Archive for the '2.3 Macroeconomics Objectives' Category

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