Income Distribution

Income distribution refers to the manner in which income in a given region or country is distributed. In the real world, we see unequal income distribution everywhere, and a lot of people are upset about this fact.

CEOs commonly get paid 100x more money than the lowest rung of employees in their company, even though they're not working 100x as hard, or 100x as many hours. And, of course, this issue is a political hot-button.

Mechanisms like taxes try to make the playing field more...level, for better or worse.

An economic way to measure how wide-spread income distribution runs? The Gini coefficient. It ranks income distribution on a scale of 0 to 1, with 1 being the most unequal income distribution and 0 being perfect income equality. Recent numbers show the US at 0.41, which is only better than a handful of countries (like Zambia and South Africa).

Who’s more equal than the U.S.? Afghanistan (0.28), Iceland (0.26), and Norway (0.27) to name a few. And note that "equal" doesn't mean good. Like, in Afhanistan pretty much everyone is equally poor-ish. Norway and Iceland are extremely...white. Homogeneous. Even. Easy to manage. Easy to deal with the 17 different diseases everyone gets. Vastly different from managing highly diverse countries like the U.S.

And through another lens, what is income distribution, really? At its essence, it’s how income (those paychecks you get sometimes) is distributed among the masses in a country. Normally, the way we’d look at income distribution is by dividing a nation’s population into five or ten equal groups. Then we can look at how much of the total GDP pie each of those equal groups of people is getting.

When the pie slices are sliced equally, that’s an equal distribution of income. The more unequal the pie slices look, the more unequal income distribution is. Those are just the facts...what we’d call “positive” economic statements. But it’s normal to have opinions when we’re talking economics, which are “normative” statements. Many people think that the more unequal income distribution is, the less fair it is.

Plus, there's some economic theory and research backing the idea that extreme income inequality can actually be bad for the economy. But even that’s up for debate. Economists have come up with a genius tool for making the measuring of income distribution as easy as pie. Well actually, even better than a pie chart: the Lorenz curve and the Gini Coefficient.

If a nation was perfectly equal, it would be a straight diagonal line. The x-axis is the buckets of people, and the y-axis is the percent of money to be spread among them. On a straight line, the bottom 10% of people are getting 10% of the money. The bottom 50% of people are getting 50% of the money. And the bottom 90% are getting 90% of income.

The more saggy the line is, the less equal it is. For instance, as income distribution has become less and less equal in recent decades, the U.S.’s Lorenz curve has gotten saggier and saggier. Just like your skin will one day, sadly.

Using data from the late 90s and early 2000s, you can compare Denmark and Hungary (two of the countries with some of the most equitable income distribution) with Namibia, one of the least equitable. The first line below the blue would be Denmark, the second...between the yellow sliver and red area...would be Hungary, and the third...between the red and green...would be Namibia.

Namibia's line would be...saggy. If you look at the bottom 80% of people (“4” on the x-axis), you see that they're only getting 21.3% of nation’s income.

Now that you understand how Lorenz curves work (either keeping things tight or sagging), we’re gonna take a look at the GIni Coefficient.

The Gini Coefficient takes the Lorenz curve, reducing income distribution down to a single number. Like a Jedi. The more sag there is to our Lorenz curve, the bigger the “A” area gets and the smaller the “B” area gets.

The Gini coefficient is A / A+B. If our Lorenz curve overlaps with our “perfectly equal” straight line, then the “A” area is 0, making our Gini coefficient also 0. What if the saggy-sag sags all the way down to the x-axis, which means income is distributed really, really unequally? Well, that would make the Gini coefficient 1.

Gini Coefficients are ratios, so they’re always between 0 and 1, sometimes expressed as a decimal or percentage. The closer to 0, the more equal the income distribution. The closer to 1, the less equal. The Gini Coefficient takes alllll of those numbers, distilling income distribution into one single number. Meaning that it’s super easy to compare income distribution of different countries.

It’s good to remember these are more estimates than actual numbers, since some countries might be inflating their GDP...international politicking, you know how it goes. Just as the US’s Lorenz curve has been sagging as time goes by, with income distribution getting less and less equal, its Gini coefficient has been getting bigger and bigger.

Okay, so...what’s the role of taxes in income distribution? How do they work? Well, there are progressive taxes...and regressive taxes. Progressive taxation is where you’ll pay a higher percentage in taxes the more money you make. For instance, in the country of United Simpletons, everyone pays 10% on their first $20,000, then 20% on their next $80,000, and then 50% on any income over $100,000. These different buckets are called “tax brackets.”

Under this progressive tax system, Billy Bob, who makes $30k, is taxed 10% on his first $20k of income, and 20% on his last $10k of income. That leaves Billy Bob with $26,000 to live on. Joe Shmo, who makes $1.5 million, is taxed 10% on his first $20k, 20% on his next $80k, and 50% on his remaining $1.4 million. That leaves Joe Shmo with $782,000 to live on.

A regressive tax, also known as a flat tax, is where all income is taxed at the same rate, no matter how much you make. It’s called a regressive tax, since it takes a more meaningful percentage of income from low-income people compared to high-income people.

For instance, if the United Simpletons had to pay 25% on their income, that would leave Billy Bob with $22,500 dollars and Joe Shmo with $1,125,000 dollars. Because there are so many normative opinions on what’s fair when it comes to income distribution, there’s plenty of debate over what level of taxation, social programs, and public services are best.

And yeah, there’s certainly plenty of room for such debate. But, uh...we’ll leave the politics for another video.