Week 7 - Inequality and Redistribution

Question 1

What does the Lorenz curve show?

Answer 1

Inequality where it shows a graph of % total income that bottom x% of households have.
E.g. bottom 20% of households might have only 5% of income

Question 2

Draw a lorenz curve?

Answer 2

X axis - share of populaton
Y axis - share of income
/ 45 deg line of complete equality
Lorenze curve bowed underneath

Question 3

What is the Gini coefficient and what does it show?

Answer 3

It is a used measure of inequality
Area A÷(A+B)

Question 4

What is the Gini coefficient of complete equality?

Answer 4

It would be a Gini of 0

Question 5

What is the Gini of complete inequality?

Answer 5

Gini coefficient of 1 meaning only one person has all the income.

Question 6

Label A and B on a lorenz curve?

Answer 6

A above the bowed curve and below the 45 degree line.
B is the area underneath the bowed line.

Question 7

What does a more bowed Lorenz curve show?

Answer 7

It shows higher inequality

Question 8

Why does inequality exists?

Answer 8

-Differences in non-labour (capital) income
–Inheritance
–Savings and borrowing behaviour

Differences in labour income
–Human capital, both innate and acquired (education)
–Effort and ambition
–Discrimination

And perhaps some luck as well
–Did I win the lottery?
–Did I get sick?
Wealth distribution is more unequal than income distribution so capital income more unequal than labour income

Question 9

What are some forms of redistribution?

Answer 9

Taxes (progressive taxes) and welfare benefits
Pensions for the elderly
Free or subsidised education and health

Question 10

Why do we redistribute and see it as important?

Answer 10

Provides social insurance against being sick, losing your job, getting old.

There are externalities from poverty
-crime
-people who cannot afford to educate their children
-people care about others wellbeing
-may harm economic growth

Question 11

What are the three goals with welfare redistribution programmes?

Answer 11

-Raise the living standards of low income families
-Provide incentives to work
-Keep costs low

Question 12

What is the problem/conflict between these three goals? (the iron triangle).

Answer 12

It is difficult if not impossible to improve one goal without worsening them in another.

Question 13

Draw the difference between the diagram of no welfare state and with a welfare state?

Answer 13

X axis - market income
Y axis - Final income

Without / 45 degrees
With less steep line

Question 14

What is a net recipient from a programme?

Answer 14

Everyone whose final income is higher than their market income. These people are ones above the 45 degree line

Question 15

What are these people called?
Everyone whose final income is higher than their market income. These people are ones above the 45 degree line

Answer 15

Net recipients

Question 16

What is a net contributor of a programme?

Answer 16

Everyone with a final income below the market income

Question 17

What are the people who have a final income below the market income?

Answer 17

A net contributor

Question 18

How is the average tax rate measured?

Answer 18

ATR= (market income - final income) ÷ market income

Question 19

What does the average tax rate show?

Answer 19

It is a measure of how much an individual gains/ looses from the programme.

Question 20

What is the average tax rate on the diagram (on no welfare vs welfare state diagram)?

Answer 20

Vertical distance between the programme line and the 45* line as a proportion of the height to the 45* line is one minus the average tax rate.

Question 21

What are the assumptions we make on the no welfare vs welfare diagram?

Answer 21

Market income is uniformly distributed up to the vertical line
Net cost will be will be area A minus area B - in this example the programme does not break even.

Question 22

How can we measure the incentives people have to increase their market income?

Answer 22

Natural measurement is how much final income rises as market income rises

Question 23

How do you measure incentives - how much final income rises as market income rises?

Answer 23

1 - marginal tax rate = Change in final income ÷ Change in market income

Question 24

For who is marginal tax rates highest for?

Answer 24

Those with lowest incomes

Question 25

For who is average tax rates highest for?

Answer 25

Those with higher incomes

Question 26

How does marginal tax rates affect incentives to work?

Answer 26

A higher marginal tax rate reduces incentives to work

Question 27

How do average tax rates affect incentives to work?

Answer 27

Increase in the average tax rate increases work. This is because leisure is a normal good

Question 28

How is the level of income provided to those with no market income shown on the diagram?

Answer 28

The height of the programme line on the vertical axis.

Question 29

How can you make the two triangles break even? Draw it on a diagram?

Answer 29

Simplest way to do so is to simply lower the programme line until the two areas are equal.

Shallower line moves down until A and B are equal

Question 30

What is the consequence of the triangles breaking even now breaking even?

Answer 30

The marginal tax rates faced are the same.
The cost is the programme now provides a lower income for those with zero market income
So its effectiveness in reducing poverty has diminished.

Question 31

What is a way of making the triangles break even while keeping the point on the vertical axis fixed? Draw it.

Answer 31

Pivot about the point. This now breaks even and provides the same income for those with zero market income.

But the cost is now the incentives to work have been reduced at the lower levels of market income

Question 32

What is the conclusion of trying to make the triangles equal with the aim of achieving equality? (keeping point fixed or reducing the programme line).

Answer 32

Both ways of reducing costs have disadvantages –
Either we reduce the effectiveness in reducing poverty
Or we reduce work incentives.
This is the “iron triangle” in action

Question 33

What is Universal Basic Income (UBI)?

Answer 33

It is an unconditional income paid to everyone
flat tax rate on higher income

Question 34

What are the advantages of UBi?

Answer 34

Simplicity

Needs less bureaucracy to administer than most welfare states (political right)

Gives people freedom and security to do what they want, whether it is studying or caring or being creative (political left)

Question 35

What are the disadvantages of UBI?

Answer 35

Does not escape the ‘iron triangle’
-UBI of x% of average income requires tax rate of x% of income
-Recent cost-neutral UK proposal is for 3.7k p.a.
-What is affordable is not transformational, what might be transformational is not affordable

Simple scheme cannot deal with complex circumstances
- E.g. Differences in housing costs

Is unconditionality desirable?
-Possible adverse effect on work incentives if scheme is generous
-People have responsibilities as well as rights (Atkinson participation income)
-Conditional cash transfer schemes seen as successful (e.g. Mexico, Brazil)

Question 36

What is the evidence of UBI suggesting?

Answer 36

A randomized control trial in US funded by Sam Altmann gave $1000 per month to some, $50 to others for 3 years
Made people better off, but they worked less
Health no better, quality of work no better

Question 37

What is the difference between Anglophone countries and others in the EU on the share of national income belonging to the top 1%?

Answer 37

Anglophones have much higher percentage owned by top 1%. USA with around 20%

Germany, Spain, France, Italy with much lower around 10%

Question 38

What are some of the arguments given for reasons behind the causes of income inequality?

Answer 38

Market Forces
-Superstar theory
Falling Marginal Tax Rates at the top
Financial market de-regulation
Increasing economic bargaining power of the rich
‘Capital is back’ - Piketty

Question 39

What is Thomas Piketty’s arguement?

Answer 39

Capital income is becoming more important again

This will continue if r>g as return to capital higher than growth rate of the economy

Consequences for inequality depends on the ownership of this capital

Question 40

What role does ownership of capital play in inequality?

Answer 40

Factors causing greater inequality:
- Richer save a higher proportion of their incomes
- Larger fortunes get a better return on their capital
But there are factors that go the other way:
- Fortunes are spread out on death
-Wars (not to be recommended)
-Inheritance taxation
-Wealth taxation
The last two are Piketty’s policy recommendations to reverse likely rise in wealth inequality – but many countries have been moving in the other direction

Question 41

What are the conclusions of these flashcards?

Answer 41

• Market outcomes are often very unequal
• Governments typically redistribute resources from rich to poor
• Inequality has grown in many countries in recent years with the rich benefitting most from economic growth
• But, ironically, recent period may have seen more people lifted out of poverty than any other period in history
• Delivering inclusive growth is currently at the heart of debates about how the economy should be run in countries like the UK.