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The term welfare state has come to refer to the collection of government programs that are designed to alleviate economic hardship. A large share of the government spending of all wealthy countries consists of government transfers—payments by the government to individuals and families—that provide financial aid to the poor, assistance to unemployed workers, guaranteed income for the elderly, and assistance in paying medical bills for those with large health care expenses.

There are three major economic rationales for the creation of the welfare state.

1. Alleviating Income Inequality Suppose that the Taylor family, which has an income of only $15,000 a year, were to receive a government check for $1,500. This check might allow the Taylors to afford a better place to live, eat a more nutritious diet, or in other ways significantly improve their quality of life. Also suppose that the Fisher family, which has an income of $300,000 a year, were to face an extra tax of $1,500. This probably wouldn’t make much difference to their quality of life: at worst, they might have to give up a few minor luxuries.

This hypothetical exchange illustrates the first major rationale for the welfare state: alleviating income inequality. Because a marginal dollar is worth more to a poor person than a rich one, modest transfers from the rich to the poor will do the rich little harm but benefit the poor a lot. So, according to this argument, a government that takes from the rich to give to the poor, does more good than harm. Programs that are designed to aid the poor are known as poverty programs.

2. Alleviating Economic Insecurity The second major rationale for the welfare state is alleviating economic insecurity. Imagine ten families, each of which can expect an income next year of $50,000 if nothing goes wrong. But suppose the odds are that something will go wrong for one of the families, although nobody knows which one. For example, suppose each of the families has a one in ten chance of experiencing a sharp drop in income because one family member is laid off or incurs large medical bills. And assume that this event will produce severe hardship for the family—a family member will have to drop out of school or the family will lose its home.

Now suppose there’s a government program that provides aid to families in distress, paying for that aid by taxing families that are having a good year. Arguably, this program will make all the families better off, because even families that don’t currently receive aid from the program might need it at some point in the future. Each family will therefore feel safer knowing that the government stands ready to help when disaster strikes. Programs designed to provide protection against unpredictable financial distress are known as social insurance programs.

These two rationales for the welfare state, alleviating income inequality and alleviating economic insecurity, are closely related to a major principle of tax fairness, the ability-to-pay principle, according to which those with greater ability to pay a tax should pay more. The principle is usually interpreted to mean that people with low incomes, for whom an additional dollar makes a big difference to economic well-being, should pay a smaller fraction of their income in taxes than people with higher incomes, for whom an additional dollar makes much less difference. The same principle suggests that those with very low incomes should actually get money back from the tax system.

3. Reducing Poverty and Providing Access to Health Care The third and final major rationale for the welfare state involves the social benefits of poverty reduction and access to health care, especially when applied to children of poor households. Researchers have documented that such children, on average, suffer lifelong disadvantage.

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Even after adjusting for ability, children from economically disadvantaged backgrounds are more likely to be underemployed or unemployed, engage in crime, and to suffer chronic health problems—all of which impose significant social costs. So, according to the evidence, programs that help to alleviate poverty and provide access to health care generate external benefits to society.

More broadly, as the For Inquiring Minds explains, some political philosophers argue that principles of social justice demand that society take care of the poor and unlucky. Others disagree, arguing that welfare state programs go beyond the proper role of government. To an important extent, the difference between those two philosophical positions defines what we mean in politics by “liberalism” and “conservatism.”

But before we get carried away, it’s important to realize that things aren’t quite that cut and dried. Even conservatives who believe in limited government typically support some welfare state programs. And even economists who support the goals of the welfare state are concerned about the effects of large-scale aid to the poor and unlucky on their incentives to work and save. Like taxes, welfare state programs can create substantial deadweight losses, so their true economic costs can be considerably larger than the direct monetary cost.

We’ll turn to the costs and benefits of the welfare state later. First, however, let’s examine the problems the welfare state is supposed to address.

For at least the past 75 years, every U.S. president has promised to do his best to reduce poverty. In 1964 President Lyndon Johnson went so far as to declare a “war on poverty,” creating a number of new programs to aid the poor. Anti-poverty programs account for a significant part of the U.S. welfare state, although social insurance programs are an even larger part.

But what, exactly, do we mean by poverty? Any definition is somewhat arbitrary. Since 1965, however, the U.S. government has maintained an official definition of the poverty threshold, a minimum annual income that is considered adequate to purchase the necessities of life. Families whose incomes fall below the poverty threshold are considered poor.

The official poverty threshold depends on the size and composition of a family. In 2015 the poverty threshold for an adult living alone was $12,331; for a household consisting of two adults and two children, it was $24,036.

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Trends in Poverty Contrary to popular misconceptions, although the official poverty threshold is adjusted each year to reflect changes in the cost of living, it has not been adjusted upward over time to reflect the long-term rise in the standard of living of the average American family. As a result, as the economy grows and becomes more prosperous, and as average incomes rise, you might expect the percentage of the population living below the poverty threshold to steadily decline.

However, this hasn’t happened. The orange line in Figure 11-1 shows the official U.S. poverty rate—the percentage of the population living below the poverty threshold—from 1967 to 2014. As you can see, since 1967 the poverty rate—which fell steeply during the early 1960s—has fluctuated up and down, with no clear trend. In 2014, the poverty rate was higher than it had been 40 years earlier, even though America as a whole was far richer. In response to this surprising result, researchers have identified a number of limitations to the official poverty measure, of which the most important is that the definition of income doesn’t actually include many forms of government aid. For example, it excludes the monetary value of food stamps. So the U.S. Census Bureau now releases a Supplemental Poverty Measure that includes income from government aid, a measure that experts consider to be more accurate. The burgundy line in Figure 11-1 shows how this measure has changed over time. While it shows more progress than the standard measure, the change is still surprisingly little considering that the real income of the average household has risen about 40% since 1970.

Who Are the Poor? Many Americans probably hold a stereotyped image of poverty: an African-American or Hispanic family with no husband present and the female head of the household unemployed at least part of the time. This picture isn’t completely off base: poverty is disproportionately high among African-Americans and Hispanics as well as among female-headed households. But a majority of the poor don’t fit the stereotype.

In 2014, 46.7 million Americans were in poverty—14.8% of the population, or slightly more than one in seven persons. And 23% of the poor were African-American, substantially exceeding their share of the overall population (only about 13% of the population is African-American). Hispanics were also more likely than the average American to be poor, with a poverty rate of 23.6%. But there was also widespread poverty among non-Hispanic Whites, who made up 42% of the poor.

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There is also a correlation between family makeup and poverty. Female-headed families with no husband present had a very high poverty rate: 30.6%. Married couples were much less likely to be poor, with a poverty rate of only 6.2%; still, about 39% of the poor were in married families with both spouses present.

What really stands out in the data, however, is the association between poverty and inadequate employment. Adults who work full time are very unlikely to be poor: only 3% of full-time workers were poor in 2014. Many industries, particularly in the retail and service sectors, now rely primarily on part-time workers. Part-time work typically lacks benefits such as health plans, paid vacation days, and retirement benefits, and it also usually pays a lower hourly wage than comparable full-time work. As a result, many of the poor are members of what analysts call the working poor: workers whose incomes fall at or below the poverty threshold.

What Causes Poverty? Poverty is often blamed on lack of education, and educational attainment clearly has a strong positive effect on income level—those with more education earn, on average, higher incomes than those with less education. For example, in 1979 the average hourly wage of men with a college degree was 38% higher than that of men with only a high school diploma; by 2014, the “college premium” had increased to 85%.

Lack of proficiency in English is also a barrier to higher income. For example, Mexican-born male workers in the United States—two-thirds of whom have not graduated from high school and many of whom have poor English skills—earn less than half of what native-born men earn.

And it’s important not to overlook the role of racial and gender discrimination; although less pervasive today than 50 years ago, discrimination still erects formidable barriers to advancement for many Americans. Non-Whites earn less and are less likely to be employed than Whites with comparable levels of education. Studies find that African-American males suffer persistent discrimination by employers in favor of Whites, African-American women, and Hispanic immigrants. Women earn lower incomes than men with similar qualifications.

Another important source of poverty that should not be overlooked is bad luck. Many families find themselves impoverished when a wage-earner loses a job or a family member falls seriously ill.

Consequences of Poverty The consequences of poverty are often severe, particularly for children. In 2014, 21% of children in the United States lived in poverty. Poverty is often associated with lack of access to health care, which can lead to further health problems that erode the ability to attend school and work later in life. Affordable housing is also frequently a problem, leading poor families to move often, disrupting school and work schedules. Recent medical studies have shown that children raised in severe poverty tend to suffer from lifelong learning disabilities. As a result, American children growing up in or near poverty don’t have an equal chance at the starting line: they tend to be at a disadvantage throughout their lives. Even talented children who come from poor families are unlikely to finish college.

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The United States is a rich country. In 2007, before the recession hit, the average U.S. household had an income (in 2014 prices) of $77,198, far exceeding the poverty threshold. Even after a devastating recession followed by a sluggish recovery, average household income in 2014 was $75,738. How is it possible, then, that so many Americans still live in poverty? The answer is that income is unequally distributed, with many households earning much less than the average and others earning much more.

Table 11-1 shows the distribution of pre-tax income—income before federal income taxes are paid—among U.S. households in 2014, as estimated by the Census Bureau. Households are grouped into quintiles, each containing 20%, or one-fifth, of the population. The first, or bottom, quintile contains households whose income put them below the 20th percentile in income, the second quintile contains households whose income put them between the 20th and 40th percentiles, and so on.

For each group, Table 11-1 shows three numbers. The second column shows the income ranges that define the group. For example, in 2014, the bottom quintile consisted of households with annual incomes of less than $21,432, the next quintile of households had incomes between $21,432 and $41,186, and so on. The third column shows the average income in each group, ranging from $11,676 for the bottom fifth to $332,347 for the top 5%. The fourth column shows the percentage of total U.S. income received by each group.

Mean versus Median Household Income At the bottom of Table 11-1 are two useful numbers for thinking about the incomes of American households. Mean household income, also called average household income, is the total income of all U.S. households divided by the number of households. Median household income is the income of a household in the exact middle of the income distribution—the level of income at which half of all households have lower income and half have higher income. It’s very important to realize that these two numbers measure different things.

Economists often illustrate the difference by asking people first to imagine a room containing several dozen more or less ordinary wage-earners, then to think about what happens to the mean and median incomes of the people in the room if a Wall Street billionaire walks in. The mean income soars, because the billionaire’s income pulls up the average, but median income hardly rises at all.

This example helps explain why economists generally regard median income as a better guide to the economic status of typical American families than mean income: mean income is strongly affected by the incomes of a relatively small number of very-high-income Americans, who are not representative of the population as a whole; median income is not.

What we learn from Table 11-1 is that income in the United States is quite unequally distributed. The average income of the poorest fifth of families is less than a quarter of the average income of families in the middle, and the richest fifth have an average income more than three times that of families in the middle. The incomes of the richest fifth of the population are, on average, about 15 times as high as those of the poorest fifth. In fact, the distribution of income in America has become more unequal since 1980, rising to a level that has made it a significant political issue. The upcoming Economics in Action discusses long-term trends in U.S. income inequality, which declined in the 1930s and 1940s, was stable for more than 30 years after World War II, but began rising again in the late 1970s.

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The Gini Coefficient It’s often convenient to have a single number that summarizes a country’s level of income inequality. The Gini coefficient, the most widely used measure of inequality, is based on how disparately income is distributed across the quintiles (as we see in the Global Comparison). A country with a perfectly equal distribution of income—that is, one in which the bottom 20% of the population received 20% of the income, the bottom 40% of the population received 40% of the income, and so on—would have a Gini coefficient of 0. At the other extreme, the highest possible value for the Gini coefficient is 1—the level it would attain if all a country’s income went to just one person.

One way to get a sense of what Gini coefficients mean in practice is to look at international comparisons. Aside from a few countries in Africa, the highest levels of income inequality are found in Latin America, especially Colombia; countries with a high degree of inequality have Gini coefficients close to 0.6. The most equal distributions of income are in Europe, especially in Scandinavia; countries with very equal income distributions, such as Sweden, have Gini coefficients around 0.33. Compared to other wealthy countries, as of 2012 the United States, with a Gini coefficient of 0.57, has unusually high inequality, though it isn’t as unequal as in Latin America.

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How serious an issue is income inequality? In a direct sense, high income inequality means that some people don’t share in a nation’s overall prosperity. As we’ve seen, rising inequality explains how it’s possible that the U.S. poverty rate has failed to fall for the past 45 years even though the country as a whole has become considerably richer. Also, extreme inequality, as found in Latin America, is often associated with political instability because of tension between a wealthy minority and the rest of the population.

It’s important to realize, however, that the data shown in Table 11-1 overstate the true degree of inequality in America, for several reasons. One is that the data represent a snapshot for a single year, whereas the incomes of many individual families fluctuate over time. That is, many of those near the bottom in any given year are having an unusually bad year and many of those at the top are having an unusually good one. Over time, their incomes will revert to a more normal level. So a table showing average incomes within quintiles over a longer period, such as a decade, would not show as much inequality.

Furthermore, a family’s income tends to vary over its life cycle: most people earn considerably less in their early working years than they will later in life, then experience a considerable drop in income when they retire. Consequently, the numbers in Table 11-1, which combine young workers, mature workers, and retirees, show more inequality than would a table that compares families of similar ages.

Despite these qualifications, there is a considerable amount of genuine inequality in the United States. In fact, inequality not only persists for long periods of time for individuals, it extends across generations. The children of poor parents are much more likely to be poor than the children of affluent parents, and vice versa—a correlation that is even stronger in the United States than in other rich countries. Moreover, the fact that families’ incomes fluctuate from year to year isn’t entirely good news. Measures of inequality in a given year do overstate true inequality. But those year-to-year fluctuations are part of a problem that worries even affluent families—economic insecurity.

As we stated earlier, although the rationale for the welfare state rests in part on the social benefits of reducing poverty and inequality, it also rests in part on the benefits of reducing economic insecurity, which afflicts even relatively well-off families.

One form economic insecurity takes is the risk of a sudden loss of income, which usually happens when a family member loses a job and either spends an extended period without work or is forced to take a new job that pays considerably less. In a given year, according to recent estimates, about one in six American families will see their income cut in half from the previous year. Related estimates show that the percentage of people who find themselves below the poverty threshold for at least one year over the course of a decade is several times higher than the percentage of people below the poverty threshold in any given year.

Even if a family doesn’t face a loss in income, it can face a surge in expenses. Until implementation of the Affordable Care Act in 2014, the most common reason for such surges was a medical problem that required expensive treatment, such as heart disease or cancer. In fact, in 2013 it was estimated that 60 percent of the personal bankruptcies of Americans were due to medical expenses. The rise in medical-bill bankruptcies—up nearly 50 percent from 46 percent in 2001, and on up to 62 percent in 2007—was a major source of support for the passage of the ACA.

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