Why Poverty Doesn't Rate

Why does the official poverty rate fail to quantify the steady improvement in the living standards of America's poor? The answer lies in a simple mistake built into the poverty measure -- one that reflects a misunderstanding of how Americans live, spend and consume. Contradicting both economic theory and readily observable facts, the poverty rate assumes that a household's annual spending cannot, by definition, exceed its annual income.

Of course, this is not true, and economists have won Nobel prizes explaining why spending can far exceed income, particularly in advanced societies. For instance, when families are experiencing an unusually bad year, they may spend more than they earn if they see better prospects in the future. Similarly, a young worker may go into debt if she anticipates increases in her pay or benefits. Living standards, in other words, are linked to purchasing power -- and a family's purchasing power is not limited to its annual earnings.

Among low-income households in the United States, the gap between reported income and reported spending has widened gradually since the 1960s and now has taken on chasm-like dimensions. In the early 1960s, the poorest quarter of U.S. households spent 12 percent more than their annual incomes. In 1973, spending by America's poorest fifth surpassed their income by almost 40 percent. And in 2004, spending by the poorest fifth of American families exceeded income by a whopping 95 percent; in effect, spending was nearly twice as much as income.

These patterns might be due to easy access to credit, with many consumers maxing out their credit cards or engaging in other unsustainable borrowing. (Curiously, however, recent credit surveys suggest that the net worth of poorer Americans has been rising, not falling.)

Another important factor could be the increasing instability of American incomes. Scholars such as Jacob Hacker at Yale University and Robert Moffitt at Johns Hopkins University have noted that the income of American families is likely to bounce around much more today than it did three decades ago -- whether due to greater global competition, increasing rewards for education or other factors. Intensified swings, in turn, mean that more households may, in any given year, earn low incomes and be temporarily classified as living in poverty. But they continue to spend as they did before, anticipating that their incomes will bounce back. Such oscillations also mean that the incomes reported by families in annual surveys -- the backbone for the official poverty estimate -- are a steadily less accurate indicator of true living standards.

These criticisms of the official U.S. poverty rate should not be confused with indifference to the plight of America's disadvantaged and poor. Indeed, the opposite is true. In the richest society humanity has ever known, material deprivation still afflicts too many Americans. We cannot expect to make progress, however, without adequate and accurate information. Advocates of social and economic justice in the United States should be in the front ranks of those demanding more accurate assessments of U.S. poverty. Without a clearer sense of where we stand, how we got here and where we are headed, most initiatives aimed at reducing poverty in the United States will be needlessly ineffective.

eberstadt@aei.org

Nicholas Eberstadt is the Henry Wendt Scholar in political economy at the American Enterprise Institute.