Understanding Income Distribution and Poverty

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1 Understanding Distribution and Poverty : Understanding the Lingo market income: quantifies total before-tax income paid to factor markets from the market (i.e. wages, interest, rent, and profit) total : quantifies total market income plus payments to households from the government (welfare, universal child benefit, government pension plans, etc.) after-tax : quantifies total income minus tax payments paid to the government by households Poverty: Understanding the Lingo absolute poverty: describes a family unit with an income below the poverty line poverty line: a measure of income below which a satisfactory standard of living cannot be maintained relative poverty: describes a family unit with a standard of living far below that enjoyed by other families in the same society Low Cut-offs (LICOs): levels at which families or unattached individuals spend 20% more of their income than the average family or unattached individual on food, shelter and clothing. This is the most widely accepted tool in Canada for measuring poverty. The following is a 2009 matrix of low income cut-offs: From FAMEX data, the Canada average family expenditure on food, shelter and clothing is calculated. This is expressed as a percentage of pre-tax income. Base year low income cut-offs are set where families spend 20 percentage points more of their income than the Canadian average on food, shelter and clothing. The FAMEX data are then analysed to determine the income levels where families spend this percentage on the basics (i.e. the overall Canada percentage plus 20 percentage points). These income levels, differentiated by size of area of residence and by family size, become the base year low income cut-offs. The following is the 2000 matrix of low income cut-offs: Family size ,000 or more 18,371 22,964 28,560 34,572 38,646 42,719 46,793 Size of Area of Residence 100,000 to 499,999 15,757 19,697 24,497 29,653 33,148 36,642 40,137 30,000 to 99,999 15,648 19,561 24,326 29,448 32,917 36,387 39,857 Small urban regions 14,561 18,201 22,635 27,401 30,629 33,857 37,085 Rural (farm and non-farm) 12,696 15,870 19,738 23,892 26,708 29,524 32,340 Ontario Welfare Poverty Line Welfare as Percentage of Poverty Line Single Employable $ 6, $ 18, % Person with a Disability 11, , % Single Parent, One Child 13, , % Couple, Two Children 18, , % Newfoundland Welfare Poverty Line Welfare as Percentage of Poverty Line Single Employable $ 3, $ 16, % Person with a Disability 8, , % Single Parent, One Child 14, , % Couple, Two Children 17, , % 1

2 Analyzing Distribution A society may be quite wealthy as a whole, but income is not often distributed equitably throughout a society. German economist Max O. Lorenz developed what is now known as the "Lorenz" curve to illustrate the degree of income disparity that exists within a society. He measured the percentage of a society s total income earned by quintiles of the population. Quintiles A quintile is a fifth of a given value. quintuplets Economists sort households from the lowest incomes to the highest incomes and then divide that range into fifths, or quintiles. Thus, each quintile contains 20% of all households. The question is, how much of society s total income does each quintile earn? Cumulative % of Y PD Y AD Exploring Disparity 45 0 line shows perfect income distribution. Disparity of Q Cumulative % of Families Lorenz Curve shows actual income distribution. The area between the 45 0 line and the Lorenz curve shows the degree of income disparity. The magnitude of disparity can be calculated using a Gini coefficient, which essentially measures the surface of this area, and then calculates this area as a percentage of the entire bottom triangle. Cumulative % of Exploring Disparity Gini Index The magnitude of disparity can be calculated using a Gini coefficient which essentially measures the surface of this area, and then calculates this area as a percentage of the entire bottom triangle. Cumulative % of Families The Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with perfect inequality (where one family has all the income, and everyone else has zero income). The Gini index is the Gini coefficient expressed in percentage form, and is equal to the Gini coefficient multiplied by 100. The Gini coefficient is a measure of inequality developed by the Italian statistician Corrado Gini and published in his 1912 paper "Variabilità e mutabilità". The Gini index is the Gini coefficient expressed in percentage form, and is equal to the Gini coefficient multiplied by

3 Distribution: Key Concepts Transfer Payment: Government facilitated transfer of funds from one group to another. Benefit Principle: A criterion for judging equity; this principle states that a tax paid should be equal to the benefits received. Engel's Law: (Developed by Ernst Engel, 19th century German statistician.) As incomes increase, the relative share of income expended on food declines. Thus, poorer families will spend a larger share of their total expenditures on food than wealthier families. (i.e. the income elasticity of demand for food is relatively low.) Wagner s Law: Named after German economist Adolph Wagner ( ), who predicted that as an economy grows larger (i.e. GDP grows) government spending will comprise a greater proportion of GDP. In other words, government spending tends to rise faster than total spending (GDP). So How Should We Distribute Wealth? According to contribution? According to need? Equal to all? Redistribution The three primary methods utilized by the Canadian government to redistribute income are: 1. Taxes, 2. Maintenance Programs, and 3. Subsidized Services Taxation: Key Concepts Progressive, Proportional, & Regressive Tax Rates: Tax rates that increase, remain constant, or decrease (respectively) in relation to income. Personal income, corporate income, consumption, and property taxes: Taxes levied against income, purchases, and property values. Average tax rate: The percentage of total income spent on tax. Marginal tax rate: The percentage of additional income spent on tax. Taxation: Key Concepts Combined Tax Brackets When we add the provincial tax onto the federal tax, we see that we will in fact pay the following percentages of our income to the government: Approximately 20% on the first $40,000 of taxable income, plus... Approximately 32% on taxable income from $40,000 to $80,000, plus... Approximately 37% on taxable income from $80,000 to $150,000, plus Approximately 42% on taxable income over $150,000. 3

4 Combined Tax Scenario for $220, Laffer Curve Tax Bracket Retained Marginal Tax Tax Rate 1 $40, $32, $8, % 2 40, , , % 3 70, , , % 4 70, , , % Totals: $220, $145, $74, % Taxes Paid Kept Total Tax Revenue Tax Rate After a certain point, total revenue falls as tax rates increase. A very high tax rate would theoretically generate the same tax revenue as a much lower tax rate. Why would this be the case? Laffer Curve Laffer Curve Total Tax Revenue After a certain point, total The Laffer curve is revenue most understandable falls as by considering taxation rates both extremes: zero percent and one-hundred percent. increase. A very high tax At either extreme the government collects no revenue: rate would Naturally, a 0% tax rate will generate no tax revenue. theoretically generate the However, a 100% tax rate would also generate no tax revenue because (in a rational taxpayers would change same their behavior tax revenue when taxed for every dollar that they earn. earners as a would much either lower completley lose incentive to work, or they would find ways to avoid paying taxes. Tax Rate tax rate. Why would this be Thus, somewhere between 0% and 100% is a theoretical tax rate that will maximize revenue. the case? Total Tax Revenue Tax Rate At either extreme the government collects no revenue: The Laffer curve is most understandable by considering taxation at both extremes: zero percent and one-hundred percent. Naturally, a 0% tax rate will generate no tax revenue. However, a 100% tax rate would also generate no tax revenue because (in a rational taxpayers would change their behavior when taxed for every dollar that they earn. earners would either completley lose incentive to work, or they would find ways to avoid paying taxes. Thus, somewhere between 0% and 100% is a theoretical tax rate that will maximize revenue. Canada s Maintenance Programs Social Security Programs: Old Age Security Program: Old Age Security Pension (65 years old) Guaranteed Supplement Spouse s Allowance Canada Pension Plan (contribute from salary, collect at age 60) Subsidized Services Education (k-12), and post-secondary (true costs are far greater than tuition) Health care Employment Insurance (contribute from salary to protect against temporary loss of income) Workers Compensation (injuries) Welfare Programs (i.e. Ontario Works) 4

5 Let s Look at Some Popular Beliefs Regarding Poverty Poverty is the failure of the individual! Many workers have lost their jobs for reasons beyond their control and cannot find work because it is not available. Many people are on welfare because they are temporarily unable to provide for themselves, often due to some personal or economic crisis beyond their control. The poor do not want to work! Welfare rates are too generous! The fact is that most poor people do work full or part-time over 60% of those heading poor families, over 70% of poor unattached individuals. All welfare rates are well below the poverty line. The highest rates are still 20% below; the lowest are 76% below the poverty line. Welfare recipients: children 37%, single mothers 16%, disabled 24% The welfare system is rife with cheating and fraud Poor families are poor because they have too many children! A study conducted by a national auditing firm estimated fraud to be in the range of 3% of the Ontario welfare budget. Most poor families have none, one or two children. On the other hand there are estimates that income tax fraud is in the order of 20% Only 15% have 3 or more children under 18. 5

6 We cannot afford the social programs needed to eliminate poverty! Based on GDP per capita, Canada is more prosperous than all European countries. Yet Canada spends less on social security and other income support measures (including Ul and welfare) as a share of GDP than most European countries. So why are some people poor? family size (many children) regional disparity (rural, Atlantic) age (young or elderly families) infirm / incapacitated single mothers (38% of low income families) self-employed (10% of low income families) What are the causes of poverty? low productivity (inside PPC) low economic growth quantity / quality of resources physical / mental disabilities discrimination: employment discrimination wage discrimination occupational discrimination 6

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