. "The Distribution of Household Income and Federal Taxes, 2008 and 2009." Terminal modified July x, 2012. http://www.cbo.gov/publication/43373.

Huang, Chye-Ching, and Nathaniel Frentz. "Myths and Realities Near the Estate Tax." Centre on Budget and Policy Priorities. Final modified August 29, 2013. http://www.cbpp.org/files/estatetaxmyths.pdf.

Glossary

effective income revenue enhancement

per centum of total taxes paid divided by total income

manor tax

a taxation imposed on the value of an inheritance

income

a period of money received, often measured on a monthly or an almanac footing

progressive tax system

a tax system in which the rich pay a higher percentage of their income in taxes, rather than a higher accented amount

redistribution

taking income from those with higher incomes and providing income to those with lower incomes

wealth

the sum of the value of all avails, including money in bank accounts, financial investments, a pension fund, and the value of a home

Solutions

Answers to Self-Check Questions

1. A very potent push for economic equality might include extremely high taxes on high-wage earners to pay for extremely large government social payments for the poor. Such a policy could limit incentives for the high-wage workers, lock the poor into a poverty trap, and thus reduce output. The PPF in this case volition take the standard appearance: it will be downwards sloping.
2. For the 2d hypothesis, a well-funded social safety net might make people experience that even if their visitor goes bankrupt or they need to alter jobs or industries, they will have some degree of protection. As a event, people may be more willing to permit markets to work without interference, and not to anteroom as hard for rules that would prevent layoffs, set price controls, or block strange merchandise. In this example, safety net programs that increase equality could as well permit the market to piece of work more freely in a mode that could increase output. In this case, at least some portion of the PPF between equality and economic output would slope upward.
3. Pure redistribution is more likely to cause a sharp tradeoff betwixt economic output and equality than policies aimed at the ladder of opportunity. A production possibility frontier showing a strict tradeoff between economical output and equality will be downward sloping. A PPF showing that information technology is possible to increase equality, at least to some extent, while either increasing output or at least not diminishing information technology would take a PPF that first rises, perhaps has a flat surface area, and so falls.
4. Many view the redistribution of income to attain greater equality equally taking away from the rich to pay the poor, or as a "zero sum" game. By taking taxes from ane group of people and redistributing them to some other, the revenue enhancement system is robbing some of the American Dream.

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