You are what you spend

I just ran into this article by W. Michael Cox and Richard Alm on the comparison of incomes and spending of rich and poor:

The share of national income going to the richest 20 percent of households rose from 43.6 percent in 1975 to 49.6 percent in 2006 . . . families in the lowest fifth saw their piece of the pie fall from 4.3 percent to 3.3 percent.

Income statistics, however, don’t tell the whole story of Americans living standards. Looking at a far more direct measure of the American family’s economic status household consumption indicates that the gap between rich and poor is far less than most assume.

The top fifth of American households earned an average of $149,963 a year in 2006. As shown in the first accompanying chart, they spent $69,863 on food, clothing, shelter, utilities, transportation, health care and other categories of consumption. The rest of their income went largely to taxes, savings, and home insurance. Home insurance is one of those expenses that you don’t see any return on unless something out of the ordinary happens, so it can be frustrating but you could be incredibly grateful for it if you suffer a bit of bad luck. It’s always best to compare prices before signing up, for example, by reading these MO insurance providers reviews, so that you can save a little bit of money where possible.

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The bottom fifth earned just $9,974 but spent nearly twice that an average of $18,153 a year. How is that possible?… lower-income families have access to various sources of spending money that doesn’t fall under taxable income. These sources include portions of sales of property like homes and cars and securities that are not subject to capital gains taxes, insurance policies redeemed, using a short term loan or the drawing down of bank accounts. Various factors can influence a household income and some may rely on these types of incomes to survive. Citizens are using loans more than ever to help them get from month to month. While some of these families are mired in poverty, many (the exact proportion is unclear) are headed by retirees and those temporarily between jobs, and thus their low-income total doesn’t accurately reflect their long-term financial status. As these low-income families rely on borrowing, their debts are increasing, making it even harder to regain control of their financial status. There are Payday Loan Consolidation services available for those who have multiple debts against their name. Consolidating the loan brings all of the loans together and makes simpler and easier payment repayment methods, allowing someone to have more financial freedom.

So, bearing this in mind, if we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. . . .

Let’s take the adjustments one step further. Richer households are larger an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1.

This would be a good example for an intro statistics class when the topic of measurement comes up. The challenge for a stat class is to focus on measurement issues–how to design a survey to estimate people’s income, assets, and spending patterns, or how to design an experiment or observational study to estimate the effects of changes in income on spending.

From the economics perspective, the example confuses me–on one hand, it makes sense to use consumption, not income, as a measure of well-being. On the other hand, if I were given the choice between two options:

(a) Earning $100,000 next year and spending $50,000, or
(b) Earning $40,000 next year and spending $60,000,

I’d prefer option (a). So I don’t know how to think about this. This sort of thing always confuses me in discussions of the utility of money (which I teach in my decision analysis class): it’s good to have more money, but, usually, it’s not money that brings joy, it’s the things that money buys that do it.

In the example above, it would certainly make sense to adjust income for taxes and transfer payments and probably for household size (even if not by simply dividing by the number of people). It’s harder for me to think about how whether to adjust for savings or non-cash benefits such as health insurance.

11 thoughts on “You are what you spend

  1. Simply put, simple measures of economic well-being, whether consumption or income are inadequate [full disclosure: I work on the Levy Institute Measure of Economic Wellbeing (LIMEW), the Cadillac of measuresd of wellbeing]. But, following the logic of the Cox and Alm piece, two households that spend the same amount of money are equally well-off, even if one has twice the income. That doesn't make any sense to me. So I don't agree with you when you say you don't know how to think about this.

  2. For what it's worth, subjective well-being data suggest that consumption, income, and wealth all kind of matter separately to people's well-being (probably because the latter two also affect people's perceptions of status and their sense of security about their futures).

  3. The suggestion that the richest 20% are, really-if-you-look-at-it, "only" twice as rich as the poorest 20% doesn't pass the laugh test, or, for that matter, the smell test. Something is wrong with either the numbers, the interpretation of the numbers, or both.

    One obvious error is that if you're going to correct for household size, you should do it at the beginning and not at the end. If dollars per person is your measure of wealth — and it certainly makes sense — then a lot of those people in the "top 20% of households" are not among "the richest 20%", and a lot of people in the "bottom 20% of households" are not in "the poorest 20%." Plenty of households in the 4th quintile make (and spend) more money PER PERSON than lots of households in the 5th quintile, and lots of households in the 2nd quintile make (and spend) less money PER PERSON than lots of households in the first quintile. Their incorrect procedure compresses the difference between top and bottom, possibly by a very large factor. In fact, it's quite possible that the difference in consumption per person, between top 20% and bottom 20%, is larger than the factor of 4 difference in consumption per household.

    I see a few other problems, too, but don't have time to go into them.

    Basically, I think the numbers are bullshit.

  4. "it's good to have more money, but, usually, it's not money that brings joy, it's the things that money buys that do it."

    Not only. Another benefit of having lots of money certainly is the safety/lack of worry that comes with it.

  5. The thing that bugs me about these discussions is any sort of statement about the sustainability of such consumption. For example, it is one thing to be spending out of the earned income tax credit but a very different thing to be running up credit card debt. This is linked to the choice of A and B above but I wish someone would explore it more forcefully…sounds like a paper!

  6. Cox and Alm acknowledge the fundamental flaw of their findings, but nobody else seems to be discussing it. (Professor Krugman? Are you home?) It's fundamental to any freshman-level equity analysis:

    "While some of these families are mired in poverty, many (the exact proportion is unclear) are headed by retirees and those temporarily between jobs, and thus their low income total doesn’t accurately reflect their long-term financial status."

    And, uh…students? Who are being supported by well- or at least better-off parents who are nevertheless not part of the "household"?

    Absent this "unclear" information, the whole things seems to tell us exactly…nothing.

  7. I think economic well being can be best summarized in a quote from the famed economist Charle Dickens:

    "Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."

    Mr. Micawber,"David Copperfield"

  8. If you look at the people you personally know whose consumption exceeds their taxable income, this mystery is a little easier to ponder.

    They may be students. When I was in grad school, my income wasn't reportable (research was required, and therefore research assistant income wasn't taxable; I don't know whether that's still the case). Expenditures on tuition were high.

    They may be elderly, living off savings.

    They may have pure cash businesses (and should report, but …).

    They may be living partly off disability and partly off family gifts below the gift reporting limit.

  9. ZBicyclist,

    It is not obvious that those would be changing over time as opposed to being constant proportions. They might be moving in the "right" direction as boomers age and the echo enters college (in favor of your story) but it is ultimately an empirical question. Looking at wage earners is the most obvious cut of the data to look at.

  10. The whole analysis is absurd. I think Krugman has written about their work several times. If I recall, they also claimed reversion to the mean as proof of social mobility.

    Isn't it obvious that poorer households do not have much savings not because they choose not to save but because there are many costs (rent/mortgage, for example) that are not discretionary? Also, it may be showing that the wealth accumulation is outstripping the growth of things for the rich to splurge on.

    It also proves that the so-called consumption tax is nothing more than a massive tax cut for the very rich.

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