Income threshold approach

Author/s: 
Joanna Mack

Many poverty measurements use household income, adjusted for household size, to find out who is in poverty. A level is set and those who fall below this are seen as being ‘in poverty’ and those above it are not.

The UK government, the European Union and many other countries use 60 per cent of median household income as the poverty ‘threshold’. Median income is the middle point in the income range, with equal numbers of households on incomes above and below that point. The 60 per cent level is chosen as an indicator of the income at which those below are likely to be suffering hardship. As such, it is a proxy measure of poverty and, without validation from direct measures of people’s living standards, is essentially arbitrary. The threshold’s importance is that it does show how the poorest members of society are doing in relation to others, it can be tracked over time, and allows comparisons between different countries.

In the past, 50 per cent of mean household income has been used as a poverty threshold. Mean (or average) income is the sum of all incomes divided by the number of incomes. Median income is now generally chosen in preference to mean income, as giving money to those on the lowest incomes will not in itself raise the median threshold but will raise the mean threshold. This means that while it is possible, in principle, to raise everyone above either 60 per cent of median or mean income, it requires less overall redistribution of income to meet the 60 per cent of median income target.

In the interactive graph below you can explore what it takes to raise all households above the 60 per cent of median income and above the 60 per cent of mean income.

The graph’s starting point shows the distribution of household income in the UK in 2009 and it marks both a poverty threshold based on 60 per cent of median income and one based on 60 per cent of mean income. The household income of each decile from the bottom tenth of households to the top tenth of households is marked by ‘people’ on the graph, one for each decile. You can move the ‘people’ along the income range to explore which people have an impact on where the threshold falls for both median and mean incomes. You can also explore how much additional income would be needed by those below the thresholds to raise themselves above those levels. You can return to the start point by pressing the ‘See actual’ button.

You will see that raising the incomes of the deciles below the 60 per cent median income threshold does not alter the position of that threshold until these people have more income than those in the middle. However, raising the incomes of those at the bottom will raise the position of the 60 per cent mean threshold, moving it further upwards along the range as you move the people along. You will also see that increasing the incomes of those in the higher income groups has no effect on the median threshold but it will raise the mean threshold. Using a percentage of the median as the poverty threshold means that the rich can get richer without having any impact on poverty measurement.

The only way to raise, or lower, the median threshold is to change the incomes of the people in the middle. As there is an even number of people on this graph you can see this by moving the fifth and sixth person along the range. As you move these people up or down, the median income threshold changes and those on lower incomes will move in and out of ‘poverty’ without any changes to their own income. So, in a recession, the numbers ‘in poverty’ (based on the numbers below a 60 per cent median threshold) may drop, not because the income of those at the bottom has risen but because the income of the median point has dropped.

Lifting the poor out of poverty

Whichever threshold is used, you will see that you can raise all the people at the bottom of the range above either threshold.

The Coalition government has been looking to downgrade this official 60 per cent of median income measure of poverty, arguing that it is impossible to meet these median-based targets (see Redefining poverty). For example, Frank Field, appointed by the Coalition government to head an independent review into poverty (see Field Review) has argued:

Any candidate sitting GCSE maths should be able to explain that raising everybody above a set percentage of the median income is rather like asking a cat to chase its own tail. As families are raised above the target level of income, the median point itself rises. Not surprisingly, therefore, no country in the free world has managed to achieve this objective.

This is simply wrong. Taking a percentage of median income as the threshold means that giving money to those on the lowest incomes (those below the median income point) will not in itself raise the threshold; this makes it possible, in principle, to lift households above the 60 per cent threshold without affecting the median point.

In the graphics below we have shown two of the many ways you could reach the target of lifting all the poor above 60 per cent of median income without raising the target income per week.

In the first ‘solution’, the incomes of those below the 60 per cent median threshold are raised but the incomes of all other deciles remain the same. The effect of this is to increase the total amount of income across all deciles: you will see that the 60 per cent of mean threshold increases from £239 per week to £248 per week.

To ensure that total household incomes do not increase when you lift those below the threshold out of poverty, you need at the same time to lower the incomes of the deciles at the top. The second solution in the graph below shows the effect of this: you will see that the 60 per cent of mean has remained at £239. The effect of this is to redistribute income from the richest groups in society to the poorest. The spread of incomes across the whole income range is now smaller; in other words there is greater equality.

In both these ‘solutions’ the spread of income across the bottom three deciles has been compacted. You could find other solutions that allowed for more differentiation at the bottom by redistributing more income from the top.

Equivalence scales

When using income to measure poverty, other decisions have to be made on whose income is being compared, what you count as income and how you compare between different people in different circumstances.

Poverty measures use net income – that is, total income minus direct taxes (income tax, national insurance and council tax) and plus the value of any social security benefits received. This is the income that people have available to buy goods and services. Most poverty measures then take household income rather than individual income and adjust the total net disposable income to reflect household composition and size – to make each income ‘equivalent’. This is called net household equivalised income.

Official government statistics use what’s known as the ‘modified OECD’ (Organisation for Economic Co-operation and Development) equivalence scale, in which an adult couple with no dependent children is taken as the benchmark with the equivalence scale of one. The equivalence of different types of household can be calculated by adding together the weight of the various household members as shown below.

Modified OECD Equivalence Scale

Head

0.67

Subsequent adult

0.33

Each child aged 0-13

0.20

Each child aged 14-18

0.33

To find out where any individual lies on the income distribution scale, you need to make a number of calculations based on the type of household they live in and the household income. If you are interested in where you lie, the Institute for Fiscal Studies provides a quick and easy calculator to do this.

Clearly, which equivalence scale is used and, in particular, what percentage is given to children in the scale can make a difference to how different types of household appear to fare. Many have argued that the current scales give insufficient weight to the costs of bringing up children and thereby produce lower estimates of poverty than a scale that more accurately reflects the costs of bringing up children.

More on this debate on equivalence scales can be found on pages 49 to 51 of ‘The concept and measurement of poverty’ in Poverty and Social Exclusion in Britain (Gordon, 2006) and in Chapter 5 of Bare Necessities: Poverty and Social Exclusion in Northern Ireland (Hillyard et al., 2003).

Limitations

These income-based measures provide important information on the extent to which government targets are being met. But they have many limitations. They are only an indirect indicator of poverty; they do not measure need and deprivation. They do not take into account financial resources other than income, or other financial deductions such as debt. And they don’t take into account non-income-based resources, such as the level of service provision.

In particular, taking a threshold as simply a percentage of median or mean income is essentially arbitrary. It is possible to set an income threshold based on the level of income required to meet certain levels of need – but this first requires an examination of people’s living standards to establish what needs should be met and who falls below this standard. To do this, other ways of thinking about and measuring poverty need to be developed.

The consensual method for measuring poverty has developed a way to calculate a poverty threshold that combines both low living standards and low income. The minimum budget standards approach looks for ways to set a minimum acceptable standard of living and then at ways to calculate the budget needed to meet this standard.

Poverty trends

Data on the extent of poverty in the UK using various income threshold measures can be found on the Joseph Rowntree poverty site.

References

Gordon, D. (2006) ‘The concept and measurement of poverty’ in Poverty and Social Exclusion in Britain, Bristol, The Policy Press.
Hillyard P., Kelly, G., McLaughlin, E., Patsios, D. and Tomlinson, M. (2003) Bare Necessities: Poverty and Social Exclusion in Northern Ireland, Belfast, Democratic Dialogue.

 

Last updated: 21 January, 2016