Lorentz Curve and Ginni coefficient

Understanding Income Distribution

In Economics there are two things that are used to measure income distribution: Lorenz Curves and Gini Coefficients. The way it works is the United States is broken into 5 income levels (a quintile), and then we determine the percent of the wealth that lies in each quintile. From these numbers, we plot it on a graph and get a Lorenz Curve. Here is an example:

The 45 degree line represents a country that each person owns exactly the same amount of wealth, and a perfectly vertical line down the far right of the graph would represent a country where 1 person owns 100% of the nations wealth. When plotting the Lorenz Curve for a country, it typically falls somewhere in the middle. The closer the curve is the the 45 degree line, the more equal its income distribution is.

Gini Coefficients

Gini Coefficients are calculated as the area between the Lorenz Curve and the 45 degree line. We use this number to compare each country (as well as populations within a country). As a general rule, countries the have a Gini Coefficient between a .50-.70 are considered to have a high level of inequality whereas a country who’s Gini Coefficient falls between a .20 and a .35 is said to have a rather equal distribution.

If a country has a Gini Coefficient below a .20 you run into a problem where there is not a lot of competition and there is not a great incentive to work. There needs to be some incentive for workers to want to do better, to want to move up and accumulate more wealth. If that condition does not exist, a country will run into big problems. Typically you see low Gini Coefficients in communist societies or very socialist societies.

If a country has a higher Gini Coefficient, there are several problems that could develop:

- The rich tend to save more and not invest it
- There is an inefficient allocation of assets
- High crime rates and greater need for private property protection
- Social unrest

The higher the Gini Coefficient, the more likely the above problems are to occur. Gini coefficients have a tendency to creep higher as time progresses.

The United States: Now and Then

We often hear in the media that income distribution in the United States has become out of line and you hear calls for higher taxes on the wealthiest Americans. Then you hear claims that raising taxes is class warfare, so what is the truth?

Below is a graph of several historical Lorenz Curves for the United States:

As you can see, the curves have been moving outward for the last 30 years. Here are some historical Gini Coefficients:

1970: .394
1980: .403
1990: .428
2000: .462
2010: .469