ECO 450G Notes

Fall 2006 Semester

University of Kentucky

Chapter 3 – Counting the Poor

I. Poverty: Drawing a Line

II. The Official Poverty Line

III. Poverty Thresholds

IV. The Number of Poor People

V. Measurement Problems

VI. Characteristics of the Poor

I. Poverty: Drawing a Line

The distribution of income looks like a “disfigured bell”, as in Figure 3.1. Who is poor? One approach uses an absolute standard of deprivation, the other a relative standard.

● Absolute approach: Some bundle of goods and services that is regarded as essential to the physical well-being of a family unit.

- Could be, for example, minimum caloric intake for survival and shelter. World Bank defines “poor” as $1/day income.

- Industrialized nations have a different concept of minimum needs, which is a problem with the “absolute” definition. This approach incorporates subjective views about what is minimally necessary for survival.

- Absolute necessities should change very little over time, yet Figure 3.2 shows that American’s expectations of what it means to “Just get by”, “Live in Reasonable Comfort” and “To Fulfill all of your dreams” has changed – according to Schiller.

- Discussion questions: Are the dollar amounts adjusted for inflation? How was the survey conducted (e.g., by phone?), and does that lead to bias? Are the results statistically significantly different from one year to the next?

- Example: “Bare-bones” budgets. See http://www.epinet.org/issueguides/poverty/poverty_issueguide.pdf . Economic Policy Institute argues that poverty thresholds are much lower than what it actually takes to support a family, and then use this as motivation for living wage ordinances. For example, after account for housing, food, child-care, transportation, health care, other necessities, and subtracting off taxes (and ignoring transfers), the bare bones budget for a single parent family with two kids was $34,822 in Baltimore in 1999.

- Discussion question: Does “bare-bones” equate to “absolute deprivation?”

● Relative approach: States that a person is poor when his or her income is significantly less than the average income of the population.

- Some approaches use lower quintile, decile, etc. In these cases the poverty rate wouldn’t change unless there was perfect equality.

- This approach says nothing about the quality of life at the bottom of the income distribution.

- Fuchs Point: Those with incomes less than half the national median are poor.

- Poverty can fall over time, but definition is ad-hoc.

● May want to consider other factors like age, family structure & number of children.

II. The Official Poverty Line

The official poverty line in the U.S. uses the absolute approach to define poverty. Thus, the government must try to identify the minimum amount of money required to sustain a family.

● In 2001, poverty line was $18,000 for family of 4.

● In 1998, it was $16,600.

Minimum Needs

To establish an “absolute” poverty line, we require some notion of what bundle of

goods and services is minimally adequate. Such a bundle will include food,

clothing, shelter, fuel, and perhaps other goods. In principle, we could generate

such a list of minimum subsistence based on components like minimum caloric

intake, etc.

Converting These Needs Into Monetary Measures

Once we arrived at some agreement on the subsistence levels for essential items,

one could try to convert those subsistence levels into money income. By doing

so, we allow for some disagreement in what the actual subsistence levels are –

individuals could choose differing amounts of the subsistence goods.

Note that although the income flow is the single best indicator of purchasing

power, other indicators like access to credit, asset levels, and in-kind assistance

are not accounted for by a poverty line that is reflected in annual income.

III. Poverty Thresholds

The CEA Line

The first officially sanctioned poverty line was establed by the Council of Economic Advisers (CEA) in 1963 at $3,000 per year per family. The established this line by observing that a minimally adequate diet for a family of four would cost about $1,000 per year, and that consumer studies indicated that low-income families spent approximately two-thirds of their income on non-food items

Thus, the CEA scaled up the $1,000 of “minimum” food expenditure per year to

$3,000 of “minimum” total expenditure.

By their estimates, 33.4 million people lived in poverty in 1963. The CEA measure did not account for family size – obviously it is somewhat more expensive to meet minimum needs with larger families, and somewhat less expensive with smaller families. Thus, the CEA measure underestimated the number of large families in poverty, and overestimated the number of small families in poverty.

The SSA Index

The Social Security Administration (SSA) revised this measure in a number of important ways; these are largely incorporated in the current poverty measure.

Family size - The poverty line was adjusted for family size, but this was not as

simple division and multiplication. They assumed families enjoy some economies of scale – for example rent and heat typically do not decline by half for a family of two. Thus, SSA computed equivalency scales – the factor that translated a budget for a 4-person household into a budget for other household sizes.

SSA’s poverty calculation for a family of four in 1963 was $3,130, not much different from the CEA’s poverty calculation.

Official Poverty Index

The current poverty line is adjusted annually for inflation. To see how inflation has varied over time, you can view Table B-60 of the Economic Report of the President, available at:

http://www.gpoaccess.gov/eop/tables06.html

Between 1963 and 2001, prices had increased by about a factor of six, and the

poverty line for a family of four was $18,104. The poverty line in the U.S., as it

currently stands, does not imply an increased standard of living for the poor. It

only accounts for rising prices (but inflation numbers are not adjusted for changes in quality, which could be important for some goods).

In reality, there has been real economic growth over time. This means that even

after adjusting for inflation, the standard of living for most households in 2001 was better than the standard of living for similar households in 1963. The absolute poverty line, which is indexed for inflation, does not reflect a rising standard of living for the population as a whole.

Selected Poverty

Thresholds in 2003

Family Size

1 $9,244

4 $18,504

8 $31,222

As can be seen from the above table, taken from Table 3.4 of Schiller, the poverty line is non-linear. Note that with the exception of Alaska and Hawaii, the poverty line in the U.S. is not adjusted for cost-of-living differences. That is, it is assumed that the same amount of money is needed to meet basic needs in different parts of the country.

Hard Choices

The American public is occasionally asked “What is the smallest amount of money a family of four needs to get along in this community?” In 1996, the median answer was $30,000 (see Figure 3.2). Schiller therefore concludes that the public’s view of minimum needs is well above official poverty thresholds and that most Americans do not believe that the official poverty standard is high enough.

It is not clear what to make of this survey evidence, however. In particular, it is not clear what goods the survey respondent is envisioning when making this income calculation. For example, does the respondent view a television, microwave oven, or automobile as essential? What does it mean to “get along”?

Cultural Context

In the U.S., the poverty line is an “official” line that separates poor from nonpoor. It does not necessarily indicate what is “enough.” There is no official definition or line for the middle class or upper class. The text points out that today’s poverty thresholds allow for a lifestyle equal to the average American family in the 1950s. World poverty – unsurprisingly – is much higher than in the U.S.

IV. The Number of Poor People

As mentioned previously, the Census Bureau uses the CPS to compute poverty statistics annually, based on money income. See:

http://www.census.gov/hhes/poverty/povdef.html

for more details.

Trends in poverty, taken from http://www.census.gov/hhes/poverty/poverty01/pov01cht.gif

show the number of people and the percentage who live in poverty over time.

The main things to take away from this chart are that the poverty rate fell dramatically in

the 1960s, increased in the late 1970s, and has remained in the 12%-15% range thereafter. Even during the economic expansion of the last decade, the poverty rate

peaked at 15.1% in 1993 and troughed at 11.3% in 2000.

How Poor?

The “poverty gap” refers to how far below the official poverty index a family is. A family that is slightly below the poverty line is clearly different than a family that is thousands of dollars below that line. The aggregate poverty gap is the total income shortfall below the poverty line by all poor people. In 2001, it was $92 billion, or approximately $2800 per poor person.

V. Measurement Problems

Is the poverty line too low or too high? Some believe that it is too low. They disagree with the notion that the poverty line should be an absolute measure, meaning that it should not increase with the improving standard of living. In addition, the fraction of the

typical budget that is devoted to food expenditure has changed over time. Others believe the poverty line is too high. For example, the poverty line only counts income, but not assets (such as owning a home).

There are at least five difficulties with the current poverty line:

In-kind income

Many poor families receive income in-kind – meaning they receive goods or services directly from the government instead of cash. These are clearly valuable. For example, poor households might receive food stamps, Medicaid health insurance, Medicare (if they are elderly), subsidized housing, energy assistance, and subsidized childcare.

Because they receive these goods in-kind, these households do not need to use their own cash to purchase them.

The official poverty count ignores in-kind income. Schiller’s Table 3.5 shows that the poverty rate in 2001 would fall from 11.3% to 8.6% if in-kind transfers and tax credits were included. About 8 million people would be taken out of poverty.

Not only is the poverty level affected by in-kind income, but poverty trends as well. In-kind income, particularly health insurance subsidies, have grown tremendously over the past forty years. In 2001, in-kind income accounted for 75% of welfare benefits, up from 55% in 1968.

At the same time, it is difficult to value many in-kind transfers. The value of health insurance, for example, depends on health status. In general, the value of in-kind assistance depends on whether the transfer is marginal or infra-marginal.

To illustrate, consider how in-kind assistance affects the budget constraint of a household compared to an equivalent amount of cash.

[Budget Constraint With Food Stamps Versus Income]

In the first budget constraint, the individual’s decision is unaffected by the cash versus in-kind transfer – thus, he values the in-kind transfer at it’s cash equivalent. In the second budget constraint, the decision is affected, and the in-kind transfer forces the person to “over-consume” food – thus, in utility terms, the in-kind transfer is not as valuable as the cash equivalent.

Underreporting

People may lie to survey takers about their income, especially if they believe that their welfare benefits or taxes might be affected, or if their incomes come from illegal sources.

Some estimates suggest that poor families spend twice as much income as they report receiving, and the gap between spending and reported income as widened over time. Of course, access to credit or changing wealth could explain this too.

This could help reconcile consumption patterns with income patterns.

Income mobility

Many spells of poverty are fairly short. There is no obvious reason why income over the course of one year is the appropriate measure. Why not one month? Or five years?

Three out of five families that are in poverty in one year are out of poverty the next year. Only one in ten families stays in poverty for five years or more.

Uncounted poor

The CPS survey does not interview the homeless, those who are institutions, and prisoners. Schiller argues that some families include unwanted aged relatives who may not share equally in a family’s resources and therefore should be counted as poor.

Schiller calls this “disguised poverty.” It is not clear, however, why this distinction could not also be made other household structures – there are marriages that certainly stay together out of economic necessity, for example, where one spouse or the other does not enjoy equal access to the resources.

By the same token, there may be households that are poor but receiving in-kind resources from relatives (like babysitting, meals, transportation, gifts, etc.), which would tend to overstate the number of poor.

Latent poverty

The poverty measure takes into account cash income from all sources, which includes not only earnings, interest income, dividends, etc., but also cash transfers such as welfare and social insurance programs like Social Security. Obviously many individuals who are collecting Social Security are elderly, and have few other sources of income.

Nearly 40% of all pre-transfer poor are kept out of poverty solely because of government checks. By pre-transfer, we mean counting income sources such as earnings, pensions, etc., but not counting government payments.

By far the largest part of this reduction in the “official poor” is because of Social Security payments. Of 26.9 million who are kept out of the official poverty rolls by government transfers, about two-thirds receive Social Security. Of course, people pay into Social Security during their working lives. If we are to exclude Social Security benefits, one should presumably consider what would have happened to those Social Security contributions during the working life. Presumably, at least some of those contributions would have been invested in the absence of Social Security. This means that private income sources like pension income and dividends would have been higher too.

VI. Characteristics of the Poor

Age and Family Status

Poverty rates vary tremendously by race: African-Americans and Hispanics have poverty rates around 22%, whites have rates around 8%.

Female headed households have very high poverty rates – around 35%.

The elderly tend to have lower poverty rates than the national average, due in large part to the generosity of Social Security.

Geography

The Northeast and Midwest regions tend to have lower poverty rates than the national average; the South and West have higher poverty rates. Interestingly, despite the discussion of the South in the text, the poverty rate in 1998 was actually higher in the West. In 2001, the poverty rate was slightly higher in the South than the West.

Of course, these estimates do not account for cost-of-living differences; presumably this would overstate poverty in the South because cost-of-living tends to be lower.

Historically, if you go to

http://www.census.gov/hhes/poverty/histpov/hstpov9.html

, you will see that the South has had the highest poverty rate, but the South made relative economic progress in the 1990s.

Labor Force Status

The definition of “in the labor force” is a person who is either employed or actively seeking employment, as well as those who are temporarily not working because of illness, bad weather, vacation or a labor-management dispute. “Out of the labor force” is everyone else, and includes those who: are keeping house, attending school, unable to work because of age or disability, or not actively seeking employment.

Table 3.9 shows the unsurprising result that for families with children (which implies that the head is almost certainly non-elderly), virtually all non-poor families had a working member, while a much smaller fraction of poor families had a working member.