Appendix 1
Methodology

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A. The Methodology of LICO
B. Variable LIM
C. The methodology of MBM

A. The Methodology of Low Income Cut-Offs (LICO)

LICOs are estimated thresholds below which a family is likely to spend significantly more of its income on food, shelter and clothing than the average family. The rationale behind LICO is the Engel's law which states that a family's relative expenditure on food tends to fall as its income rises. If a family spends a substantial proportion of its income on necessities such as food, shelter and clothing, then it would have little "discretionary income" left to spend on other items and thus would probably live under straitened circumstance.

The first set of LICOs was released in 1967 by Statistics Canada. It was estimated using data from the 1959 Family Expenditure Survey (FAMEX). There were 5 cut-offs in that release, corresponding to families of sizes 1, 2, 3, 4 and 5 or more. A new set of LICOs was produced using data from the 1969 FAMEX several years later with the same methodology. The only difference was that the number of cut-offs was extended to 35 this time, allowing family size to increase to 7 and over, with each family size being crossed by 5 community sizes: rural area, urban areas with less than 30,000, 30,000 to 99,999, 100,000 to 499,999, and 500,000 or more residents. Following the 1969 practice, the LICO thresholds were re-based in 1978, 1986 and 1992, respectively.1

Currently, the LICO thresholds are based on data from the 1992 FAMEX. The estimation starts from the following spending model,

Description

Equation 1a

where FSCi is total spending on food, shelter, and clothing by family i, INC is the income of the family (either before- or after-tax),REGION is a vector contains 5 region dummies (Atlantic provinces, Quebec, Ontario, Prairies provinces and BC), AREA contains the dummy variables for community size, and FMSZ contains dummies for different economic family size.2

Using ordinary least squares estimates for α, β, θ, δ, and λ, the low income cut-off for a family is defined as the income level at which the family spends 20 percentage points higher than the ratio of average spending on food, shelter and clothing and average family income. In particular, the LICO for a family of size k lives in area j is obtained by the following equation,

Description

Equation 1b

where p bar equals the aveage spending on food, shelter and clothing divided by the average family income and where F S C bar is the average spending on food, shelter and clothing, and inc bar is average family income. When after-tax income is used, one obtains the after-tax cut-offs and when before-tax income is used, one obtains the before-tax cut-offs. The estimates for the 1992 after-tax LICOs are contained in the upper portion of Table A1.3

Table A1 After-tax LICO: 1992 and 2007

The LICO thresholds after 1992 are obtained by adjusting the 1992 estimates with the Consumer Price Index (CPI). For example, for a family of size 3 living in rural area, the 1992 cut-off was $13,410. Multiply it by the 2007 CPI (111.5) and divide it by the 1992 CPI (84.0), we obtain $13,410 x 111.5/84.0 = $17,800 as the cut-off for the same family in 2007. The lower portion of Table 1 provides the cut-offs for the year 2007.

In the late 1990s, there were discussions and attempts within Statistics Canada to re-base the LICOs to the 1997 spending patterns. There were also attempts to construct annual LICOs as well as LICOs for the largest cities. Eventually it was decided to keep the 1992 LICOs and update them annually by CPI only.4

B. Variable LIM

Following a critical review and extensive user consultations, Statistics Canada introduced the Low Income Measure (LIM) as an alternative line in the early 1990s.5LIM measures low income from a distributional perspective. It is simply defined as half of the median adjusted economic family income, where "adjusted" indicates that different needs of families of different sizes and compositions are taken into consideration. For example, the shelter costs for two persons living together may be higher than that for one person living alone, but not necessarily twice as high due to economies of scale in consumption.

The first step in calculating the LIM thresholds is to use an "equivalence scale" to adjust family income to account for the scale economies. The equivalence scale is a set of numerical factors assigned to different members of a family such that the first person is counted as 1.0, the second person, regardless of age, is counted as 0.4. After the first two persons, if any, each additional adult is counted as 0.4 and each additional child (under 16) is counted as 0.3. For example, a family of two adults and two children would end up with an adjusted family size of 2 (= 1 + 0.4 + 0.3 + 0.3). When we sum up the factors for each member of a family, we obtain the "adjusted size" for the family.6

Secondly, we divide total family income by the adjusted family size to arrive at the "adjusted family income". The median of the adjusted family incomes is then calculated. The Low Income Measure for families with a single person is defined as half of that median -- we may refer this as the "LIM threshold of a single person" -- while the LIM thresholds for other types of families are obtained by multiplying the "LIM threshold of a single person" by the adjusted family size.

Table A2 Variable after-tax LIM: 2006

For example, using the 2006 Survey of Labour and Income Dynamics (SLID), the estimated median of adjusted family after-tax income was $30,358. Thus the after-tax LIM threshold for a single person was 0.5 x $30,358 = $15,179 in 2006. For a family of size 2, since the adjusted family size is 1.4, the threshold was $21,251 (=$15,179 x 1.4). The 2006 after-tax LIM thresholds are contained in Table A2.

Notice that Statistics Canada produces new LIM thresholds every year using data from its income survey (Survey of Consumer Finance before 1996 and Survey of Labour and Income Dynamics thereafter) and in this sense, LIM are re-based or updated every year. We refer to the published LIM thresholds as variable LIM thresholds hereafter.

C. The methodology of MBM

In order to assess the effectiveness of the Child Tax Benefit program, Human Resources and Social Development Canada (HRSDC), in consultation with a Federal-Provincial-Territorial Working Group of officials on Social Development Research and Information, started to develop the Market Basket Measure (MBM) in 1997, with the first set of MBM thresholds (for the year 2000) being released in May 2003.

The MBM measures the cost of a basket of goods and services that are deemed essential to maintain physical health and to moderately participate in community activities. A distinctive feature of MBM is that, while the basket of goods and services is identical, the thresholds are community and community size specific, reflecting differences in costs of living across communities. The community size categories are based on those currently used by LICOs (urban 500,000 and over, urban 100,000 to 499,999, urban 30,000 to 99,999, urban under 30,000 and rural). Since there is practically a one-one correspondence between a very large community and a specific city in each province, MBM replaces these large communities by the corresponding cities. As a result, a total of 48 thresholds are created, allowing each province to have its own rural threshold and a few thresholds for its cities of different sizes.

The first step in establishing the MBM thresholds is to specify the basket of goods and services. The basket contains five components: the food component, based on Health Canada's National Nutritious Food Basket 1998; the clothing and footwear component, based on the Acceptable Level of Living (ALL) measure developed by Winnipeg Harvest and the Winnipeg Social Planning Council;  shelter component, transportation component and expenditures on other goods and services. The last component includes personal care, household needs, furniture, basic telephone service, postage stamps, religious and charitable donations, school supplies and modest levels of reading material, recreation and entertainment.

The next step is to estimate the costs of the components in the basket for a reference family of two adults and two children in each community. For this family, the cost of the food component was determined using data on food prices across 40 urban centers.7 The cost of the clothing and footwear component was derived with Statistics Canada's relative spatial price index together with the cost for the reference family living in Winnipeg. The later was determined by Winnipeg Harvest and the Winnipeg Social Planning Council.

The shelter cost was the average of median rents for the two- and three-bedroom rental units for each community and community size, based on data from the Census, Labour Force Survey and Survey of Household Spending, while the cost of the transportation component follows the recommendations of the National Council of Welfare.8 The cost of other goods and services was calculated as a proportion of average spending on food, clothing and footwear by the second deciles of the reference family. The proportion (or multiplier) was estimated with data from Survey of household spending.

Table A3 MBM thresholds: 2007

Finally, with the cost of the basket for the reference family at hand, the costs for other families within each community are obtained by applying the equivalence scales of LIM. This implies that, for example, the cost for a single adult would be half of the cost for the reference family, since the LIM equivalence scale for the reference family is 2 and the equivalence scale for a single adult is 1. The 2007 MBM thresholds are contained in Table A3.

Notice that the basic concept of low income underlying the MBM is being unable to purchase the goods and services contained in the basket, the income to be compared to the thresholds would be disposable income available to purchase these goods and services. Thus, under MBM, the disposable income is equal to total income (income from employment, investment, retirement pensions and all government transfers) subtracted by income taxes, Canada and Quebec Pension Plans (CPP/QPP) contribution, Employment Insurance (EI) contribution, Registered pension plan (RPP) contribution, union dues, child/spousal support payment, work-related child care expenses and out of pocket medical expenses prescribed by medical professionals.

Appendix Table A4 Some low income indexes and their standard errors


Notes

  1. The 1967 and 1969 LICOs were based on income before-tax only. From 1978, both before- and after-income tax thresholds were released.
  2. Economic family consists of persons living in the same dwelling and related by blood, marriage, common-law relationship or adoption.
  3. Due to small number of observations, the cut-offs for families of size 7 and over are interpolated with the cut-offs for families of sizes 5 and 6. For example, for rural families of size 7 and over, the 1992 cut-off is obtained as 2 x $21,127 - $19,050 = $23,204.
  4. See Cotton, Webber and Saint-Pierre (1999), Cotton and Webber (2000), and Cotton (2001) for details.
  5. Wolfson and Evans (1989).
  6. This equivalence scale is similar to the square root of family size scale used in several Organisation for Economic Co-operation and Development (OECD) countries.
  7. For rural areas in each province, it is assumed the cost is the same as in the smallest urban centre in the province.
  8. National Council of Welfare (1998-99), A New Poverty Line: Yes, No or Maybe?
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