12.4 Income inequality and redistribution policies

Income inequality is a hot topic in economics, affecting how money is spread across society. It's measured using tools like the Gini coefficient and Lorenz curve, which show how evenly (or not) income is distributed among people.

Factors like technology, globalization, and education play big roles in creating income gaps. These differences can slow economic growth, limit social mobility, and cause health issues. Governments use various policies to try and balance things out, aiming for fairness without hurting the economy too much.

Income Inequality: Concepts and Measures

Defining and Measuring Income Inequality

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• Income inequality describes uneven income distribution across a population (individual, household, or national level)
• Gini coefficient measures income inequality ranging from 0 (perfect equality) to 1 (perfect inequality)
• Lorenz curve graphically represents income distribution plotting cumulative income share against cumulative population share
• Income quintiles and deciles divide population into equal groups based on income levels for comparative analysis
• Palma ratio compares income share of top 10% to bottom 40% providing insight into extreme inequality
• 20:20 ratio measures income of richest 20% relative to poorest 20% offering simple comparison of income disparities

Poverty Measures and Additional Inequality Metrics

• Relative poverty measures assess economic deprivation within a population comparing incomes to median income
• Absolute poverty measures use fixed income thresholds to determine poverty status (World Bank's $1.90/day international poverty line)
• Income share ratios compare incomes of different population segments (P90/P10 ratio)
• Theil index measures income inequality accounting for subgroup decomposition
• Atkinson index incorporates social welfare function to measure inequality
• Percentile ratios examine income differences between specific points in distribution (P90/P50 ratio)

Factors Contributing to Income Inequality

Economic and Technological Factors

• Technological change and skill-biased technological progress contribute to wage disparities between skilled and unskilled workers
  • Automation replacing low-skill jobs while increasing demand for high-skill workers
  • Digital divide exacerbating income gaps based on technology access and proficiency
• Globalization and international trade exacerbate income inequality through job displacement and wage pressures
  • Offshoring of manufacturing jobs to lower-wage countries
  • Increased competition from imports affecting domestic industries
• Labor market institutions influence income distribution
  • Minimum wage laws impact earnings of low-wage workers
  • Unionization rates affect collective bargaining power and wage negotiations
  • Employment protection legislation influences job security and wage structures

Social and Policy-Related Factors

• Educational attainment and access to quality education determine income potential and social mobility
  • Higher education levels correlate with higher earnings (college wage premium)
  • Unequal access to quality schools perpetuates income disparities across generations
• Inherited wealth and intergenerational transfers contribute to persistent income inequality
  • Inheritance tax policies impact wealth concentration
  • Family background influences educational and career opportunities
• Fiscal policies impact income redistribution and inequality levels
  • Progressive tax systems aim to reduce income disparities
  • Social welfare programs provide income support to lower-income groups
• Demographic factors affect income distribution patterns
  • Age structure influences earning potential and wealth accumulation
  • Household composition impacts income sharing and poverty rates
  • Urbanization affects income disparities between rural and urban areas

Consequences of Income Inequality

Economic Impacts

• High income inequality leads to reduced economic growth
  • Decreased aggregate demand due to lower consumption among low-income groups
  • Suboptimal resource allocation resulting from concentrated wealth
• Income disparities result in lower social mobility
  • Limited access to education and job opportunities for low-income individuals
  • Persistent poverty cycles across generations
• Consumer behavior and market demand patterns influenced by income distribution
  • Luxury goods market growth in highly unequal societies
  • Limited market for mass-market goods in economies with high inequality

Social and Health Consequences

• Extreme inequality contributes to social unrest and political instability
  • Increased social tensions and polarization
  • Erosion of social cohesion within societies
• Health outcomes and life expectancy correlated with income levels
  • Lower life expectancy and higher mortality rates among low-income groups
  • Limited access to healthcare services for disadvantaged populations
• Educational attainment impacted by income inequality
  • Unequal access to quality education affecting human capital development
  • Lower educational outcomes for students from low-income backgrounds
• High inequality leads to increased crime rates and social problems
  • Higher property crime rates in areas with significant income disparities
  • Increased social costs for law enforcement and criminal justice system

Effectiveness of Redistribution Policies

Tax and Transfer Policies

• Progressive taxation systems reduce income inequality
  • Higher tax rates on high-income individuals (marginal tax rates)
  • Tax credits and deductions targeted at low-income groups (Earned Income Tax Credit)
• Social transfer programs provide income support to lower-income groups
  • Unemployment benefits maintain income during job loss periods
  • Welfare payments assist individuals and families in poverty (Temporary Assistance for Needy Families)
• Conditional cash transfer programs incentivize specific behaviors while providing income support
  • Education-linked cash transfers to increase school attendance (Mexico's Prospera program)
  • Health-related cash transfers to improve maternal and child health outcomes

Social and Labor Market Policies

• Public education and healthcare policies promote equal opportunities
  • Free or subsidized education to reduce disparities in human capital development
  • Universal healthcare systems to ensure access to medical services regardless of income
• Minimum wage laws and labor market regulations protect low-income workers
  • Minimum wage increases to boost earnings of low-wage workers
  • Overtime pay regulations to ensure fair compensation for extra work hours
• Asset-building policies help reduce wealth disparities
  • Homeownership programs to assist low-income families in building equity (FHA loans)
  • Individual development accounts to encourage savings and asset accumulation
• Universal basic income proposals aim to provide guaranteed minimum income
  • Unconditional cash transfers to all citizens regardless of employment status
  • Potential to reduce income inequality and provide economic security

Efficiency vs Equity in Redistribution

Economic Trade-offs

• Equity-efficiency trade-off suggests some redistribution policies may reduce economic efficiency
  • Higher taxes on high-income earners potentially discouraging work effort and investment
  • Generous social welfare programs creating disincentives to work (welfare trap)
• Redistribution policies impact savings and investment behavior
  • Higher taxes potentially reducing capital formation and long-term economic growth
  • Social programs affecting individual savings rates and retirement planning
• Market distortions caused by redistribution policies lead to deadweight losses
  • Price controls creating shortages or surpluses in markets
  • Subsidies distorting market signals and resource allocation

Policy Considerations and Long-term Effects

• Administrative costs of implementing redistribution policies must be considered
  • Bureaucratic expenses for managing social programs and tax collection
  • Compliance costs for individuals and businesses adhering to tax regulations
• Dynamic efficiency considerations suggest some redistribution may enhance long-term growth
  • Improved human capital through increased access to education and healthcare
  • Enhanced social stability promoting economic development and investment
• Balancing short-term costs with long-term benefits of redistribution
  • Initial economic slowdown potentially offset by future productivity gains
  • Reduced income inequality contributing to sustainable and inclusive economic growth