Chapter 20: Income Inequality and Poverty

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Welcome back to the Deep Dive.

Today we're getting into a topic that, well, it definitely sparks debate.

I want to start with a quote from Winston Churchill.

Hmm.

That quote, it really gets right to a central tension, doesn't it?

Market economies, they can create incredible wealth.

I mean, prosperity we couldn't have imagined generations ago.

Absolutely.

They're powerful engines.

But that prosperity, it isn't always spread evenly.

You see huge variations in income, big gaps between, you know, the top and the bottom.

Right.

And that's exactly what we're diving into today, income inequality and poverty.

Our mission here is to try and understand, well, why do these differences exist?

What role can government realistically play?

And crucially, what are the trade -offs when it tries to step in?

Yeah.

What are the costs and benefits?

Exactly.

Well, look at how we measure all this, explore some really interesting philosophical takes on what's fair, and then get practical talk about the actual policies governments use to tackle poverty.

And, you know, it connects back to those basic economic principles we often discuss, that invisible hand idea markets are usually good at allocating resources efficiently.

Right.

Efficiency,

but not necessarily fairness.

Precisely.

And that leads to another principle.

Governments can sometimes improve market outcomes, but, and this is the big but.

There's always a but.

There is.

People face trade -offs.

Policies aimed at redistributing income, well, they can sometimes mess with incentives.

Maybe people work less or save less.

And that can actually shrink the overall economic pie.

It's a real balancing act.

Okay.

So we've got this tension.

Efficiency versus equity.

Before we get into philosophies or solutions, let's just

get a handle on the situation.

How much inequality is actually out there?

Yeah.

Let's look at the numbers.

We need to cover, like, the degree of inequality, the poverty rate, some of the challenges in even measuring this stuff, and economic mobility.

How much people move up or down the ladder.

So starting with the U .S.

Imagine lining up all families by income, lowest to highest, and splitting them into five equal groups.

These are called quintiles.

Yep.

Standard way to look at it.

Okay.

Data from 2017.

It paints a pretty clear picture.

The bottom fifth, their income was around $33 ,500 or less.

The top fifth, over $145 ,000.

And if you look at just the top 5%, you're talking over $260 ,000 a year.

That's a big spread.

It really is.

And the trend over time is arguably even more revealing.

If you go back,

say, 1935 to around 1970, inequality was actually decreasing in the U .S.

Oh, interesting.

So the gap was closing.

Yeah.

The top quintile share of total income fell while the middle and bottom shares went up.

But then after 1970, that whole trend just reversed.

Reversed.

How so?

By 2017, that bottom quintile, they were getting just 3 .8 % of all the income generated in the country.

The top quintile, though, they got 48 .8%.

Wow.

Nearly half.

So wait, 48 .8 divided by 3 .8, that's almost 13 times as much.

Roughly 13 times, yeah.

For the same number of families in each group, it's a significant shift back towards more inequality.

Okay.

So what's behind that shift?

Why did inequality start rising again after 1970?

Well, the chapter points to a couple of big factors.

Things like increased international trade, especially with countries that have much lower wages.

That tends to reduce demand for less skilled workers here.

Right.

Competition.

And then there's technology.

Technological changes have really favored skilled labor people with specialized training or education.

Their wages have gone up a lot more than wages for unskilled labor.

So trade and tech are kind of pushing the gap wider.

That seems to be a big part of the story, yeah.

Especially widening the gap at the very top.

And speaking of the very top,

measuring income for the super rich, like the top 1%, that's tricky with standard surveys, isn't it?

It really is.

Sample sizes are often too small and participation is voluntary, so you might miss those high earners.

So how do economists get around that?

Well, some economists, like Piketty and Saez, they've used income tax data.

It's a much bigger data set.

Ah, tax records.

Makes sense.

What do they show?

Their findings for 2017 really highlight the concentration.

To be in the top 1%, you needed income over about $420 ,000.

And their share of total income.

It jumped from like 7 .8 % in 1970 to 18 .1 % in 2018.

Almost tripled their share.

Exactly.

And it's even more dramatic for the top .1 % or .01%.

It really underscores that a lot of the recent rise in inequality is happening right at the peak.

Okay, so that's the U .S.

picture.

What about globally?

How does the U .S.

compare?

Well, first, a quick caution.

Comparing across countries is tough.

Data collection isn't uniform.

Got it.

Different methods.

But with that said, we can still see patterns.

One measure is the quintile ratio income of the richest fifth divided by the poorest fifth.

Okay.

You see countries like Pakistan or Sweden with ratios around 4 .5 more equal than you have places like South Africa, where it's incredibly high, like 28.

28 times.

Wow.

What does the U .S.

fit?

The U .S.

usually shows more inequality than other big advanced economies think Germany, Japan.

But less than some developing nations, like Brazil.

Actually, its level is pretty similar to China's right now.

Interesting comparison.

Okay, let's shift from the overall distribution to poverty.

How do we measure that?

We use the poverty rate.

That's the percentage of people whose family income falls below a specific level set by the government, the poverty line.

And that line isn't relative, right?

It's an absolute level.

Exactly.

It's an absolute threshold.

It's set roughly at three times the cost of an adequate diet, and it gets adjusted for inflation each year.

If your family income is below that line, you're counted as poor.

Okay.

So what were the numbers say back in 2017?

In 2017, median family income was around $76 ,000.

The poverty line for a family of four was about $24 ,800.

And the poverty rate itself was 12 .3%.

So over one in 10 people, how has that rate changed over time?

Well, historically, there was a big drop.

It went from over 22 % back in 1959 down to a low of about 11 % in 1973.

That was partly due to overall economic growth.

The rising tide lifts all boats idea.

But what happened after 1973?

Did it keep falling?

That's the striking part.

No, it didn't.

Despite the economy continuing to grow overall, the poverty rate has kind of stagnated since the early 70s.

It hasn't really fallen further.

And that's linked to the inequality trend we talk about.

Directly linked, according to the analysis.

Growth raised typical incomes, but because that growth wasn't shared equally, the poorest families didn't benefit enough to escape poverty at the same rate as before.

The increasing inequality essentially counteracted the poverty reducing effects of average income growth.

When we look at who is poor today,

are there specific groups that are disproportionately affected?

Yes.

The data shows clear correlations.

First, race.

Black and Hispanic individuals are more than twice as likely to be poor compared to white individuals.

Second, age.

Children are actually more likely to be poor than the elderly, which might surprise some people.

Yeah, you often hear concerns about elderly poverty.

And while that's important, child poverty rates were higher in 2017.

Third, family structure is huge.

Families headed by single mothers have poverty rates about five times higher than married couple families.

Five times higher?

That's a massive difference.

It is.

And when these factors combine,

say, children in households headed by black or Hispanic single mothers, the poverty rates become incredibly high, sometimes over a third.

So these are the headline numbers.

Stark figures on inequality, poverty rates stagnating despite growth,

specific groups facing higher risks.

But you mentioned measurement challenges earlier.

Are these official numbers the whole story?

Yeah, that's a really important point.

The official numbers, well, they often give an incomplete picture of someone's actual standard of living.

It gets more complex when you dig deeper.

How so?

What do the official numbers miss?

Okay, one big thing is that they're based on monetary pre -tax income.

Money income before taxes.

Got it.

Which means they leave out in -kind transfers.

These are benefits people get that aren't cash.

Think food assistance like SNMP, housing vouchers, Medicaid, health care benefits.

These are significant resources for low income families.

So people might have more resources than their cash income suggests.

Exactly.

And the official numbers also often exclude certain tax credits, like the earned income tax credit, the EITC.

That actually gives cash back to low wage working families.

So omitting these things can make poverty look worse than it might actually be in terms of resources available.

Okay, that makes sense.

What else complicates the measurement?

Well, there's the economic life cycle.

You know, your income isn't static.

It's usually low when you're young, maybe in school or starting out.

Beaks in middle age.

Right, when you have more experience.

And then it typically falls when you retire.

But people can borrow when they're young and save when they're earning more.

So their spending, their actual standard of living,

might be smoother than their income suggests.

Precisely.

Their standard of living might depend more on their lifetime income expectation than just what they earn in one particular year.

So looking only at annual income might overstate the real inequality in living standards over a lifetime.

And related to that, there's temporary versus permanent income.

Yeah, yes, exactly.

Think about, say, a farmer who has a really bad year due to weather.

That's transitory income fluctuation.

It's temporary.

But it doesn't necessarily change their long term average income expectation.

Right.

What matters more for their typical standard of living is their permanent income, their normal average income.

And because people often try to smooth their consumption, looking at what people actually spend might give a better picture of permanent income inequality than looking at current income, which bounces around more.

Consumption tends to be more equal than income.

There was a study mentioned by Cox and Alm.

Did that look at consumption?

Yes, that's a key one.

They compared the top and bottom fifths of U .S.

households.

They found, yes, a big income gap like 15 times.

After taxes, it shrank a bit.

But consumption?

That's where it got interesting.

The gap in consumption was much smaller, less than four times.

And if they adjusted for household size, because poorer households are often smaller, the gap in consumption per person was only about two times.

Only double.

That's way less than the 15 times income gap suggests.

It really suggests that the inequality in actual material living standards might be considerably less dramatic than the raw income figures imply.

And some researchers, like Meyer and Sullivan, argue that based on these kinds of consumption measures, we've actually made more progress against poverty than the official rate shows.

That's their argument, yes.

They say the official rate is flawed because it misses in -kind benefits and tax credits,

uses potentially flawed survey data, and might not adjust for inflation perfectly over long periods.

Using consumption data, they argue, shows much less severe material deprivation today compared to decades ago.

OK, so the measurement issues are significant.

Another piece of this puzzle is economic mobility.

It's not always the same people at the bottom or top.

Definitely not.

There's actually quite a bit of movement.

While the poverty rate tells you the snapshot in one year, many spells of poverty are temporary.

Like that stat about one in four families falling below the line over 10 years, but only a small percentage staying there persistently.

Exactly.

Only about 3 % are poor for, say, eight or more years in a decade.

So while poverty is a serious issue,

long -term, persistent poverty is less common than short -term spells.

And what about mobility across generations?

Do kids just inherit their parents' economic status?

There's some connection, sure, but it's far from perfect, as the text puts it.

If your father earns, say, 20 % above average, you might earn, on average, maybe 8 % above average.

There's regression towards the mean.

It's not deterministic.

And that millionaire stat was surprising.

Most made their own wealth.

Yeah.

About four out of five millionaires are considered self -made.

Only one in five primarily inherited their wealth.

It points to dynamism in the economy, people moving up.

Is mobility the same everywhere?

No.

There are international differences.

Interestingly, there tends to be a negative correlation between inequality and mobility.

Countries with more inequality, like Brazil, often have lower mobility.

It's harder to climb the ladder.

Countries with less inequality, like Sweden, tend to have higher mobility.

That raises some big questions about policy and opportunity, which maybe brings us to the next part.

We've seen the what is.

Now, what about the what should be, the philosophy behind it all?

Right.

Political philosophy.

How should society approach this?

Because how you think it should be influences what policies you support.

Okay.

First up, utilitarianism.

Bentham and Mill.

What's their main idea?

Their core goal for government is to maximize the total utility, basically, the total happiness or satisfaction of everyone in society added together.

Maximize total happiness.

How does that relate to income distribution?

Through the idea of diminishing marginal utility.

Basically, an extra dollar gives more happiness to a poor person than it does to a rich person.

Makes intuitive sense.

A thousand dollars means more to me than it does to a billionaire.

Exactly.

So if you take a dollar from a rich person, decreasing their utility slightly, and give it to a poor person, increasing their utility significantly, the total happiness in society goes up.

So does that mean utilitarians want perfect equality?

Not necessarily, because they also recognize that principle.

People respond to incentives.

If you try to equalize incomes completely through heavy taxes and transfers, you might discourage work and effort.

Ah, the leaky bucket.

The leaky bucket analogy, exactly.

Trying to transfer income, water from the rich bucket to the poor bucket, some water gets lost due to reduced incentives, administrative costs.

So a utilitarian wants to redistribute, but only up to the point where the benefit of more equality outweighs the cost of the shrinking economic pie.

They stop short of full equality.

Okay, that's utilitarianism.

Then there's liberalism, specifically John Rawls.

What's his approach?

Rawls focuses on justice.

He asks, what principles would we agree on if we were designing society from scratch, but from behind a veil of ignorance?

The veil of ignorance, meaning we don't know our own position, whether we'll be rich, poor, talented, disabled.

Exactly.

You design the rules without knowing where you'll land.

Rawls argues that in that situation, people would be most worried about being stuck at the very bottom.

They'd be risk averse.

So they'd want to make sure the worst possible outcome isn't too bad.

Precisely.

He calls this the Maximin Criterion.

Society should aim to maximize the well -being of the worst -off person.

This justifies redistribution to help the least fortunate.

But again, not necessarily total equality.

Right.

Because if trying to achieve perfect equality hurts incentives so much that the whole economy suffers, even the worst -off person could end up worse than they would be in a slightly less equal, but more prosperous society.

So like utilitarianism, it supports redistribution, but recognizes the incentive trade -off.

It's also kind of like social insurance.

We all agree to just in case we end up being the unlucky ones.

Okay, two views supporting some redistribution.

What about libertarianism?

Nozick.

Libertarians have a fundamentally different starting point.

They reject the idea that society's income is a collective pot to be divided up.

Income is earned by individuals.

The government shouldn't be taking from some to give to others.

Essentially, yes.

Their focus is not on the outcome, the final distribution, but on the process.

Is the way people earn their income just?

Was there force or fraud?

Did exchanges happen voluntarily?

Like the fairness of the rules of the game, not the final score.

Exactly.

If the process is fair, if property rights are respected and contracts enforced, then whatever income distribution results is fair, no matter how unequal it looks.

They emphasize equality of opportunity, not equality of outcome.

The government's role is to enforce the rules, protect rights, but not to rearrange the results.

Three very different perspectives on what's fair.

So given these debates, what do governments actually do?

What are the common policies used to fight poverty?

Well, most societies do implement some kind of safety net, even if they disagree on how extensive it should be.

Poverty is complex, tied to lots of other issues.

Let's look at some specific tools, minimum wage laws.

Okay, minimum wage.

Advocates say it helps low wage workers directly and the cost isn't born by government budget.

But critics worry about?

Unemployment.

If you force wages above the market equilibrium,

businesses might hire fewer low skilled workers.

The impact really hinges on how sensitive employers are to wage changes the elasticity of labor demand.

And does it actually target the poorest families effectively?

That's another critique.

Many minimum wage earners are actually teenagers or secondary earners in families that aren't poor, so it can be a bit of a blunt instrument.

Okay, what about welfare?

What is that typically involved?

Welfare usually refers to programs giving cash or other assistance directly to needy families.

Think TNF, temporary assistance for needy families, or SSI for the disabled or elderly poor.

Usually you need more than just low income.

There's often an additional requirement like having children or a disability.

What are the criticisms there?

The main concern is incentives.

Could welfare discourage work?

Could it inadvertently encourage family structures, like single parenthood, that qualify for benefits?

That concern was a big driver behind the 1996 welfare reforms in the US, which added time limits.

But proponents argue?

They'd argue that poverty itself causes these issues, not necessarily the programs, and that blaming welfare for complex social trends is an oversimplification.

All right, then there's the negative income tax idea.

How does that work?

It's a pretty neat concept.

Theoretically, high income people pay taxes.

Low income people essentially pay a negative tax, meaning they receive money from the government.

Like a guaranteed minimum income?

Sort of.

The text gives an example.

Taxes owed equals 13 of income, $15 ,000.

If you earn $60K, you pay $5K.

If you earn $30K, you pay nothing.

If you earn $15K, you get $10.

It phases out as income rises.

Pros and cons.

Pro -C.

It directly addresses poverty, sets a floor.

Con.

Some worry it might subsidize people who choose not to work, reducing labor supply.

Is there anything like this in practice?

The Earned Income Tax Credit, EITC, in the US is similar, but it's specifically targeted at the working poor.

You have to have earnings to get it.

So it avoids discouraging work.

In fact, it encourages it, but it doesn't help those who can't work.

We also talked about in -kind transfers earlier,

food stamps, housing vouchers.

Right.

Giving goods or services directly, not cash.

And there's a debate there.

Cash versus in -kind.

Yeah.

Advocates of in -kind say it ensures the aid is used for essentials, food, shelter, health care, prevents misuse, and is often more politically acceptable.

But the argument for cash is?

That it's more efficient and respects individual choice.

Poor people generally know what they need most, and giving them cash lets them make the best decision for their circumstances, rather than getting, say, more food aid when what they really need is help with utilities.

A really tough challenge with almost all these programs is the incentive problem again, specifically the phase -outs.

Yes, the effective marginal tax rate issue.

As someone earns more money, their benefits are reduced.

Sometimes the combination of taxes paid and benefits lost means that earning an extra dollar results in having very little extra disposable income, or sometimes even less.

Like running faster just to stay in the same place.

Exactly.

It can create a huge disincentive to work more hours or seek a better paying job, especially at the lower end of the income scale.

It can trap people.

And that has knock -on effects, right?

Like missing out on job experience.

Definitely.

Less work means less on -the -job training, fewer chances for advancement.

And it can impact kids too, seeing parents discouraged from working.

But fixing it is expensive.

If you phase out benefits more slowly, then many more people become eligible for at least some benefits, which drastically increases the program's cost.

It's a fundamental trade -off.

That's why other ideas like workfare requiring work for benefits or time limits get discussed and sometimes implemented.

It's fascinating how these policy debates play out differently in different countries.

That sidebar on international comparisons was interesting.

The U .S.

has a very progressive tax system.

Meaning higher earners pay a much higher rate.

Yet it does less to reduce inequality than systems in many other developed countries.

How does that work?

It's a bit of a paradox.

The argument presented is that while the U .S.

system is progressive on paper, it doesn't actually raise enough total revenue compared to other nations.

Highly progressive rates might lead to more tax avoidance or discourage economic activity, limiting the total collected.

So other countries might have flatter taxes but collect more overall?

Some do.

They might rely more on broader taxes like consumption taxes, VIT, which can raise substantial revenue even if they aren't as steeply progressive.

That larger pool of revenue then allows them to fund more extensive, often universal, social programs, health care, education, family support, which can significantly reduce inequality even if the tax rates themselves look less progressive than the U .S.

system.

Wow.

Okay.

We have definitely covered a lot of ground today.

We've looked at measuring inequality and poverty in the U .S.

and around the world, dug into the philosophical arguments about fairness and redistribution.

And examine the practical policies governments use along with all their complexities and unintended consequences.

It really brings home that this isn't a new problem.

You mentioned Plato thinking about income ratios centuries ago.

We still don't have a consensus on how much inequality is okay or how much government should really do about it.

It's an enduring challenge, absolutely.

And that leaves us, I think, with that core economic trade -off we keep bumping up against.

The idea that policy designed to slice the pie more equally often risk shrinking the size of the entire pie.

That tension between equality and efficiency seems unavoidable.

It's the central dilemma policy makers constantly grapple with.

Well, thank you for joining us for this deep dive.

We really hope this gives you a clearer framework for thinking about these incredibly important and complex issues.