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Measuring Poverty: A New Approach 4 Defining Resources The determination of whether a family (or an individual) is in or out of poverty requires two pieces of information: a poverty threshold and an estimate of the family's economic resources. In the two preceding chapters, we examined thresholds and adjustments to them; in this chapter, we review definitions of family resources. We recommend a definition and analyze the elements that go into its derivation, considering for each the justification, methods and data for implementation, and needed research for improved implementation. OVERVIEW AND RECOMMENDATION The definition of family resources that has been used for determining poverty status in the United States ever since the current measure was adopted in the 1960s is annual gross money income. We believe this definition is seriously flawed and recommend a change: namely, that family resources be defined as disposable money and near-money income that is available for consumption of goods and services in the poverty budget. A key to our recommendation is the principle of consistency between the resource definition and the threshold concept. That is, a defensible measure of poverty requires that resources and needs—the thresholds—be defined consistently. Hence, we approached the task of evaluating alternative family resource definitions by constant reference to the proposed concept for the poverty thresholds—namely, a budget for food, clothing, and shelter and a small additional amount for other needed consumption. For consistency with this budget concept, the definition of resources should include the value of
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Measuring Poverty: A New Approach near-money benefits, such as food stamps, that are available for consumption; it should exclude expenditures that are nondiscretionary and not available for consumption: out-of-pocket medical care expenditures (including health insurance premiums), income and payroll taxes, child care and other expenses that are necessary to earn income, and child support payments to another household. Instead of allowing for these kinds of expenses in the poverty budget, we propose, rather, to deduct them from resources for those families that incur them. Even within the constraints imposed by our choice of a concept for the poverty thresholds, there are alternative ways to define family resources. We considered these from the perspective of two other criteria: that the definition be publicly acceptable and operationally feasible. Data limitations are a particularly important consideration for the family resource definition because of the costs of estimating resources for a large enough sample of the population from which to reliably determine the poverty rate for the nation as a whole and for various population groups. Indeed, data limitations will likely hinder the extent to which complete consistency between a threshold concept and a resource definition can be achieved in practice. Nonetheless, we stress the importance of striving for consistency. In this respect, the current U.S. poverty measure has been deficient from the beginning. Most obviously, the poverty thresholds were derived from after-tax income data while resources were defined in before-tax terms. The reason for this discrepancy was that the data source for measuring poverty, the March income supplement to the Current Population Survey (CPS), did not obtain information that would readily allow families' taxes to be estimated.1 Income and payroll taxes on the working poor were low when the poverty measure was developed, but they subsequently increased and, more recently, declined again. The official poverty statistics reflected none of these shifts in tax policy, although they affected the resources available to poor and near-poor families. Other inconsistencies in the measure became apparent as society changed and new government programs were enacted. More mothers went to work outside their homes, thus incurring child care costs, yet the different needs of working and nonworking families were not reflected by modifying either the thresholds or the resource definition. In-kind benefit programs that provide such commodities as food and housing were small in scope when the current measure was developed but have increased enormously since then, yet the resource definition does not include their value. 1 The CPS surveys 60,000 households each month with a series of questions that are used to determine the official monthly unemployment rate. The income supplement every March asks about sources of income for each adult household member for the previous calendar year (see Chapter 5 and Appendix B).
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Measuring Poverty: A New Approach Since the current measure was adopted, data sources and procedures for estimating income have improved substantially. In 1980, the March CPS income questions were expanded, and questions were added about major in-kind benefits. In 1983, the Survey of Income and Program Participation (SIPP) was initiated to obtain more complete information on economic resources.2 Also, methods were developed to adjust the March CPS income estimates in various ways (e.g., by subtracting taxes), and work is in progress on similar methods for SIPP. Yet, there has been no change in the data source or the definition of resources that is used to measure poverty. Not only does the current poverty measure violate the consistency principle, but so does much work to date to investigate alternative measures. For example, the Census Bureau over the past decade has published a series of "experimental" poverty rate estimates from the March CPS: they are based on changes to the family resource definition but not on changes to the thresholds (see, e.g., Bureau of the Census, 1993a, 1995).3 In some instances, this approach makes good sense: thus, the Census Bureau's estimates in which federal and state income taxes are subtracted from resources reflect a definition that is more consistent with the original threshold concept than is the current before-tax resource definition. In other instances, the changes to the resource definition are not consistent with the official thresholds. In particular, estimates by the Census Bureau (and others) in which the value of public and private health insurance benefits is added to families' resources violate the consistency principle. Since the official thresholds were first developed, medical care costs have escalated greatly, so it is inconsistent to add the value of health insurance benefits to resources without also increasing the thresholds. The effect of just adding insurance values without also raising the thresholds is to ignore the added costs of staying out of poverty. It is also to assume that health insurance benefits are fungible (i.e., that they can be spent for other goods, such as food and housing) when this is not the case, except insofar as such benefits may free up other resources. Also, medical care costs vary significantly across the population, so that for appropriate comparisons of poverty among groups (e.g., the elderly versus younger people), it is not sufficient to increase the thresholds by an average amount for medical care. 2 SIPP is a panel survey. Under the design used for the 1984–1993 panels, a new sample of 12,000–20,000 households was started each February and the members interviewed eight times at 4-month intervals, for a total of 32 months. Beginning in 1996, SIPP will be designed to have panels that last 48 months each and have larger samples of households (see Chapter 5 and Appendix B). 3 The Census Bureau has been constrained in that Congress requested publication of estimates on the basis of alternative resource definitions (specifically, definitions that added the value of in-kind benefits), but the U.S. Office of Management and Budget did not change the thresholds.
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Measuring Poverty: A New Approach We discuss these issues more fully in a later section of the chapter. Here we want to emphasize our principle of consistency between the definition of family resources and the threshold concept. RECOMMENDATION 4.1. In developing poverty statistics, any significant change in the definition of family resources should be accompanied by a consistent adjustment of the poverty thresholds. ALTERNATIVES FOR DEFINING RESOURCES We considered three main alternatives to the current definition of family resources as gross money income. One alternative—the one we recommend—is to define resources as disposable money and near-money income. A second alternative, which is strongly advocated by a number of researchers, is to look at actual consumption or expenditures rather than income. A third alternative is a hybrid definition that adds to disposable income some kind of valuation of a family's asset holdings that could be used to finance consumption over a short period. This alternative is sometimes called a ''crisis" definition of resources. Each alternative raises issues of determining the particular elements that comprise the definition—in a manner consistent with the threshold concept—and of determining appropriate and feasible methods and data sources for implementing each element. Resources as Disposable Income In comparing a definition of family resources as disposable money and near-money income with the current gross money income definition, it is clear that disposable income is preferable for measuring poverty in terms of satisfying the consistency principle. This conclusion holds whether the measurement uses the concept underlying the thresholds as originally defined or the concept that we propose. The problem with the gross money income definition of family resources in relation to the threshold concept is that it is both too inclusive and not inclusive enough. Gross money income excludes the value of such in-kind benefits as food stamps, school meals, and public housing, yet these benefits support the types of consumption that were implicitly included in the originally developed poverty budget of food times three (and are included in the proposed poverty budget of food, clothing, shelter, and a little more). At the same time, gross money income does not exclude income and payroll taxes, but families have no choice in paying these taxes, and the money so spent cannot be used for consumption. Gross money income also does not exclude some other kinds of expenses that are not really discretionary and hence are not available for consumption of food, housing, and similar items. These
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Measuring Poverty: A New Approach expenses include out-of-pocket costs for medical care (including insurance premiums), expenses necessary to earn income (e.g., child care, commuting costs), and child support payments to another household. By not taking account of taxes and other nondiscretionary expenses or the value of (nonmedical) in-kind benefits, the gross money income definition does not adequately characterize the extent of poverty overall or the extent of poverty among various population groups. Moreover, the gross money income definition cannot capture the effects on poverty of important government policy changes, some of which are designed explicitly to combat poverty. For example, the Earned Income Tax Credit (EITC), which operates as a type of negative income tax, was recently expanded with the explicit goal of eliminating (or greatly reducing) poverty for the working poor. Yet it cannot have any effect on the official poverty count because the current measure does not take account of either positive or negative taxes. For example, prior to expansion of the EITC, a working family that paid taxes might have sufficiently low gross income to be classified as poor by the current measure. But if in the next year the family received a tax refund due to the expanded EITC that moved it above the poverty line, the current measure would still classify the family as poor. Another working family that paid taxes might have sufficiently high gross income to be classified as not poor under the current measure although its disposable income (after-taxes) was below the poverty line. If in the next year the second family's taxes were offset by the EITC, both the current measure and a measure that uses a disposable income definition would classify the family as not poor. The current measure would show no change in the family's poverty status across the 2 years, but a measure using disposable income would show the family as poor in the first year and as having moved out of poverty in the second. A disposable money and near-money income definition estimates the amount of resources a family actually has available for consumption. It includes the value of in-kind benefits that support consumption and excludes taxes and other nondiscretionary expenses that are not available for consumption. Such a definition provides a much better basis for comparing the extent of poverty across population groups—for example, distinguishing between working and nonworking families. It also provides a much better basis for identifying trends in poverty over time and the effects of public policy initiatives and societal changes on poverty trends. Adjusting Income, Not Thresholds Some analysts have proposed to attain a consistent poverty measure, not by changing the resource definition from gross to disposable income, but by constructing a larger array of thresholds: for example, higher thresholds for families with children in which the parents work than for other families with
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Measuring Poverty: A New Approach children, or higher thresholds for elderly people with higher expected out-of-pocket medical care costs.4 We rejected this approach for a number of reasons. Clearly, the poverty thresholds need to vary by family composition in order to represent (at least approximately) equivalent levels of need for such basic consumption items as food, clothing, and shelter. We have also argued that the thresholds should reflect the substantial differences that are evident in the cost of housing across geographic areas. However, proliferating the number of thresholds to account for other circumstances raises concerns of feasibility (as well as some concerns about presentation). It would require a large number of added thresholds to properly account for the variations among families in their expected nondiscretionary expenses, such as out-of-pocket medical care costs, taxes, or work expenses. Not to account for such variations would be to assume that different kinds of families—e.g., families with different numbers of earners or families with or without members in poor health—face average costs when this is not the case. But the sample size of the Consumer Expenditure Survey (CEX), the basic source of data on spending, is too small to produce reliable estimates of all the needed thresholds. It might be possible to use other data sources to develop amounts for nondiscretionary expenses by which to adjust the basic thresholds derived from the CEX, but such an approach would be complicated and imprecise. A preferable approach, we believe, is for the survey that measures families' incomes to measure their actual nondiscretionary expenses at the same time. Depending on the scope of the income survey, some imputations from other data sources may be necessary to implement this approach (see below), but, overall, it seems more feasible to annually estimate disposable income than all the various thresholds. 5 Another though less important problem with proliferating the number of thresholds concerns presentation: it would be difficult to have a reference threshold to use in public discussion of the poverty level. Thus, instead of citing the poverty line for a family of four, as is common practice, one would have to cite the poverty line for a family of four with, say, one earner—not nearly as intuitive a concept. Still another less important problem is that, as Watts (1993) argues, the use of different thresholds for such characteristics as work status can distort com- 4 Renwick and Bergmann (1993), for example, would use an income definition net of taxes and including values for in-kind benefits, but would account for out-of-pocket medical care costs, child care, and other work expenses in the thresholds rather than by adjusting income. 5 Indeed, adjusting the thresholds rather than estimating disposable income does not wholly reduce the data demands on the income survey. For example, the income survey will need to ascertain such characteristics as health status of family members and whether the family pays child support in order to select the appropriate threshold for determining the family's poverty status.
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Measuring Poverty: A New Approach parisons of the depth of poverty across population groups in relation to their basic consumption needs. Thus, whether child care or other work expenses are included in the thresholds or subtracted from income will not affect the poverty rate or the dollar size of the poverty gap. However, the relative importance of that gap, that is, the welfare ratio (the ratio of income to the poverty threshold), will be affected. Specifically, if the poverty thresholds are adjusted to include work expenses rather than deducting them from income, poor working families will appear relatively less poor than poor nonworking families with the same composition and dollar gap between income and needs. As Watts notes, however, one could argue that a poor working family is less well-off than a poor nonworking family with the same composition and gap between income and needs because of the greater demands on the working family's time (see Appendix C). Recommendation For a consistent measure of poverty with the proposed threshold concept, gross money income should be adjusted to obtain a disposable money and near-money income definition of family resources. Although there are issues of precisely how to define and estimate particular components of disposable income (e.g., whether and at what level to cap the deduction for child care expenditures by working parents), they do not affect the logic of the basic approach. The two other alternatives we considered (see below) also can satisfy the consistency principle; however, there are operational reasons and, in the case of the crisis definition, conceptual reasons to prefer the disposable income definition. RECOMMENDATION 4.2. The definition of family resources for comparison with the appropriate poverty threshold should be disposable money and near-money income. Specifically, resources should be calculated as follows: estimate gross money income from all public and private sources for a family or unrelated individual (which is income as defined in the current measure); add the value of near-money nonmedical in-kind benefits, such as food stamps, subsidized housing, school lunches, and home energy assistance; deduct out-of-pocket medical care expenditures, including health insurance premiums; deduct income taxes and Social Security payroll taxes; for families in which there is no nonworking parent, deduct actual child care costs, per week worked, not to exceed the earnings of the parent with the lower earnings or a cap that is adjusted annually for inflation;
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Measuring Poverty: A New Approach for each working adult, deduct a flat amount per week worked (adjusted annually for inflation and not to exceed earnings) to account for work-related transportation and miscellaneous expenses; and deduct child support payments from the income of the payer. In the remainder of this section, we review the major alternative family resource definitions and our reasons for deciding against them. In the rest of the chapter we develop in more detail the proposed definition of disposable money and near-money income. Although the definition meets the test of operational feasibility, the decision to adjust income rather than the thresholds does increase the data requirements for the survey that is used to determine families' poverty status. The March CPS does not collect all of the needed information for estimating disposable money and near-money income and, for various reasons, it is not likely to become better suited for this purpose in the future. SIPP currently obtains most of the needed information and, because it is designed as an income survey rather than as a supplement to a labor force survey, can readily be modified to provide an adequate database. We conclude (see Chapter 5) that SIPP should become the basis for the official poverty statistics in place of the March CPS. Resources as Consumption or Expenditures Many researchers argue that it is preferable, for a combination of theoretical and empirical reasons, to look at what families actually consume or spend rather than at their income in order to determine their poverty status (see, e.g., Cutler and Katz, 1991, 1992; Jorgenson and Slesnick, 1987; Mayer and Jencks, 1993; Slesnick, 1991a, 1991b). A basic premise of this view is that families and individuals derive material well-being from the actual consumption of goods and services rather than from the receipt of income per se; hence, it is appropriate to estimate their consumption directly. To "estimate consumption" does not usually mean to inspect people's clothes or what they actually eat but, rather, to estimate what they spend on such items. Researchers in the field define consumption as a subset of families' total expenditures, excluding taxes, contributions to pension funds (which represent savings), and, often, gifts, and including expenditures made with assistance from in-kind benefit programs, such as food stamps. The data source for estimating consumption or expenditures is the CEX.6 6 The CEX has two components—the Diary Survey and the Interview Survey. Researchers typically develop consumption-based measures of poverty from the Interview Survey, which provides detailed information on expenditures each quarter for about 5,000 "consumer units" (see Appendix B).
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Measuring Poverty: A New Approach Rationale One argument that is often made for consumption (or expenditures) as the resource definition rather than income is that consumption is a better estimate of families' long-term or "permanent" income. Thus, Friedman's (1957) permanent income hypothesis suggests that current income is comprised of a permanent component and a transitory component. Families with low levels of current income are disproportionately comprised of families with temporary income reductions. If consumption is based on permanent income and not on transitory income, families with negative "income shocks" will have consumption levels that are high relative to their income levels because they expect their long-term income to be higher, on average, than their current income. Consequently, they ''dissave" in order to smooth consumption and thereby material well-being: for example, they may liquidate their savings accounts or borrow on their credit cards. Such families may be income-poor but able to maintain a constant standard of living through dissaving. The reverse will be true of high-income families, who will have consumption levels that are low relative to their income levels and positive savings. Modigliani and Brumberg's (1954) closely related life-cycle model of behavior assumes that current consumption is equal to average lifetime resources. Thus, younger families, by borrowing, and older families, by spending down assets, tend to exhibit high consumption-to-income ratios, while middle-aged families with the highest earnings potential tend to exhibit relatively low consumption-to-income ratios. Again, it is supposed that families smooth consumption and well-being on the basis of wealth and on expected earnings by saving and dissaving at various points during their life cycles. We note that it is not necessary to accept all of these arguments in order to support a consumption definition of resources. Thus, one need not accept the life-cycle model or the view that what is wanted is a measure of long-term or permanent income. One could simply believe it is preferable to estimate a family's actual consumption rather than the consumption that it could potentially achieve from its available income. Another point that is often made in support of using consumption or expenditures rather than income as the resource definition is that income is poorly measured. Those making this argument can cite the known under-reporting of asset income (and other sources) in the March CPS, the likelihood that income earned "off the books" or illegally is not reported at all, and the fact that self-employed people who report business losses are often able to take sufficient cash out of their business to sustain their own standard of living. Implications Consumption and income definitions of resources have somewhat different implications for who is counted as poor. A consumption resource definition
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Measuring Poverty: A New Approach will include in the poverty count people who are income-rich but consumption-poor, that is, people who choose to spend at levels below the poverty threshold when they actually have incomes above that level. Some of these people may contract their spending because they foresee a drop in their income in the future, while others may simply opt for a low standard of living. In contrast, an income resource definition will exclude people from the poverty count who have an adequate income during the measurement period, whether they spend it or not. At the same time, a consumption resource definition will exclude from the poverty count people who are income-poor (e.g., because they lost a job) but who sustain their consumption at a level above the poverty threshold by such means as borrowing from relatives or charging to the limit on their credit cards. In contrast, an income definition will count such people as poor.7 This statement applies both to the current gross money income definition and to the proposed disposable money and near-money income definition.8 What one thinks of the contrasting ways in which consumption and income resource definitions treat people who are income-rich but consumption-poor and people who are in the reverse situation depends on one's view of the meaning and purpose of a poverty measure. One view is that the poverty measure should reflect the actual level of material well-being or consumption in the society (in terms of the number of people above the threshold), regardless of how that well-being is attained. Another view is that the poverty measure should reflect people's ability to obtain a level of material well-being above the threshold through the use of their own income and related resources. Some with this view would go farther to say that the members of a society have a right to be able to consume above the poverty level without having to resort to such means as begging, unsecured borrowing, stealing, or losing their homes. (For a discussion of the two perspectives, one emphasizing people's actual consumption levels and the other their ability to consume at a level above poverty from their own income, see Atkinson, 1989.) In a somewhat different vein, a focus on current income (e.g., income available to families over a period such as a year) accords with the view that there is policy interest in measures of relatively short-term economic distress 7 As currently implemented, an income definition will also count as poor self-employed people who have business losses in accounting terms but nonetheless have adequate cash flows from their businesses for their own needs. However, it is not necessary to estimate self-employment income in business accounting terms, and, in fact, SIPP obtains reports of cash drawn out of businesses. 8 A crisis definition that adds asset values to income will similarly count some of the income-poor as not poor. It may even more closely resemble a consumption definition in this respect if it also includes credit card and overdraft limits.
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Measuring Poverty: A New Approach among the population. This viewpoint would reject the notion that it is preferable to estimate permanent or life-cycle income. Furthermore, its proponents would argue that including amounts in income that are obtained by such means as charging to the limit on one's credit cards distorts the purpose of the poverty measure as a timely policy indicator of the possible need for public or private action to alleviate economic distress (see, e.g., Ruggles, 1990). Thus, a consumption resource definition is likely to lag behind other indicators of economic distress because of all the steps that families can take to sustain their consumption. In contrast, an income resource definition will include income-poor families who may be reaching the end of their ability to sustain their consumption through such means as unsecured borrowing. Hence, it may prove more useful as a warning signal to policy makers. Assessment On the fundamental question of whether to base the definition of family resources for the poverty measure on income or consumption, we believe that there are merits to the conceptual arguments on both sides of the debate. On balance, many members of the panel find more compelling the arguments in favor of a consumption definition that attempts to assess actual levels of material well-being. However, in the United States today, adequate data with which to implement a consumption-based resource definition for use in the official poverty measure are not available. Although the federal government sponsors several comprehensive large-scale income surveys, the only regular consumption survey is the Consumer Expenditure Survey. Although the CEX had its beginnings nearly a century ago, it was conducted only every 10-15 years until 1980, when an annual survey began. The sample size of the CEX is significantly smaller than the sample size of the major income surveys, and the delay between collection and release is longer for consumption data than for income data. The CEX is currently intended to support the periodic respecification of the market basket for the Consumer Price Index (CPI) and, more generally, to provide information on expenditure patterns. Its design—which features two separate surveys, one focused on larger and more regular expenditures and the other on smaller items—does not readily permit the development of a comprehensive resource estimate for individual families, which is essential for poverty measurement.9 The CEX questionnaire is very detailed and complex, and response rates for the survey, which have averaged about 85 percent since 1980, are significantly lower than response rates for the major income surveys. Studies of data quality in the CEX have documented serious recall and other 9 The CEX also does not readily support development of annual resource estimates (see Appendix B).
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Measuring Poverty: A New Approach out-of-pocket expenses that would be deducted from income, similar to the proposal to cap the deduction of child care expenses from the earnings of working parents (see below). However, the two situations are not the same. The assumption is that additional child care expenses, above a reasonable allowance to make it possible to work, bring added benefits that the family chooses to pay for, so that, for purposes of poverty measurement, it makes sense to cap the deduction. But it does not make sense to cap the deduction for out-of-pocket medical care expenses when they are incurred to treat an illness or disability. 29 A sick person with high medical care expenditures is not made better off than a healthy person with no or relatively low expenditures; at best, the added expenditures serve only to restore the sick person to a healthy state. Given that one cannot distinguish between discretionary expenditures (which, ideally, should be disregarded, i.e., not deducted at all) and expenditures that are needed to restore health, we decided not to propose a cap on the deduction for out-of-pocket medical care expenses for the poverty measure. However, this situation could change in the future. For example, if insurance plans that significantly limit families' out-of-pocket liabilities for medical treatment are widely available, then it may well be appropriate to cap the deduction. One could then assume that medical care spending above the limit was discretionary. Finally, an objection to our proposed approach, voiced by Moon (1993), is that it does not explicitly acknowledge a basic necessity, namely, medical care, that is just as important as food or housing. Similarly, the approach devalues the benefits of having health insurance, except indirectly, in that people who have medical costs that are covered by insurance will be measured as better off than people who have to pay such costs out of pocket. Moon suggests that one variant of the proposed approach that would acknowledge medical care needs is to have the poverty budget include an allowance for average out-of-pocket expenses. Under this approach, people with above-average expenses would have the difference subtracted from income, and people with below-average expenses would have the difference added to income. (Note, however, such a measure would still not acknowledge insurance benefits.) To be completely satisfactory, Moon argues that the poverty thresholds should vary in the allowance they make for out-of-pocket expenses by different family characteristics. Yet to move in the direction of a poverty measure that accounts for medical care needs and resources leads right back to the complex set of difficulties discussed above for which there appear to be no solutions. Single-index approaches, whether dealing only with out-of-pocket expenses or with 29 Some of these expenses may also be unnecessary, but the consumer (the patient) usually has little control over treatment decisions by providers.
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Measuring Poverty: A New Approach insurance values as well, entail all of the problems with multiple thresholds. Two-index approaches have a similar problem of defining the insurance standard appropriately for different types of families; furthermore, such approaches do not avoid the problem that the medical component is measuring risk, not the ability to satisfy actual needs during a particular year. Moon (1993:18) suggests that a way out of this morass could be to have a clean nonmedical poverty measure and a separate health care risk measure. The two could always be cross-tabulated, but the poverty measure per se would be reserved for the nonmedical component. This suggestion is in fact our proposal. Not only do we recommend a consistent measure of economic poverty, in which disposable income net of out-of-pocket medical care costs is compared with a poverty budget for food, clothing, and shelter, and similar items, but we also support the development of one or more indexes of medical care risk. The necessity to monitor people's risks of incurring medical care costs that exceed their ability to pay is clear. Current indicators that simply record the presence of any type of health insurance coverage are too simplistic (see, e.g., Bureau of the Census, 1993b: Table 24). What is needed are measures of the adequacy of coverage and the ability to pay for required out-of-pocket costs. It will be difficult to develop good measures, but the effort appears well worth the costs. We repeat, however, that measures of medical care risk should be developed separately from the economic poverty measure. To do otherwise is to overwhelm the poverty measure with operational and conceptual difficulties. Taxes Both the concept that underlies the official poverty thresholds and the concept that we propose represent budgets for consumption aftertaxes; however, the current definition of family resources is beforetaxes. For consistent measurement, there is little disagreement that income and payroll taxes need to be taken into account: such tax payments represent a mandatory cost of obtaining income and hence are not available for consumption. It seems particularly important to take account of taxes because of frequent changes in tax laws that may leave gross incomes unchanged but affect net incomes to a significant degree. The Census Bureau has considerable experience with estimating Social Security payroll tax and federal and state income tax liabilities (see below). Improvements in the methodology are certainly possible and should be pursued; also, for completeness, estimates should be developed for local income taxes, where applicable. However, there is no need to wait for further research to implement the tax adjustments that the Census Bureau has already developed. We do not propose that adjustments be made to income for other kinds of
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Measuring Poverty: A New Approach taxes, such as sales, excise, or property taxes. These taxes are an integral part of consumption, and the CEX expenditure data that we recommend be used to develop the reference family poverty threshold include them (e.g., clothing expenditures in the CEX include the applicable sales taxes). It is true that such taxes vary from locality to locality, so that the average amounts included in the thresholds may not be completely appropriate for specific areas (even with the housing cost adjustments by region and size of place). Yet it is clearly not feasible to develop the large number of thresholds that would be needed to take account of different levels of property and other consumption taxes across areas. It might be possible for people with above-average values of consumption taxes to subtract the difference from income (and vice versa for people with below-average values). However, the costs of obtaining the necessary data would be high and the measurement problems would be great. Census Bureau Tax Estimation Procedures For more than a decade, the Census Bureau has published experimental poverty estimates that deduct payroll and federal and state income taxes from annual income as measured in the March CPS (see, e.g., Bureau of the Census, 1993a). The current procedure for imputing Social Security payroll taxes is straightforward. CPS-reported wage and salary earnings are multiplied by the Social Security payroll tax for the employee portion up to the specified limit; CPS-reported net self-employment earnings are multiplied by the (higher) payroll tax rate for the self-employed up to the specified limit; and certain employees (based on unpublished statistics from the Social Security Administration) are assigned noncovered status (e.g., federal government employees and proportions of workers in certain occupation groups). For imputing federal income taxes, including the refundable Earned Income Tax Credit, the current Census Bureau procedure involves a complex series of operations. The Bureau first assigns members of CPS households to tax filing units, using a set of rules to try to approximate Internal Revenue Service (IRS) filing provisions. Next, the Bureau calculates adjusted gross income by summing reported amounts for wages and salaries, net farm and nonfarm self-employment income, net rental and property income, dividends, interest, income from estates and trusts, private and government pensions, unemployment compensation, and alimony; plus a portion of Social Security income and imputed amounts for net realized capital gains; minus imputed contributions to Individual Retirement Accounts (IRAs). Statistics of Income (SOI) data from the IRS are used for the capital gains and IRA imputations; the May 1983 CPS pension supplement is also used to estimate probabilities for IRA contributions. No attempt is made to adjust for other exclusions from income, such as moving expenses or alimony paid. Second, the Census Bureau determines which tax filing units itemize
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Measuring Poverty: A New Approach deductions and the amount of their deductions. A statistical match of data from the March CPS and the AHS is used to determine mortgage and property tax amounts for homeowners in the CPS; probabilities of itemizing are applied to assign itemizing status;30 and amounts of itemized deductions are computed using a matrix derived from SOI data. Third, the Census Bureau computes the standard deduction according to the number of exemptions and calculates tax liabilities using the appropriate tax schedule for the simulated return type. Finally, the Bureau estimates the dependent care tax credit (using data from the June 1982 CPS supplement to estimate probabilities of tax filers paying for child care) and computes the EITC (which can be larger than the tax liability). For estimating state income taxes for those states with such taxes (44 in 1992), the current Census Bureau procedures involve variants of the federal income tax simulation model. The definitions of tax filing units and adjusted gross income used in the federal model are used in the state models. Not all details of each state's income tax system are simulated, but the important aspects are accounted for. Census Bureau staff have found that their estimates of state income tax liability are biased upwards, probably because they use the federal definition of adjusted gross income and do not incorporate the various adjustments made by a number of states. Assessment The simulation of Social Security payroll taxes, as noted above, is quite straightforward. In contrast, there are a number of problems with the simulation of federal and state income taxes (see Nelson and Green, 1986), some of which are particularly important for poverty measurement. A key problem concerns the determination of dependent members of tax filing units. This classification is essential for computing initial tax liability and for computing the dependent care tax credit and the EITC, both of which are important for the working poor. The March CPS lacks information on whether children in one household are dependents of a taxpayer in another household and, conversely, whether a taxpayer is claiming members of another household as dependents. The March CPS also lacks other information (e.g., child care and homeowner costs) that could improve the accuracy of the tax simulations. By comparison, SIPP has the advantage of including extensive information relative to federal income taxes. (SIPP also asks about state and local income taxes.) Generally, SIPP panels each year include a tax module that 30 The probabilities of itemizing are derived for homeowners by monthly mortgage categories from the 1979 Income Survey Development Program Research Panel and for renters by adjusted gross income categories.
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Measuring Poverty: A New Approach asks about tax payments for the previous year. (SIPP panels also generally obtain information about dependent care and housing costs.) Questions on tax filing status, number of exemptions, type of form filed (joint, single, etc.), and schedules filed (A, C, etc.) are answered by more than 90 percent of respondents, but questions on adjusted gross income, itemized deductions, tax credits, and net tax liabilities have high nonresponse rates. The primary reason for the nonresponse is that respondents are asked to produce their tax form and use it as the basis for answers to these questions, but only about one-third do so; see Bureau of the Census, no date(a). The Census Bureau has begun work to develop a tax estimation model for SIPP similar to the one used for the March CPS. The SIPP tax information, even with quality problems, should make possible improved estimates of income tax liabilities for families in the survey. Work-Related Expenses The current poverty measure takes no explicit account of expenses, such as child care and commuting costs, that are necessary to earn income. As originally developed, the official poverty thresholds implicitly included some allowance for such costs (through the multiplier), but the thresholds have never been adjusted to reflect increases in these costs due to changes in societal work patterns. In particular, many working families face sizable child care expenses that would not have been necessary 30 years ago. Perhaps more important, the fact that the allowance in the official thresholds for work-related expenses is averaged over all families means that the thresholds do not adequately distinguish between the needs of working and nonworking families. To properly assess poverty for both working families and nonworking families, we believe it is incumbent either to develop thresholds that appropriately account for needed work-related expenses or to deduct such expenses from income.31 Our proposal is to deduct child care and other work-related expenses from income (rather than creating additional thresholds, for the reasons that we presented above). Child Care In 1960, an estimated 72 percent of families with children had a parent who could care for the children at home, while the remaining 28 percent had both parents in the work force or were headed by single parents. The situation was just the reverse in 1990, when an estimated 69 percent of families with children had both parents in the work force or were headed by single parents 31 Not discussed here are various arguments for distinguishing between working and nonworking families in terms of the value of time, see Appendix C.
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Measuring Poverty: A New Approach and only 31 percent had a parent at home (estimated from Bureau of the Census, 1992d: Tables 56, 67, 618, 620). While only a fraction of families with both parents (or the only parent in the work force) pay out of pocket for child care, the estimated share of their income that is spent on child care can be significant. Thus, in 1987, one-third of all employed mothers and almost three-fifths of employed mothers with a child under age 5 paid for child care. The average amount they spent accounted for 7 percent of their total family income. Of employed mothers with family income below or near the official poverty line, one-quarter paid for child care, and the average amount they spent accounted for 22 percent of their total family income (O'Connell and Bachu, 1990: Table 7). In order to more appropriately characterize the poverty status of working versus nonworking families, we propose to deduct weekly out-of-pocket child care costs from the income of families with both parents or the only resident parent in the work force, for each week worked in the year. We further propose to limit the deduction to the earnings of the parent with the lower earnings or to the value of a cap that is adjusted annually for inflation, whichever is lower (see below). To make this adjustment to income in the March CPS requires imputing child care expenses because the survey does not ask about expenditures, whether for child care or other items. However, information is available on the numbers and ages of children and on the work status of parents with which to make a reasonable imputation. In contrast, SIPP has regularly asked about child care costs, either as part of a detailed child care module or as a single question in one of the other modules. Indeed, we used SIPP data to impute child care costs to the March CPS to analyze the effects on poverty rates of implementing the proposed measure (see Chapter 5). On the question of how high to set the cap for child care expenses, one possibility is to set it at a percentage of median expenditures, following the procedure that we recommend to derive the food, clothing, and shelter component of the poverty thresholds. Data from the 1990 SIPP indicate that median weekly child care expenditures for working families with such expenses were $44 for families with one child and $51 for families with two or more children.32 However, amounts that are below these medians may be too low to serve as a cap, particularly for larger families, for several reasons. For example, they do not make allowances for such factors as the age of the children, and child care expenditures for children under 5 are considerably higher than for school-age children (see O'Connell and Bachu, 1990: Table 7). Indeed, the relatively low median expense by families with two or more children relative to families with one child is undoubtedly because more families in the former group have older children. 32 Based on tabulations prepared for the panel; dollar amounts are for 1992.
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Measuring Poverty: A New Approach An alternative would be to use the caps specified for the federal income tax dependent care tax credit.33 Currently, the IRS limits eligible dependent care expenses to $2,400 a year for one dependent, or $46 per week, and $4,800 a year for two or more dependents, or $92 per week. By comparison, the AFDC program currently allows a maximum deduction of $175 per month ($40 per week) for work-related child care expenses for each child aged 2 years or older and a maximum deduction of $200 per month ($46 per week) for each younger child, giving a maximum deduction for families with two children of $86 per week. The Food Stamp Program has the same limits, and also allows deductions for day care expenses incurred for adult dependents and expenses incurred so that the caretaker can attend school. Whatever cap is set, the guiding principle that we recommend is that it should represent a reasonable level of expenses necessary to hold a job, excluding additional expenses that parents may elect in order to provide enrichment for their children. In other words, we propose treating child care costs solely from the viewpoint of calculating a measure of disposable income that recognizes that some portion of the earnings of working families is not available for consumption. We are very much aware that there are many other aspects of child care beyond out-of-pocket costs that are important to examine in order to measure well-being of children (and their parents) in a broader sense. The quality of the care is one key aspect. Families with high child care costs may be less well off in terms of resources available for consumption, but they may have a higher level of overall well-being if their expenditures are for a high-quality program that enhances the development of their children and correspondingly increases the mental comfort of the parents. Indeed, families with high child care costs may be better off on some dimensions than families with no such costs, if the latter situation results from leaving the children at home unattended (rather than because child care is donated by a grandmother or other loving relative or because the family receives a subsidy). As with the treatment of medical care expenditures, we believe that it is important to develop measures of the adequacy of child care, but we underline the necessity of keeping such measures separate from the economic poverty measure. Other Work-Related Expenses Most workers incur commuting and other costs (e.g., union dues, licenses, permits, tools, uniforms) to hold a job and, consequently, have less than the full amount of their earnings available for consumption. Hence, we propose to subtract a flat weekly amount for other work-related expenses (updated annually for inflation) from the earnings of each adult for each week worked 33 Watts (1993) recommends this approach, and we adopted it for our analysis in Chapter 5.
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Measuring Poverty: A New Approach in the year. The amount deducted should not exceed the person's earnings. For working families with children, the earnings of the parent with the smaller amount of earnings should limit the combined deduction for child care expenses and that parent's own other work-related expenses. The reason to deduct a flat amount, rather than actual expenses, is because of the tradeoff that people often make between housing and commuting costs—by choosing a more expensive home closer to work or a less expensive one farther away. The adjustment to the poverty thresholds for geographic area differences in housing costs will be the same for all families in an area (see Chapter 3). For example, within a large metropolitan area that, on average, has higher housing costs relative to smaller areas in a region, the families of people who commute from outlying suburbs with cheaper housing costs will have the same housing cost adjustment as the families of people who commute short distances from more expensive, closer-in neighborhoods. For consistency, then, each worker needs to have the same work expense deduction. Tabulations that we obtained from Wave 3 of the 1987 SIPP panel provide a basis for designating a flat weekly amount of work-related expenses. 34 They indicate that 84 percent of workers drove to work; 10 percent had parking or public transportation expenses; and 30 percent had other work expenses (e.g., for uniforms). Summing the three categories (driving, other transportation costs, and all other work expenses), 91 percent of all workers had some type of work expense. For workers with low to moderate family incomes (specifically, with per capita family income below the third decile), 74 percent drove to work; 10 percent had parking or public transportation expenses; and 25 percent had other work expenses. In all, 85 percent of these workers incurred some type of work-related expense. In 1992 dollars, the mean weekly amount for combined work-related expenses for all workers (including those with no expenses) was $29 ($1,450 for a 50-week work year); the median weekly amount was $17 ($850 for a 50-week work year).35 We believe it would be reasonable to develop an amount for the work expenses deduction as a percentage of the median. For our empirical analysis in Chapter 5, we deducted about $14.40 per week ($720 for a 50-week work year), which represents 85 percent of the median. Child Support Payments Since the current poverty measure was developed, the number of parents who live apart from their children has grown, and a large fraction of them incur 34 The 1984-1987 SIPP panels included a work expense module. It would be useful to repeat such a module periodically, to determine if there is a need to realign the amount of the work expense deduction in real terms. 35 Combined work-related expenses were calculated for the first job reported by each worker in Wave 3 of the 1987 SIPP panel by summing the reported weekly amount for parking and public transportation, the reported annual amount divided by 12 for all other expenses (e.g., uniforms), and the reported weekly miles driven to work times the 1987 IRS mileage allowance of 22.5 cents per mile. Mean and median values for all workers were then updated for price changes to 1992.
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Measuring Poverty: A New Approach child support obligations. A recent estimate (Sorenson, 1993), using data from the 1990 SIPP panel, was that 14-18 percent of men aged 18-54 were noncustodial fathers. The range (rather than one number) comes from two factors—nonresponse to the question on parenthood and an apparent undercount of black noncustodial fathers relative to black custodial mothers. About 44 percent of noncustodial fathers paid child support, and, on average, the payments accounted for about 9 percent of their families' incomes (calculated from Sorenson, 1993: Table 3).36 The current poverty measure counts child support payments as income to the recipient families, but it does not subtract such payments from the income of the payers. Yet child support payments, which are not discretionary in the sense that gifts of money to another household would be, cannot be used to support consumption by members of a payer's current family. For consistency, we propose to subtract child support payments from the income of the paying family (and to continue to count them as income to the recipient family). The March CPS does not ask about child support payments to another household, and no information is available with which to make a reasonable imputation. The addition of one two-part question—whether the respondent pays child support and, if yes, how much—would remedy this deficiency. SIPP, in contrast, has regularly asked about child support payments, and we used SIPP data to estimate the effect on the poverty rate of subtracting child support payments from the payer's income (see Chapter 5). Home Ownership Services Economists have long argued that estimates of families' economic resources, to be comparable for renters and homeowners, need to take account of the flow of services that owners obtain from their homes. Thus, analysts who estimate resources by using a consumption definition almost always add the rental equivalence value (or ''imputed rent") for homeowners to their other expenditures. The value added is net of owners' actual outlays for mortgage principal and interest, property taxes, and maintenance costs (i.e., nothing is added if owners already have mortgage, tax, and maintenance expenses that equal or exceed the estimated rental equivalence value). The intent is to measure housing consumption in a comparable manner for renters and owners by estimating what an owner would have had to pay in rent (not including 36 Presumably, some noncustodial mothers also pay child support, but Sorenson's analysis was restricted to men.
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Measuring Poverty: A New Approach utilities). If the rental equivalence value is not added to homeowners' consumption, then people who own their homes outright or who have housing costs below the rental value of their homes would appear to consume less than renters or homeowners with higher costs.37 The same logic applies to resource estimates that are based on an income definition, namely, that people with low or no mortgage payments or other homeownership costs should have a rental equivalence value added to their income to recognize the fact that they do not face the same housing costs as renters or other homeowners. The concept of imputed rent is hardly intuitive or palatable to many people, yet, theoretically, the case is unarguable: owners with low housing costs have more of their income available for consumption of other items (e.g., food) and, hence, not to include imputed rent is to underestimate their income relative to their poverty threshold. The imputed rent value would be net of mortgage and other costs that do not exceed the amount of imputed rent: that is, we do not suggest that homeowners who assume mortgage payments that exceed the rental value of their home obtain a deduction from income. An alternative would be to develop separate thresholds for owners with low or no housing costs and other owners and renters. Data from the 1991 American Housing Survey indicate that 39 percent of low-income households own their homes, compared with 68 percent of other households.38 Among low-income households headed by someone aged 65 or older, 61 percent own their homes, compared with 81 percent of other households headed by someone aged 65 or older (Grall, 1994: Tables 4,5). The question is what proportion of low-income homeowners would likely have significant amounts of imputed net rent added to their income. A high proportion of low-income homeowners—66 percent—do not have a mortgage. However, a large proportion of low-income homeowners who do not have mortgages (62%) nonetheless have housing costs (for property taxes, insurance, and utilities) that are 30 percent or more of their income (34% have housing costs that are 50% or more of their income). An even higher proportion of low-income homeowners who have a mortgage (89%) have housing costs that are 30 percent or more of their income (65% have housing costs that are 50% or more of their income) (Grall, 1994: Tables 5,11,12). Overall, perhaps one-fourth of low-income homeowners could have significant 37 Similarly, consumption-based resource estimates typically include the estimated service flows from automobiles and consumer durables (and, correspondingly, exclude actual expenditures on these items). 38 The AHS "low-income" measure is not the same as the current poverty measure: it uses the official poverty thresholds, but it defines the unit of analysis as the whole household, not the family, and it measures income for the 12 months preceding the interview, which is not necessarily a calendar year. There are other differences as well (see Bureau of the Census, 1991).
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Measuring Poverty: A New Approach amounts of imputed net rent added to their income that could possibly raise them above the poverty line (those owning their homes free and clear with other housing costs less than 30% of income). These homeowners represent one-tenth of all low-income households. Although, for consistency, imputed net rent should be added to homeowners' income for purposes of poverty measurement, the idea is not easy to implement, at least not in the near term. Rental equivalences can be determined by asking owners what they think their houses would bring in rent. The CEX includes such questions, which could be added to SIPP or the March CPS, but the responses are likely to be subject to reporting errors. Another method is to collect data on housing characteristics (a topic not currently covered in SIPP or the March CPS) and, by means of hedonic regression equations, estimate rental equivalences for houses of particular types (e.g., with one, two, or three bathrooms, with or without air conditioning, etc.). This method requires asking a large number of questions of renters, including net rent and characteristics of their housing for input to the regressions, and also of owners, including characteristics of their housing for imputing rental equivalence from the estimated regression coefficients. With either method, homeowners must be asked about their mortgage payments and property taxes in order to make a net calculation; SIPP obtains this information but the March CPS does not. Finally, some analysts argue (see, e.g., Ruggles, 1990) that it may not always be appropriate to base imputed rent on the characteristics of one's current home. Thus, many elderly people who have paid off their mortgages or have low payments continue to live in homes that are larger than their current needs. It would seem inappropriate to impute a full rental value for a larger-than-needed home, although it is not clear what type of downward adjustment to the value would be appropriate. One approach would be to cap the amount of imputed rent at the level of the housing component of the poverty thresholds to recognize that the imputed rent offsets housing costs but does not represent additional money that is actually available for other consumption. Given the practical difficulties, we do not propose that the income calculated for a family for purposes of poverty measurement now include imputed rent. However, we urge that high priority be given to research to develop data and methods that could make possible a reasonably accurate calculation of imputed net rent. The next regular review of the poverty measure should give serious consideration to revising the income definition to include imputed net rental values in homeowners' income.
Representative terms from entire chapter: