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Chapter 11

THE MEASUREMENT OF THE DISTRIBUTION OF INCOME

Economists measure the distribution of income and wealth by constructing a Lorenz Curvewhichgraphs data on income shares for equal groupings of the population or income units (such as 20%quintiles) as shown in Figure 11.1. Te Lorenz Curve has four important properties:

1. It begins at zero, with zero families earning no income or wealth (refer to the bottom left handcorner of Figure 11.1).

2. It ends where 100% of families earn 100% of all income or wealth (refer to the top right hand

corner of Figure 11.1);3. Te line of perfect equality is a diagonal line showing that the bottom 20% of families account for

20% of all income; the next 20% of families receive 20% of all income; 60% of all families receive60% of total income (i.e. point C in Figure 11.1) and so on.

4. In reality there are significant differences in the distribution of income and wealth in economies, sothe Lorenz Curve will lie below the line of perfect equality (see Figure 11.1).

Te size of the area between the line of perfect equality and the Lorenz Curve (Area A) is used as ameasure of inequality. Any change in the distribution of income or wealth causing the Lorenz Curveto shift inwards (to the left) would indicate reduced inequality. An outward shift (to the right) of theexisting Lorenz Curve would represent increased inequality. Te Gini co-efficientis a mathematicalexpression of the degree of income or wealth inequality. It can be calculated by comparing Area A (see

Figure 11.1) with the total area of the triangle bounded by the line of perfect equality and the incomeand wealth, and income units axes (Area A + Area B). Te Gini co-efficient is calculated as follows:

Area AGini co-efficient = Area A + Area B

Figure 11.1: The Lorenz Curve

Area A

Line of Perfect Equality

Cumulative % of families or income units

Cumulative%o

fincomeo

rwealth

020

20

40

40

60

60

80

80

100

100

C

Area B

Lorenz Curve

(quintiles)

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Chapter 11: Distribution of Income and Wealth Tim Riley Publications Pty Ltd242

Year 12 Economics 2014 Tim Riley Publications Pty Ltd

If there was perfect equality, Area A would not exist and the Gini co-efficient (GC) would be zero i.e.

0Gini co-efficient = 0 + B = 0 (i.e. if the GC is equal to 0 there is perfect equality)

If there was perfect inequality, the whole right side triangle would be equal to Area A, and the value of

the Gini co-efficient would be equal to one i.e.

A 1Gini co-efficient = A + B = 1 + 0 = 1 (i.e. if the GC is equal to 1 there is perfect inequality)

Terefore the Gini co-efficient has a value ranging between zero (perfect equality) and one (perfectinequality). An increasing Gini co-efficient (0 to 1) indicates increasing inequality or decreasing equality,

whereas a decreasing Gini co-efficient (1 to 0) denotes increasing equality or decreasing inequality.

THE SOURCES OF INCOME

Personal incomerefers to the money and the value of benefits in kind received by individuals during aperiod of time, in return for their factors of production (i.e. land, labour, capital and enterprise), or asgovernment transfer payments such as pensions, job search allowances and other forms of welfare. Temain forms of earned personal incomeinclude wages and salaries from the contribution of labour toproduction. Te main forms of unearned personal incomeinclude rent from the use of land, intereston capital, and profit from business enterprises. Income is a flow concept in economics, as it can varyover time according to a persons contribution to production and changes in personal circumstances.

Figure 11.2 shows that the main sources of household income in Australia in 2011-12 were wages andsalaries (56%), profits (17.5%), property income (11.8%) and social benefits (9.7%). Table 11.1liststhe dollar values of all the main sources of income from the household income account compiled by the

ABS for 2011-12, with total gross income increasing by 6.6% between 2010-11 and 2011-12.

Wages and salaries and supplements (i.e. workers compensation and superannuation), termed as

compensation of employees, accounted for 56% of total gross income in 2011-12. Gross operatingsurplus and mixed income is the income from the profits generated by private incorporated andunincorporated trading enterprises and was 17.5% of total gross income in 2011-12. Property incomeis the rent, interest and dividends received by households (e.g. retirees and wealth holders) and was11.8% of total gross income in 2011-12. A majority of dividend, rental and interest income is receivedby self funded retirees, not reliant on government social benefits for income. Te main trends in sourcesof income in 2011-12 were strong growth in wages and salaries, (+6.2%), profits (+5.7%) and propertyincome (+10.1%) due to economic recovery in Australia after the Global Financial Crisis in 2008-09.

Figure 11.2: Sources of Household Income in Australia 2011-12

Source: ABS (2013), Australian National Accounts, Catalogue 5206.0, March.

Other 5.0%

Social Benefits 9.7%

Rent, Interest and Dividends 11.8%

Profits 17.5%

Wages and Salaries 56.0%

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Social benefits accounted for 9.7% of total gross income in 2011-12 and include pensions and othermeans tested government allowances (e.g. family benefits), paid mainly to households unable to earnsufficient market income to sustain a minimum standard of living. Social benefits receivable grew by7% in 2011-12 as the unemployment rose slightly from 4.9% to 5.2%. Non life insurance claims (2.4%of the total) are net payments to households from non life insurance policies. Current transfers tonon profit institutions (2.3% of the total) include non capital transfers from government to charitableinstitutions. Other current transfers (0.3% of the total) include government transfers to householdsnot elsewhere classified.

Taxation, Transfer Payments and Other Assistance

Te Australian governments welfare or social policy is based on the redistribution of income from highincome earners to low income earners through the systems of progressive taxation and means tested

welfare payments. Te three main elements of the governments tax-transfer system are the following:

1. Te system of progressive taxation, where the proportion of tax and the rate at which tax is paid onpersonal income, increases as gross income increases. From July 1st 2012 all taxpayers were givena tax free threshold of $18,200. Tereafter the four income tax thresholds attract higher marginaltax rates (MRs), ranging from 19% to 45%:

$0$18,200 Nil MR $80,001$180,000 37% MR $18,201$37,000 19% MR $180,00+ 45% MR $37,001$80,000 32.5% MR

2. Around 35% of the revenue raised by the progressive taxation system is spent by the governmenton transfer payments such as pensions, allowances and tax benefits or tax expenditures. Te mainrecipients of transfer payments are the aged, veterans and their dependants, people with disabilities,low income families with children, the unemployed, the sick, youth, Aborigines and orres StraitIslanders and other welfare beneficiaries such as carers. Tese payments are income and assetstested to ensure that only the most needy are in receipt of government social welfare payments.

3. Other assistance by governments to disadvantaged and low income individuals and families includesexpenditure on the social wage. Tis refers to public spending on health, education, transport,housing, childcare and community services, which provides a safety net for low income earners andfamilies with children. Tese benefits may be in the form of direct government provision such as

the federal Medicare system for health, or state government provision through subsidies and rebatesfor public health, education, housing, rates, utilities, transport and community services.

Table 11.1: The Sources of Household Income in Australia 2011-12

Annual $m % of Total %rfromGross Income 2010-11

Compensation of employees (wages and salaries) 705,665 56.0 6.2Gross operating surplus and mixed income (profits) 219,891 17.5 5.7

Property Income (rent, interest and dividends) 149,225 11.8 10.1

Social Benefits Receivable (social welfare) 122,565 9.7 7.0

Non Life Insurance Claims 30,572 2.4 -4.3

Current Transfers to Non Profit Institutions 29,567 2.3 20.7

Other Current Transfers 3,903 0.3 -0.8

Total Gross Income 1,261,388 100.0 6.6

Source: ABS (2013), Australian National Accounts, Catalogue 5206.0, March.

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THE SOURCES OF WEALTH

Personal wealthis the net value or stock of real and financial assets owned by individuals at a particularpoint in time. Real or non financial assets include property (e.g. owner occupied houses, home units,and investment properties) and consumer durables (e.g. cars and household contents). Financial assets

include cash, bank deposits, shares, trusts, debentures and bonds. Te net value of assets or net worthis calculated by subtracting any debts (i.e. financial liabilities such as mortgages) owed by an individualfrom the gross value of total non financial and financial assets owned by that individual. Wealth is astock concept in economics, since it is the amount of a persons net assets at any one point in time:

Net Value of Assets or Net Worth = otal Non Financial and Financial Assets - otal Financial Liabilities

Tere is a strong correlation between income and wealth. People with little wealth usually have lowincomes, while people with substantial wealth usually have high incomes. Tis is because wealth generatesincome, and in most cases, high incomes can generate increasing levels of wealth. High income earnersusually have high saving ratios, which allows them to accumulate wealth such as property and financialassets, which in turn generates unearned forms of income such as profit, rent, interest and dividends.

Persons with a substantial stock of wealth therefore have the ability to derive unearned income such asrent, interest, profits and dividends, in addition to earned sources of income such as wages and salaries.

Most of the wealth owned in Australia is private wealth consisting of domestic and foreign assets. Temain component of private sector wealth (according to the latest ABS Survey in 2011-12) in Australia isowner occupied dwellings (i.e. houses and home units) and other property (such as investment propertiesand businesses) which accounted for 58.5% of total household assets in 2011-12 as shown in Table11.2. Other major forms of wealth in 2011-12 included superannuation (15.4% of total householdassets) and the value of household contents (7.3% of total household assets). Te rest of household

wealth consisted of the value of own incorporated and unincorporated businesses (5.6%); shares, trusts,debentures and bonds (6.4%); savings with financial institutions (4.3%); and motor vehicles (2.5%).

In 2011-12 the value of total household assets was estimated by the ABS to be $8,582b, increasing by21.7% from $7,050b in 2009-10. otal household liabilities (consisting mainly of mortgage, personaland other loans) were estimated by the ABS at $1,301b in 2011-12. Subtracting total householdliabilities (-$1,301b) from total household assets ($8,582b), gave households an aggregate net worthor net wealth of $7,281b in 2011-12. Net wealth in 2011-12 of $7,281b represented about five times

Australias annual GDP in 2011-12, and had increased by $1,237b or 20.4% since 2009-10.

Table 11.2: Main Components of Household Assets in Australia 2011-12(% of total)

Type of Household Asset 2011-12 % of Total

Value of accounts held with financial institutions $370b 4.3%

Value of shares, trusts, debentures and bonds $551b 6.4%

Value of own incorporated and unincorporated businesses $482b 5.6%

Value of superannuation $1,323b 15.4%

Value of owner occupied housing and other property $5,018 58.5%

Value of contents of dwellings $626b 7.3%

Value of vehicles $212b 2.5%

Total Household Assets $8,582b 100.0%

Source: ABS (2013), Household Wealth and Wealth Distribution2011-12, Catalogue 6554.0, page 22.

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Table 11.3: Percentage Income Share for Income Quintiles, Australia 2005 to 2012

2005-06 2007-08 2009-10 2011-12 Incomepw 11-12

Equiv. Disp. Income Quintile

Lowest 7.8% 7.3% 7.4% 7.5% ($346)

Second 12.7% 12.3% 12.4% 12.6% ($581)

Third 17.4% 16.9% 17.0% 17.3% ($793)

Fourth 23.0% 22.6% 23.0% 23.0% ($1,057)

Highest 39.2% 41.0% 40.2% 39.5% ($1,814)All Income Units 100.0% 100.0% 100.0% 100.0% (av. $918)

Gini co-efficient 0.314 0.336 0.329 0.320

Source: ABS (2013), Household Income and Income Distribution2011-12*, Catalogue 6523.0, July.NB: figures are rounded and do not total * The Household Income and Income Distribution 2011-12 is the latest ABS survey

TRENDS IN THE DISTRIBUTION OF INCOME AND WEALTH

Te distribution of income is measured by the ABS from data in the Survey of Income and Housing. TeAustralian population is divided into quintiles or equal 20% groupings of the population, and the ABScalculates the percentage of total equivalised disposable household income received by each quintile,

starting from the lowest quintile and proceeding to the second, third, fourth and highest quintiles.Equivalised disposable household incomeadjusts disposable income (gross income less taxes) for thedifferent needs of households arising from the different numbers of people and proportions of adultsand children in households. An equivalence scale is applied to make the needs of households equivalent.

In Table 11.3 income shares are shown for the five quintiles of the Australian population between2005-06 and 2011-12. Tey indicate that there is a high degree of income inequality in Australia as inmost market economies in the OECD. For example, the lowest quintile or 20% of households received7.5% of total equivalised disposable household income in 2011-12, whereas the highest quintile or20% received 39.5% of total equivalised disposable household income. Te middle three quintiles(60% of the population) received 52.9% of total equivalised disposable household income in 2011-12.

Te ABS survey of the distribution of equivalised disposable household income in Table 11.3indicateschanges in the shares of income for the five quintile groups between 2005-06 and 2011-12. Te lowestquintiles income share fell by 0.3%, the second quintiles share fell by 0.1%, the third quintiles sharefell by 0.1%, the fourth quintiles share stayed the same at 23%, and the highest quintiles share rose by0.3%. Te Gini co-efficient of 0.314 in 2005-06 rose to 0.336 in 2007-08, indicating an increase inincome inequality of 7% between 2005-06 and 2007-08 due to strong growth in wages and salaries andunearned sources of income to households in the highest income quintile, relative to those householdsin the lowest, second, third and fourth income quintiles. However the Gini co-efficient fell from 0.336in 2007-08 to 0.329 in 2009-10, and to 0.320 in 2011-12, which was a reduction in inequality of 4.8%because of tax cuts and increased welfare payments to low income households.

Te mean or average equivalised disposable household income in 2011-12 for all households was $918per week (refer to Figure 11.3). Te median income (i.e. the midpoint where all people are ranked inascending order of income) in 2011-12 for all households was lower at $790 per week. Tis differencereflects the typically asymmetric distribution of Australian incomes which is illustrated in Figure 11.3:

A relatively small number of people have relatively high household incomes; and

A large number of people have relatively lower household incomes.

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Real average equivalised disposable household income for all persons living in private dwellings (22.2m)in 2011-12, was $918 per week. According to the ABS real average equivalised disposable householdincome did not show any significant change between 2009-10 ($894) and 2011-12 ($918). Averageequivalised disposable household income increased from 2009-10 to 2011-12 by 5% for low incomehouseholds, and by 4% for middle income households as shown in Figure 11.4. Tere was littlesignificant change in average equivalised disposable household income for high income households.

Figure 11.3: Distribution of Equivalised Disposable Household Income in 2011-12

Source: ABS (2013), Household Income and Income Distribution2011-12, Catalogue 6523.0, July.

Figure 11.4: Changes in Mean Real Equivalised Disposable Household Income

Source: ABS (2013), Household Income and Income Distribution 2011-12, Catalogue 6523.0, July.

Figure 11.5: Lorenz Curves for Australia 2011-12

Source: ABS (2013), Household Income and Income Distribution,

2011-12, Catalogue 6523.0, July.

Normally the degree of inequality isgreater for the population as a wholethan for a subgroup within thepopulation, because sub populationsare usually more homogeneous thanfull populations.

Tis is illustrated in Figure 11.5which shows two Lorenz curves fromthe ABS 2011-12 Survey of Incomeand Housing. Te Lorenz curve forthe whole population of the surveyis further from the diagonal lineof perfect equality than the curvefor persons living in one parenthouseholds. Correspondingly theGini co-efficient for all persons was0.320 while the Gini co-efficient forpersons in one parent households

was 0.245.

Equivalised Disposable Household Income ($ per week)

%o

fHousehold

s

Median$790

Mean$918

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Table 11.4: Shares of Household Net Worth and Income 2011-12

Quintile Household Gross Household Equivalised DisposableNet Worth Income Per Week Household Income Per Week

Lowest quintile 0.9% 4.3% 7.5%

Second quintile 5.2% 9.3% 12.6%

Third quintile 12.0% 15.7% 17.3%

Fourth quintile 21.0% 24.3% 23.0%

Highest quintile 60.8% 46.5% 39.5%

All households 100.0% 100.0% 100.0%

Source: ABS (2013), Household Wealth and Wealth Distribution, Catalogue 6554.0.NB: figures are rounded & do not total

Te ABS measures wealth as the net worth of households by subtracting the value of household

liabilities (e.g. loans) from household assets (e.g. cash, bank deposits, homes, superannuation and valueof businesses). Te ABS survey of Household Wealth and Wealth Distribution 2011-12 calculated themean value of household assets at $858,200, and the mean value of household liabilities (e.g. mortgageloans and other debts) at $130,100, resulting in average household wealth of $728,100, with medianhousehold wealth substantially lower at $434,000. Te distribution of Australian household wealth isshown in Figure 11.6. Differences reflect the asymmetric distribution of wealth between households:

A relatively small proportion of households had relatively high net worth in 2011-12; and

A large number of households had relatively low net worth in 2011-12.

Te distribution of wealth is more unequal in Australia than the distribution of income. Table 11.4shows quintile shares of household net worth, gross household income per week and equivalised

disposable income per week for 2011-12. While the 20% of households comprising the lowest quintileaccounted for only 0.9% of total household net worth, they accounted for 4.3% of total gross income.In contrast the 20% of households comprising the highest quintile accounted for 60.8% of totalhousehold net worth, but a lower share of gross household income of 46.5%.

Differences in the distribution of wealth and income partly reflect wealth being accumulated duringa persons working life and being utilised during retirement. Terefore many households with low

wealth have relatively high income, such as younger households. Conversely older households tendto accumulate relatively high net worth over their lifetimes but have relatively low income in theirretirement, accounting for the top quintiles high share of net worth but lower share of income.

Figure 11.6: Distribution of Household Net Worth 2011-12

Source: ABS (2013), Household Wealth and Wealth Distribution 2011-12, Catalogue 6554.0, August.

Net worth $000s

%o

fhouseholds

Mean$728,100

Median$434,000

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DIMENSIONS IN THE DISTRIBUTION OF INCOME

Te distribution of income in Australia is also analysed in terms of socio-economic characteristics suchas gender, age, occupation, ethnicity and family structure. In terms of gender, males on average earnconsiderably more than females. In 2013, average weekly earnings (AWE) for males were $1,516compared to $1,250 for females. For males and females in the same occupational category, male earnings

were also considerably higher than average female earnings. Te distribution of income according tooccupation also reveals large variations in incomes between highly skilled and lower skilled occupations.Managers and professionals earnt an average of $1,926 per week in 2013 compared to labourers, clerksand salespersons who earnt an average of between $606 and $1,249 per week in 2013.

In terms of age, young males and females (15 to 24 years) earn less income than other adult male andfemale workers. In 2011 the average weekly earnings (AWE) for young males was $558, and $575 for

young females, compared to AWE of $1,273 for adult males and $818 for adult females (ABS surveyof earnings in 2011). Income for males and females is at a maximum in the 35 to 54 year age group.

In terms of ethnicity, persons born overseas earn higher incomes than those born in Australia. Howeverpersons from non English speaking backgrounds earn less than those from English speaking backgrounds.In addition, the period of residence of migrants impacts on the level of income, with migrants residingin Australia for longer periods of time earning higher incomes than migrants residing for less time. Alsothe country of origin of migrants is correlated with income. Migrants from countries such as Britain,the USA, New Zealand and South Africa earn higher incomes than more recent migrants from countriessuch as China, Vietnam, Iraq and Lebanon. Indigenous Australians (i.e. Aborigines and orres StraitIslanders) earn considerably less income than non indigenous Australians, and are amongst the lowestincome earners in the Australian community, many being reliant on government welfare for income.

REVIEW QUESTIONSMEASUREMENT, SOURCES AND TRENDS IN THE

DISTRIBUTION OF INCOME AND WEALTH1. Refer to Figure 11.1 and the text and explain how the distribution of income is measured using

the Lorenz curve and the Gini co-efficient.

2. Distinguish between income as a flow concept and wealth as a stock concept in economics.

3. List the main sources of household income and wealth in Australia. Refer to Table 11.1,Table 11.2 and Figure 11.2 in your answer.

4. Discuss the relationship between income and wealth.

5. Describe trends in the distribution of equivalised disposable household income between 2005-06

and 2011-12 using the data in Table 11.3.

6. Discuss the main features of the distribution of equivalised household disposable income in2011-12 from Figure 11.3. Discuss changes in this distribution between 2005-06 and2011-12 by referring to the text and the trends in Figure 11.4.

7. Discuss the distribution of household net worth or wealth in 2011-12 with reference to the textand the trends in Figure 11.6.

8. Contrast the distributions of wealth and income in Australia using the data in Table 11.4.

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In terms of family structure, it is common to analyse income distribution in terms of householdsat different stages of the life cycle. A typical life cycle covers early adulthood, and the formation,maturation and dissolution of nuclear families. Households range from young single people just outof school, to couples with dependent children, couples without children, single parents with children,elderly couples and elderly single people. Table 11.5shows selected characteristics of four household

types by equivalised disposable household income quintiles and their mean weekly incomes in 2011-12.Households in the lowest quintile were mainly lone persons (either young or elderly), single parents withchildren and elderly couples without dependent children. In comparison, households in the highestquintile tended to be couples with or without dependent children. Most of these couple householdshad two income earners, with the principal source of income being wages and salaries.

Table 11.5: Selected Characteristics of Households, by Equivalised DisposableHousehold Income Quintiles 2011-12

Household Lowest Second Third Fourth Highest Mean WeeklyCharacteristics 20% quintile quintile quintile 20% Income ($)

Couple withdependent children 14.9 21.6 23.9 21.5 18.1 $915

Couple withoutdependent children 24.1 18.2 11.6 17.3 28.8 $1,030

One parent family 34.4 31.7 20.8 10.3 2.7 $618

Lone person 43.9 14.3 14.9 13.3 13.6 $747

Source: ABS (2013), Household Income and Income Distribution 2011-12, Catalogue 6523.0, July.

ECONOMIC AND SOCIAL BENEFITS AND COSTS OF INEQUALITY

Since there is significant inequality in the distribution of income and wealth in Australia it is relevant todiscuss the economic and social benefits and costs of income and wealth inequality. Many economistsbelieve that the market economy is the most efficient mechanism for resource allocation, and argue thatsome inequality in the distribution of income is an inevitable outcome of the market economic system.Some level of inequality may also be the result of ongoing structural change or microeconomic reform(such as labour market reform) experienced by Australia in the 1980s, 1990s and 2000s.

Other economists (such as R. Gregory, 1993) argue that growing inequality leads to social divisivenessand the marginalisation of some groups in society (such as the unemployed, low income earners,migrants and indigenous people), and can lead to increased social tension in the community. Tereforethe debate about inequality centres on the benefits of increasing economic efficiency (leading to risingincome inequality), versus lower economic efficiency, but greater income equality and social cohesion.

A perceived economic benefit of income inequality is the incentive effect on workers and entrepreneurs.Employees will work harder to achieve higher wages and other rewards if these can be attained throughhigher levels of education, training, skill acquisition and productivity. People may therefore be willing to

work longer hours and sacrifice less leisure time for additional income. Te economy will benefit fromhigher labour productivity and labour mobility if there is relative wage flexibility, which helps to allocatelabour more efficiently. Entrepreneurs may also be willing to take more risks if the potential profitrewards are higher. In market economies an unequal distribution of income is usually characterised bya growing share of GDP going to capital in the form of profits, rent, interest and dividends, relative tothe share of GDP going to labour in the form of wages and salaries.

Tis trend emerged in Australia in the latter stages of the resources boom when the profit, rent, dividendand interest share of household income rose from 30% in 2006-07 to 31% in 2007-08, whilst the wagesshare of household income fell from 56.3% in 2006-07 to 55.3% in 2007-08.

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Higher incomes in the economy may boost national saving and investmentand create more positiveconditions for economic and employment growth. Tis may be sourced from higher levels of capitalformation and a greater rate of technological progress, leading to an increase in the economys productivecapacity. More businesses may be established or existing businesses expanded as a result of highereconomic growth. A growing market economy like Australia may also be able to create more job

opportunities for unskilled, skilled and professional labour, and generate higher tax revenue (i.e. thegrowth dividend) which the government can use to fund targeted welfare assistance to alleviate poverty.

Te major social benefits of inequality accrue to high income households and individuals whose materialstandard of living and access to lifestyle and personal opportunities is greater than for other groups insociety. Australia has been characterised as a very middle class society, with the majority of the populationearning comparable incomes and enjoying similar standards of living. A result of this is less discrete socialdivisions according to differences in income and wealth in Australia, compared to other countries (suchas the USA and UK), where inequality is greater, and can be based on ethnic groups and social classes.Inequality in Australia may be the result of social and economic disadvantage faced by certain groups inthe labour market, relative to the greater opportunities of high income earners to succeed in the economicsystem, because of the inheritance of wealth or greater access to educational or business opportunities.

Te economic costs of inequality are put forward by economists who argue for improvements in the socialwelfare system and greater opportunities for low income earners to achieve higher market incomes. Teopportunity cost of income inequality in Australia is reflected in lower consumptionand utility levelsfor low income earners, compared to high and middle income earners. In macroeconomic terms, J. M.Keynes (1936) argued that deficient aggregate demand, could be corrected by government redistributivepolicies. Greater income inequality in Australia may lead tohigher spending on social welfare paymentsby the Australian government in supporting the unemployed, low income families, and the aged, if theyhave insufficient market income to be placed above the poverty line. However increased governmentspending on welfare can lead to a higher tax burden on taxpayers, and a deterioration in the federalgovernments fiscal position, through a higher budget deficit or a smaller budget surplus.

Tere are also social costs of inequality such as the emergence of social divisionsbased upon differencesin income. Social tensions can be raised when particular groups in Australian society such as Aboriginesand orres Strait Islanders, the unemployed, migrants, single parents, large low income families andaged pensioners are the main recipients of welfare. Tese groups may feel alienated from marketopportunities, and some taxpayers may resent contributing taxes to support welfare recipients. Howeverthe major social cost of income inequality in Australia is the relative povertyof various minority groups.

Research by R. Gregory (1993) revealed evidence of a working poor section of the workforce unableto earn high incomes because of low skills and a reliance on annual adjustments to Modern Awards andthe National Minimum Wage to increase their income and living standards. Tere is also evidence in

Australia of an underclass of young and middle aged workers who are marginalised in the labour marketbecause of changes to the structure of industry, and the systems of industrial relations and welfare.

Decentralised wage fixing through enterprise bargaining has forced many low paid workers to rely onannual safety net adjustments to the National Minimum Wage for wage annual increases. In addition,social security spending on the unemployed and welfare beneficiaries is also finely targeted with the useof strict eligibility criteria such as income and assets tests applied to the recipients of income support.

Te interaction between the social security and personal taxation systems can lead to poverty trapswhere welfare dependency rises, which may become intergenerational. A persons motivation to seekand retain paid work is influenced by a series of complex interactions, including the rate at whichincome support is withdrawn once work is found; the eligibility for other concessions such as rentassistance; and the marginal taxation rate (MR). Such interactions can create high effective marginaltaxation rates (EMRs) and reduce the incentive to work. Te Australian government cut MRs forlow income earners in federal budgets between 2000 and 2009, raised tax thresholds and reformed the

welfare system to strengthen the incentives for those on welfare to obtain more paid work.

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POLICIES TO REDUCE INCOME AND WEALTH INEQUALITYTe main policy used to reduce inequality in the distribution of income and wealth is known as socialpolicy, which is based on the tax-transfer system. Tis refers to the governments use of the progressivesystem of taxation; and the system of tax expenditures, which provides income support to low income

earners, the aged, families with children on a single income, the unemployed, the sick and the disabled.Te system of progressive taxationof personal income in Australia means that the more income a personearns, the more tax they pay as a percentage of their gross income. Te progressive tax system providesrevenue to the government enabling it to redistribute incomefrom high income earners to low incomeearners, through transfer payments such as old age and disability pensions, job search allowances, youthallowances and family benefits. Tis helps to create a more even distribution of income and wealth.

ax policy can also be used to lower marginal taxation rates for low income earners and to raise the taxthresholds for low to lower middle income earners, as was undertaken in numerous federal budgets inthe 2000s. In 2012, the tax free threshold was raised from $6,000 to $18,200 to encourage those on

welfare to seek paid work, and in each budget between 2003 and 2012, other tax thresholds were raisedto take into account the growth in incomes over time and the effect of bracket creep (where taxpayerspay more tax as they move into higher tax thresholds). Tese tax changes reduced the tax burden (i.ethe percentage of income paid in tax) on low and middle income earners relative to high income earners.

Te use of fringe benefits tax on fringe benefits such as company cars, and capital gains tax on the realgains from the sale of shares and real estate are taxes on wealth. Tey assist in redistributing income (likethe progressive income tax system), since they tax fringe benefits and capital gains on a progressive scalethrough rising marginal taxation rates. In Australia there is an absence of death duties, inheritance taxesor a specific tax on wealth so the government has to rely on progressive taxes to tax wealth.

In the 2012-13 budget the Australian government raised the tax free threshold from $6,000 to $18,200;the second tax bracket from $6,001-$37,000 to $18,201-$37,000; the MR from 15% to 19% in thesecond tax threshold; and the MR from 30% to 32.5% in the third tax threshold. Tese tax changes

are shown in Table 11.6and were designed to give tax relief to low and middle income earners in dealingwith the impact of the carbon tax on the cost of household utilities. Tese measures also strengthenedthe incentive for workforce participation for mature age and young workers and those on welfare.

Table 11.6: Changes to the Personal Income Tax System in the 2012-13 Budget

Previous Tax Thresholds Tax Rate New Tax Thresholds Tax Rate

(from July 1st 2011) (%) (from July 1st 2012) (%)

Income Range MTR Income Range MTR

0 $6,000 0% 0 $18,200 0%

$6,001$37,000 15% $18,201$37,000 19%

$37,001$80,000 30% $37,001$80,000 32.5%

$80,001$180,000 37% $80,001$180,000 37%

$180,001 + 45% $180,001 + 45%

Source: Commonwealth of Australia (2012), Budget Strategy and Outlook 2012-13,page 5-18.

Expenditure on social security by the Australian government represents around 35% of total budgetaryexpenditure. In the 2013-14 budget, $138.1b was allocated for expenditure on social security and

welfare. Te main areas of social security assistance are listed in Table 11.7. argeted and means testedwelfare assistance in the form of pensions, family benefits and job search allowances provide incomesupport for groups such as the aged, veterans, disabled, low income families with children and the

unemployed. Government support helps these disadvantaged groups to raise their of standard of living.

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Table 11.7: Expenditure on Social Security and Welfare in the 2013-14 Budget*

Type of Assistance 2012-13 2013-14 Budget (f) %r

Assistance to the Aged $50,984m $54,754m 7.4

Assistance to Veterans and Dependants $7,046m $7,006m -0.5

Assistance to People with Disabilities $23,873m $25,479m 6.7

Assistance to Families with Children $35,256m $34,945m -0.8

Assistance to the Unemployed and Sick $8,559m $9,550m 11.5

Other Welfare Programmes $1,663m $1,637m -1.5

Assistance for Indigenous Australians $1,145m $1,043m -8.9

General Administration $3,861m $3,731m -3.3

Total Social Security and Welfare $132,387m $138,145m 4.3NB: Most welfare payments are indexed to inflation with pensions set at 27.7% of Male Total Average WeeklyEarnings in the 2010-11 budget. The growth in assistance to the aged and disabled reflects population ageing.

Source: Commonwealth of Australia (2013), Budget Strategy and Outlook 2013-14, page 6-31.

Te continuing demographic shift to an older Australian population as outlined in the 2010Intergenerational Reportcontinues to contribute to increased government spending on social securityand welfare. Tis is because more Australians are becoming eligible for the age pension and are enteringresidential and community care facilities. Te ageing of the population is also leading to an increasein the number of people caring for senior Australians and becoming eligible for carer payments. Tegovernment also announced the $3.7b Living Longer, Living Betteraged care reform package in the 2012budget to improve access to aged care services over the period from 2012-13 to 2017-18.

In 2009-10 as the Global Financial Crisis impacted on the Australian economy, the governmentimplemented an Economic Security Strategywhich provided stimulus payments to low and middleincome earners to support household incomes, and a First Home Owners Boost to support the housingindustry. A Nation Building and Jobs Planin the 2009-10 budget directed $30b in spending to areassuch as public schools, housing, community infrastructure and roads. Te government also announcedaJobs and Training Compactto provide labour market assistance to people who were affected by theeconomic downturn such as young Australians, retrenched workers and local communities.

Te Spreading the Benefits of the Boompackage was introduced in the 2012 budget to ease cost of livingpressures on families and the unemployed. Families would benefit from an additional $1.8b over threeyears from 2013-14 to provide an increase in Family ax Benefit Part A. All families receiving FB Part

A with one child will receive an additional $300 per annum, and families with two or more childrenwill receive $600 per annum. Te package also provided $1.1b over four years from 2012-13 for a newincome support supplement to those receiving payments such as Youth Allowance, Newstart Allowanceand Parenting Payments, at a rate of $210 per annum for eligible singles and $350 for eligible couples. Inthe 2013-14 budget the government introduced the first stage of a National Disability Insurance Schemecalled Disability Care Australia to provide personalised care for people with permanent disabilities.

Elements of the social wage such as the safety net of Modern Awards, the ten National EmploymentStandards and annual adjustments to the National Minimum Wage provide minimum levels of incomeand working conditions to workers with low skills and low bargaining power in the labour market.TeFair Work Act 2009 introduced ten national employment standards and a new Better Off Overall est

for negotiated enterprise agreements. Te Fair Work Commission is responsible for making annualadjustments to the National Minimum Wage which helps to maintain the real wages of low paid workers.

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DIMENSIONS IN THE DISTRIBUTION OF INCOME AND THEECONOMIC AND SOCIAL BENEFITS COSTS OF INEQUALITY

1. Explain how the distribution of income varies according to gender, age, occupation,and ethnicity.

2. What is meant by the income life cycle?

3. How does the income life cycle affect the income earning capacity of different householdgroups?

4. Refer to Table 11.5 and contrast the distribution of income in Australia in 2011-12 according tothe four types of households listed.

5. Discuss the economic benefits and costs of inequality in the distribution of income in Australia.

6. Discuss the social benefits and costs of inequality in the distribution of income in Australia.

7. How can unemployment affect the distribution of income in Australia?

8. Discuss the range of government policies used to reduce inequality in the distribution of incomeand wealth and the incidence of poverty traps. Refer to Tables 11.6 and 11.7 in your answer.

9. Define the following terms and add them to a glossary:

REVIEW QUESTIONS

Other elements of the social wage include government spending on public health, education, housing,transport and community services which provide a safety net for low income earners and their families.Tese benefits may be in the form of direct federal government provision such as the safety net of theMedicare system for health care, and state government provision through subsidised goods and servicessuch as public health, education, housing, utilities, transport and community services.

In terms of general macroeconomic management, the government used expansionary settings ofmonetary and fiscal policies in 2008-09 to support aggregate demand as the Global Financial Crisis andrecession impacted adversely on the Australian economy. Te main priorities were threefold:

1. o support economic growth, household incomes and living standards in the short term;

2. o minimise the increasing rate of unemployment in the labour market in the medium term; and

3. o increase public investment in economic and social infrastructure to increase Australias productivecapacity in the medium to long term.

With economic recovery between 2010 and 2012, the Australian government planned to return thebudget to surplus by 2015-16. It made important spending decisions and tax changes as part of itsredistributive policy in the 2012 budget and introduced Disability Care Australia in the 2013 budget.Te effective conduct of macroeconomic policy, together with the tax-transfer system, the safety net ofminimum wages and employment conditions, and the social wage elements of government spendingare important mechanisms for creating a more equal distribution of income and wealth in Australia.

disposable incomedistribution of incomeequivalised incomeGini co-efficienthousehold disposable income

income

income inequalityincome quintileincome tax thresholdLorenz Curvemarginal tax rate (MTR)

net worth

poverty trapprogressive taxationsocial security and welfaresocial wagewages

wealth

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Equivalised Disposable Household Income QuintilesType of Income Unit Lowest Second Third Fourth Highest Gini co-efficient

Couples with dependent children 14.9 21.6 23.9 21.5 18.1 0.31

Couples without dependent children 24.1 18.2 11.6 17.3 28.8 0.35

Single parent family with children 34.4 31.7 20.8 10.3 2.7 0.26

Single persons (15 - 65+ years) 43.9 14.3 14.9 13.3 13.6 0.38

Refer to the table above of income shares for four types of income unit from the ABSHouseholdIncome and Income Distributionfor 2011-12 and answer the questions below. Marks

1. Define gross weekly income. (1)

2. List FOUR separate sources of income that are included in gross weekly income. (2)

3. Explain what the Gini co-efficient measures. (2)

4. Which type of income unit had the highest level of income inequality in 2011-12? (2)Suggest a possible reason for the high level of inequality in this income unitsdistribution of equivalised disposable household income in 2011-12.

5. Discuss TWO costs and TWO benefits of inequality in the distribution of income in Australia. (3)

[CHAPTER 11: SHORT ANSWER QUESTIONS

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[CHAPTER FOCUS ON THE DISTRIBUTION OF INCOME AND WEALTH

Lorenz Curves for Australia 2009-10

[CHAPTER 11: EXTENDED RESPONSE QUESTION

Discuss the extent of inequality in the distribution of income and wealth in Australia and explainthe use of Australian government policies to reduce income and wealth inequality.

The distribution of income in Australia was quite unequal in 2009-10, with 7.4% of totalhousehold income going to people in the low income group (the 20% of the population in thelowest income quintile), 52.4% going to the middle three quintiles, and 40.2% to the highincome or top quintile. Wages and salaries were the main source of income for the top fourquintiles while social benefits were the main source of income for the lowest quintile.

Source: ABS (2011), Household Income and Income Distribution 2009-10, Catalogue 6523.0.

Explain how the distribution of income is measured and discuss the main costs and benefits ofinequality in the distribution of income and wealth in Australia.

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DISTRIBUTION OF INCOME AND WEALTH

1. The distribution of income and wealth is a reflection of how the benefits of economic growth areshared amongst the population as a whole. Most democratic societies have in place policiesto ensure that inequality is minimised and a social safety net exists to protect those on minimumincomes. Redistributive policies are also aimed at reducing the extent of poverty in society.

2. The distribution of income and wealth is measured by economists through the construction of aLorenz Curve showing shares of income or wealth for equal groupings of the population such as20% quintiles. A Gini co-efficient can then be calculated, which measures the extent of inequalityin the distribution of income or wealth over time. The Gini co-efficient varies in value from zero toone. A rise in the value (towards unity) of the Gini co-efficient implies an increase in inequality,whereas a fall in the value (towards zero) of the Gini co-efficient implies a reduction in inequality.

3. The main sources of income in Australia include compensation of employees (wages and salaries);gross operating surplus and mixed income (profits from business enterprises); property income(rent, interest and dividends); and social benefits receivable (pensions and allowances) paid bythe government to households with zero or low levels of income.

4. The main sources of wealth or net worth in Australia include owner occupied dwellings and otherproperty; the value of businesses; superannuation; financial accounts; shares and trusts; the valueof household contents; and motor vehicles.

5. Statistical data from the ABS and other sources indicate that there is a high degree of incomeinequality in Australia. This is especially the case in the distribution of wages and salaries. Howeverthe distribution of equivalised disposable household income is less unequal than the distribution ofgross income because of the impact of progressive taxation in taking a higher proportion of taxfrom those on high incomes compared to those on low and middle incomes.

6. ABS surveys and other research studies suggest that the distribution of wealth in Australia is moreunequal than the distribution of income. There is a link between the distribution of income andwealth in that those earning high incomes are more likely to accumulate wealth and receive nonwage forms of income which helps to boost their personal income relative to low income earners.

7. Dimensions in the distribution of income include analysis of the distribution in terms of age, gender,occupation, ethnicity and family structure. For example, twin income households tend to havehigher incomes than households with a sole person, one parent or only one income earner.

8. There are various economic and social benefits and costs of income and wealth inequality. Someeconomists argue that income inequality is a natural consequence of a market economy where thehighly skilled and educated are rewarded for their contribution to production. Also differences

in income have an incentive effect on workers and entrepreneurs to raise productivity or to takemore risks in establishing and operating business enterprises. Higher incomes may also boostsavings and investment and promote economic and employment growth and capital accumulation.The social benefits of inequality flow mainly to high income households who experience a higherstandard of living relative to low and middle income households.

9. The major economic costs of income inequality include lower consumption and utility by those onlow incomes, which reduces potential aggregate demand. Increased income inequality may alsolead to greater welfare spending by the government and a deterioration in the budget balance.

10. The major social costs of inequality include the emergence of social divisions in the communityand the alienation of marginalised groups. This can lead to a greater incidence of absoluteand relative poverty amongst low income groups, who may become dependent on welfare andexperience poverty traps, because they face high effective marginal taxation rates (EMTRs).



CHAPTER SUMMARY

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