ECONOMICS OF SOCIAL POLICY: POVERTY, INEQUALITY

CHOICE VS CONSTRAINTIncome

Before we discuss problems of defining poverty, we must illustrate the difficulty in distinguishing between someone who is poor BY CHOICE and someone who is poor BY CONSTRAINT. The diagram shows two people who earn the same level of income ² whatever definition is being used ² and fall below what society regards as the ¶poverty line·. However, one (on the red indifference curve) is poor by choice Poverty ² by working more hours he could go above the poverty line. The other one works far more (22 hours a day) yet will always be below the poverty line. Thus, because preferences differ, we can only help to give the OPPORTUNITY to stay above the poverty line.

Hrs of Leisure 2 22 24

INCOME

Because Income is central to all definitions and measurement of Poverty and Inequality, one must first define it. The most logical and complete definition of income is:
y

The sum of all forms of money income (salary) and all forms of non money income (job satisfaction etc.)

However, there are distinct problems in measurement. What do we include in Income?
y

Due to not being able to observe non-money income, we are restricted to money income; HOWEVER, there is no systematic link between the two component parts which means that money income is not necessarily a good proxy for full income. Do we observe income per person or per household? The former would leave a family as mostly destitute (if it relied on one bread winner), the latter would not ² nor would it pick up on inter-family inequality. Income may not be a steady flow; although in the long run one may earn a lot, he may earn nothing (a student) at points in time. Thus the time period under consideration has to vary with purpose.

The Income Unit:
y

Time Period:
y

POVERTY

Problems of Definition: What indicator of welfare to use?
y y y y

Because we cannot calculate Full Income (and therefore we cannot calculate the budget constraint in the diagram), three other measures are used: Money Income, Consumption, Expenditure All measures are problematic (we have already discussed Money Income), but they also share a devastating flaw; They do not account for CHOICE. They are all ex-post measures, and as such cannot discern between a person who is poor by choice (and thus has the opportunity to be rich) and one who is poor by constraint (and therefore needs help). We have already discussed the problem of the income unit, but there is also a problem of comparing income between families of different size. Arguments when considering poverty between families; one may gain utility from an extra child which compensates for the lower income per capita ² suggesting no change of full income and therefore no need for intervention. Either ABSOLUTE or RELATIVE. A relative version will vary with general trends in living standards, whilst an absolute version will vary much less. What concept to use depends on the utility functions of the rich ² if the rich are supremely concerned with their own income, an absolute measure would be more appropriate ² vice versa if they are more concerned about the incomes of the poor. Finally, relative poverty also encapsulates ¶Social Exclusion·.

Whose income?
y y

What Concept of Poverty?
y y y

y

POVERTY

Problems of Measurement: UK Empirical Definitions of the Poverty Line
y

y y

The UK uses a relative concept of poverty ² the real value of benefits has risen in line with pre-tax earnings (until the mid ² 80·s, at the very least). It has a broad definition of an income unit ² will lump together those living in the same household, irrespective of marital status. A single person is considered below the poverty line if he is below 20% of average earnings, whilst it is 40% for a family of four - this implies that the Government feels that the utility gained from having a child offsets some of the loss in income per capita. Need to consider three fronts: HOW MUCH, HOW MANY, HOW LONG. How Many The Poverty headcount. Count the number of people under £X a week. However, needs to be done via surveys ² counting those on benefits gives an underestimate due to some not taking up benefits even if they are entitled to. How Much The Poverty gap improves on the headcount by considering the extent by which people fall under the line. Can be weighted to take into account people with greater shortfalls. How Long Distinguishing between transient and persistent poverty is an important endeavour, but is not the focus of any current measures.

Extent of poverty
y y

y

y

POVERTY

Empirical Evidence on Poverty: Care therefore needs to be taken in interpreting results of poverty studies. Poverty, by the headcount measure, rose sharply in the 1980·s. New Labour were determined to reduce Poverty ² in particular Child Poverty (aiming to eliminate it by 2020). However, whilst poverty has declined under Labour (according to an IFS briefing note), the decline has been mitigated by a rise in poverty since 2005, under both the Before Housing Costs and After Housing Costs measures.
The fall in poverty has therefore been very slight ² only by around 3% under the latter measure. y Important to note that child and old age poverty were the greatest beneficiaries of the measures.
y

It is unlikely that the child poverty target for 2010 will be met, and it will take time to tell whether a new Government will be able to follow the now legally binding commitment. Although there are problems with cross-country comparisons (completeness of data, common currency/measures), the UK fares relatively badly The Nordic countries tend to perform the best.

POVERTY

Poverty relief is conducted in the UK via Cash Transfers. There are numerous different benefits available, each targeting a different demographic, however, there are 6 main benefits:
y

y

y y

y y

Income Support For those under 60 who have an income below a specified minimum. Usually conditional on registering for work. Can be thought of ¶topping up· current income to achieve a minimum level. Pension Credit income support for those over 60; however, has less weighting on the effect of personal wealth avoid penalizing pensioners with savings. Housing Benefit Helps with paying rent (if receiving income support, pays full rent) and local taxes. Working Tax Credit Aimed at relieving poverty AND incentivising people to work. Not available for those under income support. Child Tax Credit Heavily linked to WTC, but is not conditional on being in work, scales with children and income. Child Benefit Universal Benefit for ALL families.

POVERTY

The State intervenes for both efficiency and equity arguments:
Efficiency ² the previous benefits and credits tackle the problem of those whose National Insurance leaves them still short of the poverty line and those who don·t have NI benefits for some reason. y Thus, raising NI will not solve the problem fully and the Private Insurance market will be unable to provide for these risks, as much poverty is associated with children or high housing costs ² issues of moral hazard. y Equity ² broad agreement amongst all schools that the state should enforce a minimum standard of income to avoid destituteness.
y

Poverty reducing schemes should be assessed on:
y y y

The Level of Benefits. Targeting Costs

Targeting in particular is tricky as there are numerous approaches:
Means ² testing Highly accurate, but creates disincentives to work to stay within the bracket and creates an implicit tax on first earnings. Also, can be stigmatizing. y Indicator targeting ¶Back to Beveridge·; uses non-income characteristics of poverty. However, these characteristics need to be highly correlated with poverty, be easily identifiable and exogenous to the individual. y Self ² Targeting Provide incentives; price subsidies for inferior goods (limited), Conditional benefits; ¶workfare·, receive benefit only if doing training.
y

POVERTY

Assessment of Poverty Relief: Income Support:
y y y

Level: Generally seen to be about right; no one starves, but there are concerns about fuel payments. Targeting: Take-up is incomplete due to inconvenience and stigma ² hence, there are gaps; However, there are no leakages ² only those who should be on it get it. Costs: Spending has sharply risen, despite National Insurance, and administrative costs have also risen (in 2003/4 DWP spent £5.8 billion) Largely the same issues as Income support as if you receive I.S, you automatically become eligible for Housing Benefit. The economic problem of housing is more to do with insufficient income, and so should therefore be moved from price support to income support, as has happened. Level: Again, generally seen to be about right, however there are incentive effects, especially for secondary earners. Targeting: Mix of all three targeting types, by tying WTC to work, there is an incentive to find work in order to qualify. Costs: MC of WTC very small due to ¶piggybacking· off Income Support. No major problems with the level, but problems lie with the Targeting. Because Child Benefit is universal, it may be accused of being poorly targeted; however, since parents tend to be relatively young, they are also relatively more destitute. Hence, Child Benefit is fairly well targeted, although there are exceptions. In addition, along with CTC and WTC, it can provide positive incentives ² if paid to the mother, it empowers her, allowing for inter family targeting. Admin is relatively cheap.

Housing Benefit:
y y

Working Tax Credit/Child Tax Credit:
y y y

Child Benefit:
y y y y y

POVERTY

Income

Poverty/Unemployment Trap: Income support has a 100% rate of withdrawal; for every pound earnt over the threshold, income support withdraws by a £1, acting like an implicit tax. It is shown in stylized form to the side. The red line shows the budget constraint under Income Support. If we assume a certain amount of initial earnings is disregarded, then there will only be an incentive to work up until point a, as between ¶a· and ¶b·, income is constant, but you achieve less leisure (fall onto a lower utility level). Official figures have shown this to be very real and very intense: in the 1990·s, if your income rose from £50 £200 per week, average weekly spending allowance rose only by £10. However, this effect is mitigated by the fixed nature of WTC and CTC ² fixed for a year. Because they are fixed, they will not be immediately withdrawn; thus the negative effect they have on earnings may be discounted. Thus, they may cushion the impact of I.S withdrawal.

b

a

Poverty Hrs of Leisure 24

POVERTY

Empirical Evidence: Level of Benefits:
y

y y

As already noted, poverty has fallen, but only slightly. The lack of a definitive poverty ¶line· makes analysis difficult, but the benchmark appears to be about 60% of median household income. However, most of the poverty is transient ² in any four year period between 1991 ² 2000, only 1/10 of those in poverty remained such for three of those years. It does not appear that the level of benefits is too low; the problems lie in the targeting and incentive effects. Take up has risen - £9 out of every £10 of potential benefit is being taken up in 1994/5, so there are few gaps. Leakages are fairly few ² benefits based on means testing tend to go to the lower income quintiles, and taper off abruptly. Indicator targeting ² in particular the use of the CTC ² has proved accurate in practice. WTC schemes in the UK and US are associated with a rise in the participation of single people; although there is no clear evidence of impact on the hours worked. The secondary earner is less likely to work if it pushes the family income up to point ¶a· on the diagram. There is a trade off between creating incentives for participation at the expense of creating incentives for moving from full time to part time work. There is, in some cases, a spike in the number of hours worked which are the minimum requirement to participate for that scheme.

Targeting:
y y y

Incentive Effects:
y y y y

POVERTY + INEQUALITY

Before discussing inequality, the distinction between poverty must be made. Poverty is concerned with the amount of individuals in a society who fall behind a certain defined income. Inequality is (crudely) concerned with the dispersion between incomes in a society ² the distance and relative magnitudes of the very poorest to the richest. The distinction is important to make in order to realise that alleviating one may come at the expense of alleviating the other;
Cutting the top rate of taxes may foster economic growth which will pull people out of poverty, but at the expense of more inequality. y Taxing the rich highly may reduce economic growth, which may reduce inequality at the expense of poverty.
y

INEQUALITY

Problems of definition: Major problem is Inequality of WHAT?
y y y y

Ideally Equality of Full Income But we can·t measure this. Equality of use/outcome/expenditure? All these, as discussed in the equity essay, are incomplete. ¶Best· measurable definition is probably Equality of Opportunity. Means that all people have the opportunity to earn the same income regardless of nonrelevant characteristics (social class, race, religion etc.).

However, where to set the bar? What characteristics are down to ¶choice· and what are ¶discriminatory·? In addition, Equality of Opportunity must apply to both money income and inkind transfers; for the latter, there must therefore be equality of access (which raises further issues). Problems of Measurement: Between Individuals:
y

Because we are using a definition based on opportunity, money income is a poor proxy because of variables such as AGE (lifecycle hypothesis), CHOICE and TIME the difference between transient and intra-generational inequality. Much the same argument as for poverty; do families gain utility from children or not? Depending on the weighting the scale gives, inequality between families can vary drastically.

Between Families:
y

However, main issue is AGGREGATE MEASURES.

INEQUALITY

Aggregate Measures: Using A Frequency Distribution (i.e., histogram):
y y y y

One can use the Variance of income ¶V·, although it is sensitive to the absolute level of income. Alternatively, use the Coefficient of Variation ¶C· (which uses ¶V·), but it is neutral to the level at which income transfers take place. These problems are ameliorated by using ¶H· The variance of the logarithm of income. However, ALL suffer from arbitrary procedures of squaring the distance from the mean and ONLY considering the distance from the mean. Shown on the next slide; it shows what percent of the population own what percent of the income. The Gini Coefficient is the ratio of A / B. It has the advantage of being non-arbitrary in it·s procedure and comparing all incomes with EVERY OTHER INCOME, not just the mean. Problems with the Lorenz Curves/Gini arise when they CROSS, as shown. Then there is no unambiguous answer on whether inequality has risen or fallen.

The Lorenz Curve/Gini Coefficient:
y y y y

The main criticism of These measures is that they all use and ARBITRARY and IMPLICIT Social Welfare Function. ¶V· and ¶C· consider all redistribution to be beneficial, regardless of the level it takes place at, ¶H· uses implied weights in it·s formula and the Gini Coefficient uses weights by a person·s rank order in a distribution ² the very poorest has a higher weight than the very richest. To Continue, we need to make these Social Welfare Functions Explicit.

INEQUALITY
% of Income % of Income

Equality line

A

B

Lorenz Curve % of People % of People

INEQUALITY

Social Welfare Functions in Measurement: Consider the second diagram (from the red curve to the blue one); although at the lower end of the income scale income power has increased, that story is reversed higher up. There is therefore no unambiguous answer as to whether society prefers the blue distribution or red one; it depends on the weighting society gives people at each income group. If the curves did not intersect and the blue was wholly inside the red, it would be unambiguous that the blue puts society onto a higher utility level. The Atkinson Inequality Measure:
y y y

y y

Hinges on the use of a constant relative inequality aversion, . If = 0, society is indifferent to inequality, if it is infinity it is a Rawlsian society that is concerned with the position of the least well off. Can be calculated by thinking of a ¶leaky bucket· ² how much can £100 be reduced by due to admin costs etc. Before it·s redistribution from rich to poor is no longer seen as desirable? The Atkinson Measure can then act as both a measure of inequality and an index of welfare gains from redistribution. The main criticism of the Atkinson measure is that it relies on the additive nature of utility functions ² the welfare of society is the sum of all individual·s utility.

INEQUALITY

Empirical Evidence: 2007/8 income inequality was slightly higher than when Labour came to power in 1997.
y y y

However, the rise in income inequality was far less than what occurred under the Conservative·s administration. In addition, the inequality was driven by different income growth at the EXTREMES of the spectrum; across most of the population income growth was even ² IFS. Labour·s tax and benefit measures have reduced inequality relative to what would have occurred if the conservative era infrastructure had simply been duly maintained.

The UK performs badly in cross country comparisons, often appearing with a relatively high level of inequality, using data from the Luxembourg Income Study.
y

Interestingly, post 1997, Wage Inequality rise has been in line with OECD average, suggesting a fundamental and global driving force for this rise. Finds that Inequality has risen under Labour, however this has been driven by changes in the top half of the distribution (Bankers· Bonuses), with no increases (but some decreases) in the bottom half. Largely due to a change in the tax + benefit system, as well as the NMW. Although the specific extent by which Labour has redistributed changes depending on what index you use, broad agreement that there has been significant redistribution from rich poor.

A report by the LSE is broadly congruous with the conclusion of the IFS report;
y

y y

The next step is to focus on REDUCING inequality rather than stabilising it. However, one has to be careful in interpreting the results, given the previously listed criticisms of the various measures.

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