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Lecture note Public finance (10th Edition) - Chapter 12: Income redistribution: Conceptual issues

In this chapter, the following content will be discussed: Poverty rates in the U.S. vary greatly by age, race, ethnicity, and gender; measuring the extent of poverty is difficult for various reasons; the rationale for redistributing income stems from attempts to maximize a social welfare function; determining the impact of income redistribution on real incomes is difficult primarily due to changes in relative prices resulting from the redistribution. | INCOME REDISTRIBUTION: CONCEPTUAL ISSUES Chapter 12 The Distribution of Money Income Among Households Source: US Bureau of the Census [2011a] Note: These figures do not include the value of in-kind transfers. 12- Who is Poor? Source: US Bureau of the Census, [2012a] 12- U.S. Poverty Rate Source: US Bureau of the Census [2012a] 12- Interpreting the Distributional Data Issues Poverty Line: fixed level of real income considered enough to provide a minimally adequate well-being Census income on which poverty level is based consists only of family’s cash receipts In-kind transfers Official figures ignore taxes Income measured annually Consumption data may provide better assessment of well-being Problems defining unit of observation 12- Rationale for Income Distribution Simple Utilitarianism Utilitarian Social Welfare Function: W = F(U1, U2, , Un) “Promote Greatest Good for Greatest Number” Additive Social Welfare Function W = U1 + U2 + + Un . | INCOME REDISTRIBUTION: CONCEPTUAL ISSUES Chapter 12 The Distribution of Money Income Among Households Source: US Bureau of the Census [2011a] Note: These figures do not include the value of in-kind transfers. 12- Who is Poor? Source: US Bureau of the Census, [2012a] 12- U.S. Poverty Rate Source: US Bureau of the Census [2012a] 12- Interpreting the Distributional Data Issues Poverty Line: fixed level of real income considered enough to provide a minimally adequate well-being Census income on which poverty level is based consists only of family’s cash receipts In-kind transfers Official figures ignore taxes Income measured annually Consumption data may provide better assessment of well-being Problems defining unit of observation 12- Rationale for Income Distribution Simple Utilitarianism Utilitarian Social Welfare Function: W = F(U1, U2, , Un) “Promote Greatest Good for Greatest Number” Additive Social Welfare Function W = U1 + U2 + + Un Assumptions 1. Individuals have identical utility functions that depend only on their incomes 2. Utility functions exhibit diminishing marginal utility of income 3. Total amount of income is fixed 0 12- Review General Concept of Social Welfare Function Utilitarianism simply means W a function of people’s utility Conventional Welfare Economics posits W = F(U1, U2, , Un), but this so general it doesn’t tell us much Utilitarian's believed in additive welfare function, although W = F( ) is called a utilitarian welfare function Implications for Income Inequality Equalizing income will increase W Paul’s marginal utility 0 Peter’s marginal utility Paul’s income Peter’s income 0 0’ MUPaul MUPeter a e c d f I* b Take ab from Peter and give to Paul Paul gains this much utility Peter loses this much utility This is the net gain to society Social welfare maximized 12- The Maximin Criterion Social Welfare Function W = Minimum(U1, U2, , Un) Maximin criterion - No inequality acceptable unless