HSC Economics, Topic 3: Economic Issues, Part Five

Distribution of income and wealth

Key concepts in the distribution of income and wealth

 Personal income
o The amount of funds, or other benefits measured in money terms, that flow to individuals or households from the sale
of factors of production over a period of time
 Reward to the owners of the FoP for owning, maintaining, managing productive R
o Forms
 Wages from labour, rent from land, interest from capital, profit from enterprise
 Social welfare from government
 Income inequality
o The degree to which income is unevenly distributed among people in the economy
o Distinguished by the amount of personal income earned by each individuals
 Low level of inequality; people receive a similar share of Y
 High level of inequality; people receive highly varying shares of Y
 Personal wealth
o The net value of real and financial assets owned by an individual at a particular point in time
 Real assets include consumer durables, property
 Financial assets include shares, bonds, cash
o Calculation: personal wealth = assets – liabilities
 Wealth inequality
o The degree to which wealth is unevenly distributed among people

Measurement – Lorenz curve and Gini coefficient

Measuring the distribution of income

 Y inequality may be measured by the degree of variance in the total share of Y earned by different quintiles of equalised
disposable household income
o High degree of variance, high degree of inequality
o Low degree of variance, low degree of inequality

 Key observations from data

o In 2005-06;
 Poorest 20% of population received 8% of the total income
 Richest 20% of population received 39% of the total income
 Key concepts necessary to interpret data
o Mean income
 The average level of income
 Calculated by dividing the total income of a group by the number of income recipients in that group
o Median income
 The level of income which divides the income recipients in a group into two halves
 The Lorenz curve
o A graphical representation of income distribution, plotting the cumulative increase in population against the cumulative
increase in income
o X-axis: cumulative proportion of income units, Y-axis: cumulative proportion of total income
o Begins at 0 as 0% of families earn 0% of income
o Ends at 100 as 100% of families earn 100% of income
o Line of perfect equality is a diagonal line
 Bottom 20% account for 20% of total income, bottom 40% account for 40% of total income, bottom 60%
account for 60% of total income, etc.
  The Lorenz curve lies below the line of perfect equality
 There is a degree of inequality in Y distribution
 The greater the distance bw Lorenz curve, line of perfect equality, the greater the inequality in Y distribution
 Decrease in degree of inequality; Lorenz curve shifts inward towards line of perfect equality
 Increase in degree of inequality; Lorenz curve shifts outward away from line of perfect equality

 The Gini coefficient

o A mathematical expression of the degree of Y inequality
o Calculation of Gini coefficient
 It is calculated as the ratio of area A to (Area A + Area B)
 Gini coefficient = Area A/(Area A + Area B)
 Where area A = area bw Lorenz curve, line of perfect equality
 Where area B = total area under line of equality
o Gini coefficient ranges from 0 to 1
 At perfect equality; Gini coefficient is 0 = 0/0 + 0
 All incomes are equal
 At perfect inequality; Gini coefficient is 1 = 1/1 + 0
 1 individual owns 100% of total income
o The smaller the Gini coefficient, the greater the level of equality
 Decreasing GC, increasing equality
o The greater the Gini coefficient, the smaller the level of equality
 Increasing GC, decreasing equality

Measuring the distribution of wealth

 Wealth inequality may be measured by the degree of variance in the total share of wealth owned by different quintiles of net
household wealth
o High degree of variance, high degree of inequality
o Low degree of variance, low degree of inequality

 Key observations from data

o In 2006;
 Poorest 20% of population received 1% of the total wealth
 Richest 20% of population received 61% of the total wealth

Trends in the distribution of income

 Nature of data collected

o Inequality in distribution of Y is measured by ABS
 Published in ‘Survey of Income and Housing’
 o Population split into quintiles pertaining to equivalised disposable household incomes
 20% portions of population
 First quintile (20%) have lowest equivalised disposable household incomes
 Second quintile (20%) have second lowest equivalised disposable household incomes
 Third quintile (20%) have middle equivalised disposable household incomes
 Fourth quintile (20%) have second highest equivalised disposable household incomes
 Fifth quintile (20%) have highest equivalised disposable household incomes
 Analysis of data collected
o Percentage income share for income quintiles, Gini coefficient (1997-2006)

o Key observations pertaining to quintiles

 In 2005-06
 First quintile received 7.9% of total equivalised disposable household Y
 Middle three quintiles relieved 53.7% of total equivalised disposable household Y
 Fifth quintile received 38.5% of total equivalised disposable household Y
 Between 1997-98, 2005-06
 Fall in share of total Y by;
o First quintile; 0.1% fall
o Third quintile; 0.1% fall
o Fourth quintile; 0.6%
 Rise in share of total Y by;
o Second quintile; 0.1%
o Fifth quintile; 0.6%
o Key observations pertaining to Gini coefficient
 In 1997-98: Gini coefficient at 0.303
 In 2000-01: Gini coefficient at 0.311 (peak)
 in 2005-06: Gini coefficient at 0.307
 Bw 1997-98, 2005-06
 Reduction to income inequality by 1.3%
o Due to: introduction of new welfare payments for families, carers; modest income tax
cuts in 2004-05 federal budget
 Median and mean equivalised disposable household incomes
o Distribution of income is asymmetric
 A relatively small number of people have relatively very large household incomes
 A large number of people have relatively lower household incomes
o Key observations in median equivalised disposable household incomes
 In 2005-06; >$550 per week for all persons
o Key observations in mean equivalised disposable household incomes
 In 2005-06; >$600 per week for all persons
 In 2003-04l >$550 per week for all persons
 In 1994-95; >$450 per week for all persons
 Bw 1994-95, 2005-06
 31% growth of mean incomes for low-income earners
 32% growth of mean incomes for middle-income earners
 36% growth of mean incomes for high-income earners

Trends in the distribution of wealth

 Nature of data collected

o Inequality in distribution of wealth is measured by ABS
 Published in ‘Household Wealth and Wealth Distribution 2005-06’
 o Wealth is measured as net worth
 Net worth = value of liabilities - value of assets
 Liabilities may include loans, mortgages, credit card debts
 Assets may include houses, shares, cars, businesses
o Distribution of wealth is more unequal than distribution of income
o Population split into quintiles pertaining to household net worth
 20% portions of population
 First quintile (20%) have lowest household net worth
 Second quintile (20%) have second lowest household net worth
 Third quintile (20%) have middle household net worth
 Fourth quintile (20%) have second highest household net worth
 Fifth quintile (20%) have highest household net worth
 Analysis of data collected
o Shares of household net worth and income (2005-06)

o Key observations pertaining to quintiles

 In 2005-06
 First quintile accounted for 1% of total household net worth
 Middle three quintiles accounted for 37/8% of total household net worth
 Fifth quintile accounted for 61.1% of total household net worth
 Median and mean household net worth
o Distribution of wealth is asymmetric
 A relatively small proportion of households had relatively high net worth
 A large number of households had relatively low net worth
o Key observations in mean household net worth
 In 2005-06
 Mean value of household assets; >$650,000
 Mean value of household liabilities; >$90,000
o Mean net household net worth; >$550,000
o Key observations in median household net worth
 In 2005-06
 Median net household worth; >$300,000
 Additional notes
o Bw 1915, 1967 wealth inequality improved significantly
 Due to urbanisation, industrialisation, development of middle class
o Bw 1967, 1986 wealth inequality has remained relatively stable
 Eg Gini coefficient remained near 0.64 bw 1986, 1998
 This improved to 0.61 in 2006 largely due to growth of superannuation

Sources of income as a percentage of household income

Source of income

 Main sources of household income

o Wages and salaries
 This accounted for 56% of total gross income (2006-07)
 Return to labour
 Form: wage or salary payment for sale/use of labour, non-wage benefits (eg fringe benefits, employer
contributions to superannuation, workers’ compensation payments)
o Rent
 This accounted for 12% of total gross income (2006-07)
 Return to land
 Form: rent, dividends, interest from sale/use of land
o Gross operating surplus
  This accounted for 18% of total gross income (2006-07)
 Return to capital, entrepreneurial skills
 Form: interest, dividends, profit from sale/use of capital, entrepreneurial skills
o Social welfare
 This accounted for 10% of total gross income (2006-07)
 Collected through tax, transferred from gov to households
 A third (+) of gov revenue is spent on social welfare
 Form: pension, unemployment benefits, carers allowances, etc.

Sources of wealth

Sources of wealth

 Main sources of household wealth

o Owner occupied dwellings and other property (eg houses, units, investment properties)
 This accounted for 57% of gross household wealth (2005-06)
 This has experienced growth largely due to growth of property prices in 2005-06
o Superannuation
 This accounted for 13% of gross household wealth (2005-06)
o Incorporated businesses
 This accounted for 9% of gross household wealth (2005-06)
o Value of household contents (eg consumer durables)
 This accounted for 8% of gross household wealth (2005-06)
o Value of shares and trusts
 This accounted for 5% of gross household wealth (2005-06)
o Value of vehicles
 This accounted for 4% of gross household wealth (2005-06)
o Savings with financial institutions
 This accounted for 4% of gross household wealth (2005-06)

 Current value of household wealth

o In 2005-06;
 Total household assets estimated at >$5 trillion
 Total household liabilities estimated at >$700 billion
 Aggregate net worth of households estimated a >$4 trillion
Dimensions and trends, according to gender, age, occupation, ethnic background and family structure

Dimensions in the distribution of income and wealth

Current nature of income

 Degree of inequality in income distribution is relatively high
o Incomes range from $150 to $1300
 Income distribution is asymmetric
o 55% of total population earns less than mean income of $644 (2006-07)
Current nature of wealth
 Degree of inequality in wealth distribution is relatively high
 Wealth distribution is asymmetric
o 65%+ of total population net worth less than $500,000 (2005-06)
Variation in income and wealth according to;
 Age
o Distribution of income
 Income is highest bw ages 35, 44
 35-44 yr olds earn highest mean income per week; >$1000
 15-19 yr olds earn lowest mean income per week; >$250
 Income levels decline w decrease in age due to lack of skills, experience, education
 Income levels decline w increase in age due to reliance on social welfare payments, retirement income
o Distribution of wealth
 Wealth rises until age of retirement due to increasing income levels, declining financial responsibilities
 Wealth declines after age of retirement due to expenditure of wealth on needs and wants
 Education
o Distribution of income and wealth
 Increase in level of education retention, increase in average level of income
 Increase in level of education retention, increase in average level of net worth

 Gender
o Distribution of income
 Males tend to earn higher incomes than females
 Eg female average weekly income is two thirds the male average weekly income
o $700 for females compared to $1000 for males (2005-06)
 Due to:
o Human capital factors
 Lower aggregate levels of education, skills, experience and qualification
 Due to childbirth; reduction to total experience
 Due to past attitudes towards women and education; reduction to
total education
o Discrimination
 Eg gap in average weekly income for women has increased over time for
younger female workers (born after 1976)
 Occupation
o Distribution of income
 Higher skilled workers tend to earn higher average incomes than lower skilled workers
 Eg managers, administrators and professionals earn income >4x the income of labourers, clerks and
salespersons
o $1250 for high skilled compared to $400 for low skilled (2005-06)
 Ethnic and cultural background
o Migrants
 Distribution of income
 Dependent on;
o Length of time (eg long-standing, recently arriving)
o Country of origin (eg English speaking, non-English speaking)
 English speaking migrants
o Long standing: simulates pattern of income of individuals born in Australia
 Relatively equal distribution
o Recently arriving: average incomes tend to be higher than those of individuals born in Aus
 Distribution is tended towards higher Y end
 Relatively advantaged
 Non-English speaking migrants
o Long standing: simulates pattern of income of individuals born in Australia
 Relatively equal distribution
o Recently arriving: average incomes tend to be lower than those of individuals born in Aus
 Distribution is tended towards lower Y end
 Due to: discrimination, misrecognition of skills and qualifications, poor
understanding of English language
 Relatively disadvantaged
o Indigenous Australians
 Distribution of income
 Indigenous persons tend to earn lower incomes than non-indigenous persons: average HH Y for
indigenous persons is 60% that of average HH Y for non-Indigenous persons
o >$450 pw for indigenous persons compared w >$700 pw for non-indigenous persons
o Relatively disadvantaged
 Growth in average HH incomes for indigenous persons
o 9% growth bw 2001, 2006
o Relatively stable; no recent improvements/deteriorations of Y relativities
 Representation in quintiles of income
o 5% of lowest quintile, 1% of highest quintile
 Note: indigenous persons make up 2.5% of total population
 Indigenous incomes are lowest in remote areas
o >$300 pw for indigenous persons in remote areas compared w >$800 pw for indigenous
persons in urban areas
 Indigenous incomes are highest for full-time employed
o >$700 pw for indigenous persons employed in full-time work compared w >$500 pw for
indigenous persons employed
 Family structure
o Distribution of income and wealth
 Greater disparity bw income, wealth due to family structure
 Couples independent of children had highest median net worth
o Median net worth at >$440,000 (2005-06)
 Compared w median net income per week of >$550 (2005-06)
 Couples w dependent children had second highest median net worth
o Median net worth at >$410,000 (2005-06)
 Compared w median net income per week of $590 (2005-06)
 Single persons had second lowest median net worth
o Median net worth at >$210,000 (2005-06)
 Compared w median net income per week of $400 (2005-06)
 Single parents had lowest median net worth
o Median net worth of >$70,000 (2005-06)
 Compared w median net income per week of >$350 (2005-06)
 Income level is influenced by age
 Couples without dependents tend to be older (prior to retirement)
o Older workers tend to earn a higher average weekly income
o Higher proportion of household members in paid work
 Couples with dependents tend to be middle aged
o Middle aged workers tend to earn a moderate average weekly income
o Lower proportion of household members in paid work
 Single persons tend to be younger or older (after retirement)
o Younger workers tend to earn a lower average weekly income
o Older workers tend to earn a lower average weekly income
 Net wealth is influenced by age (increase in age, decrease in financial responsibility, increase in net wealth)
 Geography
o Distribution of income
 Difference in distribution of income bw states
 Highest average weekly income earned in ACT (>$1000 in 2007-08)
  Lowest average weekly income earned in Tasmania (<$800 in 2007-08)
 High level of average weekly income earned in R-rich states
o Eg NT at $930 pw (2007-08), WA at $990 per week (2007-08)
 High level of average weekly income earned in younger states
o Eg NSW a $920 pw (2007-08)
 Difference in distribution of income within states
 Higher average weekly income earned in major cities
o Average Y level is 8% above state average median
 Lower average weekly income earned in regional areas
o Average Y level is 20-40% below state average median

Economic and social costs and benefits of inequality

Economic benefits of inequality

 ‘Incentive’ effect on workers, entrepreneurs

o Inequality improves productivity of labour
 Due to: increased incentive for labour to work longer hours, at a greater level of efficiency
 Increase in hours worked, level of efficiency; increase in wage earned
 Effects: increase in efficiency, productive capacity, economic growth of an economy
 Denoted by outwards shift of PPF
 Note: backward bending supply curve suggests that incentive of increase in wage is limited to certain number
of hours worked
 Due to level at which individuals forgo trade-off bw leisure time, increase in wage
o Inequality improves quality of labour
 Due to: increased incentive for labour to gain higher levels of education, training and skill
 Increase in education, training, skill; increase in wage earned
 Effects: increase in efficiency, productive capacity, economic growth of an economy
 Denoted by outwards shift of PPF
 Note: this is limited by financial capacity of individuals to pay for education services
 Reduced through gov supplements of university fees, etc.
o Inequality improves mobility of labour
 Due to: increased incentive for labour to move to occupations, geographical areas in which demand for
labour is relatively greater
 Increase in geographical or occupational mobility of labour; increase in wage earned
 Effects: more efficient allocation of labour resources, increase in productive capacity, economic growth
 Denoted by outwards shift if PPF
o Inequality encourages entrepreneurs to accept risks more readily
 Due to: increased incentive for entrepreneurs to accept/take risks more readily
 Increase in risk-taking; increase in capacity to make profit, magnitude of potential profit
 Effects: increase in productive capacity, economic growth, employment opportunities for individuals
 Denoted by outwards shift in PPF
 Inequality creates the potential for higher savings and capital formation
o Due to: higher proportion of high Y earners in the economy
 High income earners have a greater MPS
o Effects: higher levels of capital formation, technological progress
 Due to increased capacity to borrow funds
o Effects: improvement of CAD
 Due to increase in proportion of borrowed funds generated from domestic sources, decrease in proportion of
borrowed funds generated from foreign sources
 Decrease in NFD, increase in external stability, increase in economic growth
o Effects: improvements to efficiency, increase in productive capacity, economic growth, employment opportunities,
decline in UE rate
 Denoted by outwards shift in PPF

Economic costs of inequality

 Inequality reduces total utility

o Due to: larger portion of population earns higher portion of total income
 Principle of diminishing marginal utility states that as more of a good is consumed it will provide progressively
less utility to the consumer
 Greater portion of low income earners, high income earners; decline in overall utility
 Greater portion of middle income earners; incline in overall utility
o Effects: decrease in productivity of labour, decrease in efficiency, decrease in economic growth
 Denoted by inwards shift in PPF
 Inequality can reduce economic growth
o Reduction to total consumption
 Due to: larger portion of population earns lower portion of total income
 Lower income earners have a higher MPC
o Greater portion of low income earners, high income earners; relative decline in overall
consumption
o Higher portion of middle income earners; relative incline in overall consumption
 Relatively higher level of savings, lower level of consumption
 Effects: decrease in economic growth, employment, average incomes
 Denoted by inwards shift in PPF
o Reduction to total investment
 Due to: larger portion of population earns lower portion of total income
 Lower income earners have a higher MPC
o Relatively lower level of consumption; decline in D, decline in S (investment)
 Relatively higher level of savings, lower level of investment
 Effects: decrease in economic growth, employment, average incomes
 Denoted by inwards shift in PPF
 Inequality creates poverty and social problems
o Due to: existence of relative poverty, absolute poverty
 Relative poverty refers to those whose standards of living are substantially lower than the average of the
economy as a whole and is often defined as a level of income below 30% of average earnings
 Absolute poverty refers to the condition of people with the lowest living standards in the global economy and
is measured by an income level of less than $1US per day
o Effects: development of an underclass w limited access to social services, opportunities for advancement
 Creates self-perpetuating cycle of disadvantage
o Effects: decline in overall utility, efficiency of labour force, economic growth
 Denoted by inwards shift in PPF
o Effects: increase in social tensions, increase in demands on gov revenue
 Due to: higher level of D for social welfare
 Effects: deterioration in federal gov’s fiscal position
 Eg increase in budget deficit, decrease in budget surplus
 Inequality creates conspicuous consumption
o Due to: creation of a ‘leisure class’ consisting of high income earners
 Increase in money spent on expensive goods (eg designer labels)
 Deemed ‘conspicuous consumption’
o Effects: culture where individuals’ sense of worth is determined by their relative position in the wealth, income
hierarchy; decline in overall utility, productivity of labour, economic growth

Social costs of inequality

 Creation of social class divisions

o Due to: difference in level of income earned
 Consequent difference in level of material standard of living, access to lifestyle and career opportunities
o Effects: social tensions bw different groups in society
 Increase in crime rate, decline in overall utility, increase in demands on gov revenue
 Increase in tensions bw employers and employees
 Higher level of industrial disputation, decline in labour efficiency, economic growth
 Existence of poverty
o Nature: relative and absolute poverty exists in Australia
 Minimal level of absolute poverty
 Considerable level of relative poverty
 12% of the Australian population live below the relative poverty line
o According to 2007-08 Human Development Report
o Defined as individuals in receipt of below 50% of the median income level
o Effects: poverty trap
 System of intergeneration welfare dependency
 Increase in demands on gov revenue, decline in economic growth
o Effects: social tensions, crime, decrease in overall utility

Government policy to maintain equality in the distribution of income and wealth

 Introduction to policy
o Social policy is the main policy used to reduce inequality in the distribution of income, wealth
 Based on tax-transfer system
 System of progressive taxation of personal income
o Increase in level of income, increase in percentage of gross income paid as tax
o Provides revenue for gov
o Greatest proportion paid by high income earners
 System of taxation expenditure
o Due to revenue from income tax
 o Paid in the form of transfer payments
 Eg job search allowances, disability pensions, youth allowances
o Greatest proportion gained by low income earners
o Policy to reduce inequality in distribution of income
 Change in policy regarding personal income tax
 Reduction to marginal tax rates for low income earners
o Or increase in marginal tax rates for high income earners
 Increase in tax thresholds for low income earners
o Or decrease in tax thresholds for high income earners
o Eg tax threshold raised to $6,000 in 2000
o Policy to reduce inequality in distribution of wealth
 Change in policy regarding other taxes
 Increase in fringe benefits tax
o Taxed on a progressive scale through rising marginal tax rates
o Affects company cars, holidays, mobile phones
 Increase in capital gains tax
o Taxed on a progressive scale through rising marginal tax rates
o Affects real gains from sale of shares, real estate
 Overview of policy
o Pertaining to personal income tax
 Increase in tax thresholds for second, third, fourth, fifth tax brackets
 2008-09 federal budget; effective on July 1 2008
 Effect; tax relief to low, middle, high income earners
 Increase in tax thresholds for second, third tax brackets
 2008-09 federal budget; effective on July 1, 2009
 Reduction to marginal rate of tax for fourth tax bracket from 40% to 38%
 2008-09 federal budget; effective on July 1, 2009
o Pertaining to expenditure on social security
 Social security expenditure is around 35% of total gov expenditure
 $102.4b in 2008-09
 Increases in expenditure allocated to all sectors of social security
 Total increase of 5.3% under 2008-09 federal budget
 Significant increases to;
o Assistance to unemployed (17.7% increase)
o Assistance to families with children (6.8% increase)
o Assistance to aged (5.7% increase)
 Increase in eligibility of criteria for receipt of income support
 Strict targeting of welfare to disadvantaged, needy groups in society
 Increase in applications of ‘means tested’ payments
 Increase in emphasis on mutual obligations
o Eg Welfare to Work scheme
 Introduced in 2005
 Disabled, parents w school aged children required to work minimum of 15 hrs
per week in order to receive income support
 Eg parenting allowance, disability support pension
 Aims to reduce welfare dependency, increase labour force participation
o Pertaining to wage levels
 Minimum levels of income, working conditions determined by safety net of award wages, conditions
 Provides support for low skilled workers w minimal bargaining power
 Undermined by Workplace Relations Amendment Act (WorkChoices) [2006] and Workplace
Relations Amendment Act (A Stronger Safety Net) [2007]
o Reduction to bargaining power of low skilled workers
 Reinstated by Workplace Relations Amendment Act (Transition to Fairness) [2008]
o Reintroduction of No Disadvantage Test to all workplace agreements
o Minimum levels of pay, working conditions determined by Australian Fair Pay Commission
 Levels of pay adjusted at annual General Wage Setting Decision
 Working conditions determined by Australian Fair Pay and Conditions Standard
o Pertaining to government spending on public health, education, housing, transport, community services
 Minimum access to health, education, housing, transport, community services
 Provides safety net for low income earners
o Through direct federal gov provision
 Eg Medicare system for health
o Through indirect state gov provision
 Eg subsidised health, education, housing, transport
o Pertaining to economic growth
 Maintenance of economic growth
 Increase in real GDP per capita
o Increase in general level of incomes
 o Increase in living standards
 Decrease in total unemployed
 Specific policies
o Working Families Support Package
 2008-09 federal budget
 Aims to help families cope with increased cost of living pressures
 Eg dearer food, transport, housing
 Key components;
 Personal income tax cuts of $40b+ bw 2008, 2012
o Specifically aimed at middle to low income earners
 Low Income Tax Offset to assist low to middle income earners
 Increase in Child Care tax rebate, introduction of new Education Allowance
 Gov contribution of 17% to first $5,000 saved in First Home Saver Accounts
 National Surveillance Schemes
o Targeted at the cost of food, petrol
 Increase in Utilities allowance to assist household utility bills
o Increase in financial support for carers, elderly
o Major review of tax system
 2008-09 federal budget, to be implemented in 2010
 Aims to make tax system simpler, fairer, more efficient
 Key components;
 Reduction of marginal tax brackets from 4 to 3
 Reduction to effective marginal tax rates
o Increase in gov expenditure on public health, education, housing, transport, community services
 2008-09 federal budget
 Key components;
 Increase in spending on education
o Education and Investment Fund ($11b)
o Education Revolution Package ($6b)
 Increase in spending on health
o National Health and Hospitals Reform Plan ($3b)
o Health and Hospitals Fund for capital works ($10b)