Oct 23 2012

Income Inequality’s Effects on Social and Economic Well-being

Inequality exists everywhere we look. Whether you live in a rich country or a poor one, there is inequality both within and between societies. Even a rich country like Switzerland has vast gaps between its richest and poorest households; and while there is no absolute poverty in rich countries like Switzerland, relative poverty exists as some within society earn an income and enjoy a standard of living significantly below those of others.

Is inequality a problem worth worrying about, however? There are arguments for and against making the reduction of income inequality a priority for government policy makers. To reduce inequality, argue some, the rich must be forced to give up some of their wealth in order to provide for the poor. Such ‘redistribution’ reduces incentives to work hard and therefore reduces the efficiency and productivity of society as a whole. ‘Handouts’ to the poor reduce their motivation to work, since more work and higher incomes would mean fewer government benefits and higher taxes.

Such a view is widely held among members of the Republican Party in the United States, including presidential candidate Mitt Romney, whose now infamous ‘47%’ comments reveal his lack of concern over the existence of inequality within the United States.

Romney’s 47% comments are in reference to Americans who, due to the progressive nature of America’s tax system, do not pay federal income taxes. (USA Today produced a very informative interactive graph providing a closer look at the 47%, which can be viewed here. Interestingly, of Romey’s 47%, 28% did pay federal payroll taxes which are non-progressive. Only 6.9% are the ‘working poor’ whose incomes are so low they pay no federal tax at all. The other 10% are elderly Americans who are no longer earning incomes and thus pay no income taxes).

The purpose of a progressive income tax scheme such as America’s is to place a larger burden of the total tax collections on the richest households, those who can most afford to pay taxes. When higher income earners pay a higher percentage of their income in taxes, and lower income earners pay lower tax rates, the after tax incomes earned by households will be more equal, and government is provided with a pool of tax revenues overwhelmingly paid by the rich. A large proportion of government programs intended to help the middle and lower income earners are then funded by the rich, effectively reducing the level of income inequality in society.

All forms of government spending are, essentially, forms of redistribution. Military spending redistributes income from households to defense, agricultural subsidies redistribute income from everyone to farmers and agro-businesses, spending on primary education redistributes income from all households to just those families with young children, the paving of roads redistributes income to people with cars, and so on… Fiscal policy itself is the act of collecting and redistributing income between different groups of households and firms. The extent to which fiscal policy can reduce income inequality, or SHOULD try to reduce income inequality, is the topic of much debate.

Recent studies have found that the existence of high levels of income inequality may be correlated with low levels of achievement in many social, human health, and economic indicators of well-being. Notably, the research undertaken by Richard Wilkinson, of the University of Nottingham, sheds a light on the effect that inequality has on society. Watch the TED talk below in which Wilkinson shares his research.

Inequality’s effects on social well-being

Using publicly available data, Google’s Public Data Directory allows us to create interactive graphs demonstrating the correlation between the level of inequality in nations and other social and economic indicators. The links below will take you to different charts I created while exploring the available data. Study each of the graphs and discuss with your class the relationship illustrated and possible explanations for the relationship.

Next, use Google’s software to create your own graphs exploring the relationship between income inequality (as measured by the Gini Index) and other economic or social indicators of well-being. Were you able to observe other correlations between inequality and social or economic welfare?

More reading on inequality

Last week’s Economist featured a special report on inequality, For richer, for poorerIt provides a great overview of the issue of inequality around the world, but focuses on inequality within countries, the threats it poses and the possible solutions to reducing it without undermining efficiency and economic growth.

I have selected the three most important articles from this report, which my students can access and read here.

Discussion Questions in Inequality

  1.  Identify two methods used for measuring income inequality (one used in Wilkinson’s talk and one is used in the Google Public Data Explorer). How are these two methods similar? How are they different? What are their short-comings?
  2. How have changes to nation’s economies brought about by globalization helped simultaneously reduce inequality between nations while increased inequality within nations?
  3. The existence of high levels of income inequality actually contributes to the efficiency with which an economy functions. Provide one argument for this claim and one argument against it.
  4. A highly progressive income tax system in the United States has somehow failed to reduce income inequality, which has actually grown. Besides a progressive tax system, what other elements must a nation’s fiscal policy include to promote greater equality? (Refer to the section from the Economist’s report on Sweden in your answer).

2 responses so far

2 Responses to “Income Inequality’s Effects on Social and Economic Well-being”

  1. Giulioon 28 Oct 2012 at 12:47 pm

    Discussion Questions in Inequality

    1. Identify two methods used for measuring income inequality (one used in Wilkinson’s talk and one is used in the Google Public Data Explorer). How are these two methods similar? How are they different? What are their short-comings? The method used in the TedTalk is comparing income inequality within countries to something like murder rate, and then compare that between many nations. The method in Google is to compare many set of data to each other to find a pattern for income inequality. These two methods are similar because they both try to give an explanation of why income inequality has a pattern within a nation and it doesn't when more than one nation is taken into consideration.

    2. How have changes to nation’s economies brought about by globalization helped simultaneously reduce inequality between nations while increased inequality within nations? This happened because, when for example Europe was going through the globalization phase, all the countries experienced the same growth and they advanced in the same ways. But once this happened inside every country there were people who got richer than others, creating this paradox of reduced inequality between countries, but increased inequality within nations.

    3. The existence of high levels of income inequality actually contributes to the efficiency with which an economy functions. Provide one argument for this claim and one argument against it. Having high levels of income inequality causes the richer to earn more money but pay more taxes, which will be divided between the porrest people, making the economy of a country run smooth. One argument against is that if the poor don't become equal, or at least there isn't equity they will never have the opportunity to chance their social status, meaning they will always stay poor. So inequality causes the rich to get richer and the poor to stay poor.

    4. A highly progressive income tax system in the United States has somehow failed to reduce income inequality, which has actually grown. Besides a progressive tax system, what other elements must a nation’s fiscal policy include to promote greater equality? The nation should promote equity, which means same chance for the rich and the poor to succeed in their job career. If a nation would promote equity than also the poor people would have the same possibilties and opportunities as the rich. meaning that the poor can change their social status. Equity is the key to reduce income inequality.

  2. Annalea Maureron 29 Oct 2012 at 11:05 am

    1. Identify two methods used for measuring income inequality (one used in Wilkinson’s talk and one is used in the Google Public Data Explorer). How are these two methods similar? How are they different? What are their short-comings?

    In the TED talk, Wilkinson measures income inequality through the comparison of the level of income inequality to the index of social situations such as life expectancy, teenage births, homicides, etc. In Google Public Data explorer, data is compared against the GINI index, which is a numerical measure of income inequality, against social, political, and economic measures such as literacy rate, poverty gap, and tax payments over time in order to determine a trend or correlation. The methods are similar because they often show a clear correlation between the effects that income inequality may have on other aspects of life in a nation. The possible short-comings are that many countries may not have data available for specific categories.

    2.How have changes to nation’s economies brought about by globalization helped simultaneously reduce inequality between nations while increased inequality within nations?

    The reduction of inequality between nations has occurred because the less-developed countries are catching up to the fully-developed ones. As globalization progresses, countries who were less developed in the past have been able to improve at a faster pace than already developed countries, as they have much more potential progress to make. Therefore, the inequalities between separate nations have decreased. However, within each nation, there still remain those who own the assets that industrialize and globalize a nation, thus making them significantly wealthier than the remainder of the population. As globalization progresses, certain individuals will become much wealthier than others, making the inequality greater.

    3.The existence of high levels of income inequality actually contributes to the efficiency with which an economy functions. Provide one argument for this claim and one argument against it.

    High income inequality does contribute to the efficiency of an economy because it means that the richest are earning a very large amount. This money is then distributed through taxes and household spending which benefits the economy and can contribute to growth. However, income inequality can be very deficient to an economy because the greater the inequality, the less opportunities the poor have to gain money and have an equal chance at work opportunities within the nation.

    4.A highly progressive income tax system in the United States has somehow failed to reduce income inequality, which has actually grown. Besides a progressive tax system, what other elements must a nation’s fiscal policy include to promote greater equality? (Refer to the section from the Economist’s report on Sweden in your answer).

    A nation’s fiscal policy should also include redistribution by the state, like in Sweden. Social services must be provided to the population in order for members of society with lower incomes to be given similar or the same opportunities as those with higher incomes. This is known as equity, or giving the entire population the same opportunities and services. Sweden has also created tax plans that create incentives for lower-skilled individuals to work, which reduces the unemployment rate and gives people the opportunity to earn more money, thus reducing inequality. The combination of lower taxes and not a great amount of social benefits and public services will create a strong incentive for individuals to work.

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