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Income: It Ain't Where You Start, It's What You Got, and Where You End

Key Economic Concepts:

• Distribution of Income
• Income

Description:

This year's federal elections will involve electing a president, all members of the House of Representatives, and one third of the Senate. Barring some international crisis, economic issues appear likely to dominate the debates. In past elections, macroeconomic issues related to the business cycle, such as problems of inflation, unemployment, and slow economic growth, were the main focus of debate. Because of the recent overall economic performance, current debate on these issues has been muted. In its place, debates concerning the distribution of wealth and income have come to the forefront.

Lesson Objectives:

Students will:

• Present data on the distribution of household income and indicate how an unequal distribution of income is often used to indicate the persistence of poverty in a country.
• Show how data on the distribution of spending contradict income distribution data.
• Define and discuss income mobility and how it affects the composition of the income distributions.
• Show how cost of living affect poverty statistics.

Introduction:

 [Note to the teacher. Because of the length of this EconomicsMinute topic, it has two parts. Income distribution data usually discussed in the popular press cannot be evaluated separately from the poverty and cost of living data.]

This year's federal elections will involve electing a president, all members of the House of Representatives, and one third of the Senate. Barring some international crisis, economic issues appear likely to dominate the debates. In past elections, macroeconomic issues related to the business cycle, such as problems of inflation, unemployment, and slow economic growth, were the main focus of debate. Because of the recent overall economic performance, current debate on these issues has been muted. In its place, debates concerning the distribution of wealth and income have come to the forefront.

Process:

Specifically, Republicans and Democrats differ on how the benefits of our economic prosperity should be distributed. Particularly, they differ on what should be done with current and future budget surpluses. The Republican plan appears straightforward: cut taxes. After all, returning money to those paying the taxes will stimulate the economy and encourage additional investment. The resulting economic expansion will mean more jobs, higher incomes, more employment, world peace, and heaven on earth.

Democrats don't buy the argument. They argue that the wealthy have been the major beneficiaries of the current economic expansion, and that reducing taxes will allow them to receive still greater benefits. Therefore, we must first assure the solvency of the social security program and then undertake programs that will directly benefit lower income individuals and families -- and not through some "trickle down" benefits that result indirectly from the tax cuts.

Republicans respond by stating that the Democrats are presenting arguments that are promoting class warfare. They are pitting lower income households against upper income households rather than promoting policies that benefit all. Democrats argue that the policies advocated by Republicans largely benefit the wealthy, and they present evidence that during the current expansion the distribution of income has become more unequal and the poor have been left behind.

What do the income distribution data show? Can we infer from the data that the wealthy are benefiting relative to the less wealthy? Who has benefited from the recent economic expansion? Who has not benefited? Why? These are among the questions regarding the effects of the current economic expansion that are examined in this Economics Minute.

A cursory examination of data, whether it be income distribution data or something else, often hides more than it reveals. A major purpose of this Economics Minute is to encourage individuals to look deeper into economic data before making decisions.

Income distribution:

For reasons such as differences in education, age, skills, workers' preferences, experience, heredity, marital status, and luck, incomes among individuals and households differ. The Bureau of the Census periodically publishes data on the distribution of income. Traditionally, the income distribution data are divided into quintiles (fifths); the lowest 20 percent of income earners, the second 20 percent of income earners, and so on. If all households were to receive exactly the same income, each 20 percent (one fifth or each quintile) of households would receive 20 percent of the national income. The shares of aggregate income received by each fifth (each quintile) of all households and by the top 5 percent of all households are shown in Table H-2 on the website: www.census.gov/hhes/www/income/histinc/h02ar.html ^[1]

Activities:

• Is the distribution of income in 1998 equal? Starting with the lowest 20 percent of income-earning households, what proportion of the income is received by each 20 percent of households and the top 5 percent of households? [In 1998 the proportion of income received by the lowest 20 percent of households was 3.6 percent; the proportion received by the top 20 percent of households was 49.2 percent. The richest 5 percent of households received 21.4 percent of the national income.]

• Has the distribution of income become more or less equal since 1967? Which income class has seen its share of income increase? Which income class has seen its share of income decrease? What pattern emerges for the 1967-1998 period? [The data show that the top 20 percent of households found their share of income increasing, while the lowest three quintiles of households found their share of income decreasing. The second highest quintile of income earners maintained their share of income; the top 5 percent experienced significant gains in their share of income.]

• What do these data indicate? Are the wealthy benefiting at the expense of the poor? Does it appear that there is a perpetual underclass mired in a state of poverty? [Without additional information, these questions cannot be answered. However, much discussion in the popular press and elsewhere is centered on this issue and clearly indicates that many people hold the views expressed in the questions. The intent of the activity is to encourage students to start thinking about this issue.]

Distribution of spending:

While the distribution of income figures imply a pattern of persistent poverty for the lowest income earners in society, other data portray a different picture. The Census Bureau's annual report on poverty has information on the number of Americans living in poverty. Other government reports detail the material conditions of those defined as poor. The Heritage Foundation has published some facts about the material conditions of those classified by the Census Bureau as poor.

Have students access the following website and read the "Backgrounder" of the report, "The Myth of Widespread American Poverty" (the site also contains a short Executive Summary and the full text version of the report). Then have them answer the following questions. 

www.heritage.org/Research/Welfare/BG1221.cfm ^[2]

1. How many people are declared as living in poverty each year? [For the past decade between 31.5 million and 39 million persons. In 1997, 36.5 million persons were living in poverty.]
2. In 1995, what was the average household income of those living in poverty? What were their average household expenditures? What were their average household expenditures, including government household and health subsidies? [$8,350, $14,607, $20,335, respectively. Note, the latter two amounts are not used to determine who lives in poverty.]
3. Examine Table 1, The Percentage of Households with Various Consumer Goods. What goods that you deem necessities are absent from the average poor household? [There is nothing in the Table that indicates that the vast majority of the poor lack material necessities or conveniences, although opinions could differ on this issue.]
4. Do the poor have significantly less housing space than the average U.S. household? Do the poor have significantly less housing space than the poor in other countries? [Yes, the poor have less square feet per person and more people per room than the average U.S. household. No, the poor in the U.S. have significantly more square feet per person than the poor in other countries.]
5. As a group, are the poor chronically and malnourished? [No. Poor people are more likely to be overweight than are middle-class persons; 84 % of the poor report that their families have enough food to eat. The average consumption of protein, vitamins, and minerals for the poor is about the same as the amount consumed by the middle class, and poor children appear to be healthy.]
6. Is there a problem of poverty in the U.S.? [Most poor people live in adequate material conditions. However, material hardship is a problem for a large number of persons. Children of a never-married parent are most likely to live in poverty.]

Income mobility:

The income distribution data show the percent of households in different income categories. It gives an impression that our society is a class society, with a relatively small percentage of the population having high incomes and a large majority having relatively small incomes. Moreover, it gives the impression that there is permanence to one's status in society .

The U.S. Senate's Joint Economic Committee's (JEC) recent study titled "Income Mobility and Economic Opportunity" belies the picture given by the income distribution data. In short, the U.S. society is not a static society, but a very dynamic society. It provides opportunities for individuals to alter their status. A look at the JEC's most recent study of income mobility provides data regarding the movements among households across the income distribution categories.

www.house.gov/jec/middle/mobility/mobility.htm ^[3]

Two graphs and one table summarize the JEC's findings with respect to income mobility in the United States. [Teachers: Unfortunately, the first graph is barely readable and the second graph is totally illegible. Nevertheless, the information appearing in the graphs is summarized in the body of the document.] As an activity, have the students answer the following questions.

1. Between 1979 and 1988, what percentage of income tax filers in the lowest quintile of income levels left the lowest quintile by 1988? The second lowest quintile? The third, fourth, and fifth quintiles, and the top 1 percent of income tax filers? [85% left the lowest quintile. The percent leaving the other quintiles was 71%, 67%, 62.5%, and 35.5%, respectively. More than half of those in the top 1 percent were no longer in there in 1988.]
2. Table 1 presents data showing the direction of movement between 1979 and 1988 for the tax filers in each of the five income distribution quintiles. Do the data show that those in the lowest quintile in 1979 remained there in 1988? [No. Approximately 14% remained in the lowest quintile; 21%, 25%. 25%, and 15%, went to the 2nd, 3rd, 4th, and 5th quintiles, respectively.] What about the individuals in the other income categories? Did they remain in the same place or was there substantial movement up and down the income ladder? [There was substantial movement up and down the income ladder. The movement is well documented in the table and in the discussion of the table.]

   [Note to the teacher: There are two additional websites that contain excellent presentations and discussions of income mobility data. They summarize studies by the staff at the Urban Institute.]
   www.urban.org/publications/309465.html ^[4]

3. Is the American economy static or dynamic? Does the information about income mobility provide a different picture of our economy as compared with the income distribution data? Does it appear to you that poverty is widespread with no opportunity for individuals to improve their lot in life? Support your answer.

The Declining Cost of Living:

We have seen that many people do meet the Census Bureau's criteria for being poor. Yet substantially fewer persons are in abject poverty. Moreover, of the 20 percent of the households in the lowest income quintile, relatively few remain at the low end of the income scale over time. Nevertheless, the poor are always with us.

Is there any evidence that the cost of acquiring goods and services is lower today than it has been in the past? If it is, then the plight of lower income families is not as dire as people often say it is. Indeed, lower prices may help explain why the poor can acquire goods and services that were only available to those in higher income groups in the past. In other words, if the cost of living has declined, the poor may be better off than before because the necessities of life now cost them less, in terms of income and in time

W. Michael Cox, of the Federal Reserve Bank of Dallas, and Richard Alm, of the Dallas Morning News, have documented changes in the cost of living in the United States. Their work is presented in an article titled "Time Well Spent: The Declining Real Cost of Living in America." The article appeared in the 1997 Annual Report of the Federal Reserve Bank of Dallas and can be accessed at the following web-site.

www.dallasfed.org/fed/annual/1999p/ar97.cfm ^[5]

Exhibits 1 and 2 in this report contain information about average wages over the past 100 years and show that today's wages are substantially higher than in the past. For example, the average wage for production and non-supervisory workers in 1897 was almost 15 cents per hour. In 1997, it was $13.18. This is not what is today considered a high wage, but as Cox and Alm point out it is a livable wage. What is important, however, is not the wage rate or income, but what that wage or income level can purchase. Information concerning the time and effort required to acquire various products over various time periods begins in Exhibit 3.

Activities

• At the average wage in 1919 and 1997, have students compare the minutes of work necessary to purchase five basic food items. [Exhibit 3 contains the number of minutes of work needed to purchase 12 different food items in the two years. For example, it took 68 minutes of work in 1919 and 9 minutes of work in 1997 to purchase one dozen oranges. For a dozen eggs, the comparable figures were 80 minutes and 5 minutes.]

• Students should examine Exhibit 4 and compare the differences in the size and characteristics of homes in 1956 and 1996. On average, are homes in 1996 more likely to be equipped with more "gadgets" than in 1956? Are they larger? Are they more expensive? [A substantially greater percentage of homes have more in them in 1996 than in 1956. For example, in 1996, 81 percent had central heating; in 1959, 6 percent had central heating. The average square footage was 1,150 feet in 1956; it was 1,950 in 1996. The price of the average home in 1996 was $140,000, while in 1956 it was $14,500. It took 6.5 hours of work to purchase one square foot of housing in 1956 and 5.6 hours of work to purchase one square foot of housing in 1996.]

To the instructor: This report contains numerous examples of the declining costs of living in the United States. As an example, the cost of a refrigerator was $800, $700, $375, and $900 in 1916, 1958, 1970, and 1997, respectively. The size of the refrigerator has increased from 9 to 20 cubic feet over this time period. It took 3,162 hours of work to acquire the "icebox" in 1916. The cost of the "frig" declined to 333 hours in 1958, 112 hours in 1970, and 68 hours in 1997.

• Divide the students into teams and have them page through the report. Ask the teams what they found to be the most surprising change in the cost of living. Why were they surprised? Challenge them to find any item where the cost has remained the same or increased in both the dollar amount and the time necessary to purchase the good or service. Ask the students why the cost remained the same or increased on the items they identified. [Students probably will differ in their opinions about what is surprising. Women's haircuts increased in price from $0.25 in 1920 to $1.50 in 1950 to $10 in 1997; this represented 27 minutes, 63 minutes, and 46 minutes of work time in 1920, 1950, and 1997, respectively. 1997 movie ticket prices were greater than in 1926, but the number of minutes of work needed to pay the ticket price was the same: 19 minutes. The hours of work cost of attending private universities has also increased over this time period. In these cases, the services in question hardly fall into the necessities of life category, but are more likely leisure or luxury goods.]

Conclusion:

Divide the students into teams of four. Remind the students that they have looked at income distribution data, distribution of spending data, income mobility data, and cost of living data. Ask them to discuss whether there are large percentages of the population that are stuck at the low end of the income distribution.

Do individuals classified as poor find that they cannot acquire the necessities of life (or even a significant proportion of the goods and services that are available to most)? If they can acquire these goods and services, what enables them to do so? Where are the persistent and serious hardships associated with poverty most likely to be present? [Answer: Over time, there is substantial movement up and down the income distribution ladder. Because of the various welfare programs in existence, there is evidence that the distribution of spending is more equal than the distribution of income. Moreover, the amount of work necessary to acquire most goods and services is substantially less than in the past. Consequently, the problem of persistent and serious hardships usually associated with poverty is not as great as it is generally depicted. It appears that the problem of poverty is most serious in single parent families and in situations where the family structure is weakest.]

Links Used:

1. ^{^} "www.census.gov/hhes/www/income/histinc/h02ar.html" - (www.census.gov)
2. ^{^} "www.heritage.org/Research/Welfare/BG1221.cfm" - (www.heritage.org)
3. ^{^} "www.house.gov/jec/middle/mobility/mobility.htm" - (www.house.gov)
4. ^{^} "www.urban.org/publications/309465.html" - (www.urban.org)
5. ^{^} "http://dallasfed.org/fed/annual/1999p/ar97.cfm" - (dallasfed.org)

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