September 2001

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Time Reveals the Truth about Low Income

by Jason Clemens & Joel Emes

"Time shall unfold what plaited cunning hides."
—Shakespeare, King Lear, Act i. Sc. 1.

Shakespeare may have made a better public policy analyst than many now in the business. Those calling for greater wealth redistribution in order to address the perceived plight of those whose incomes are currently lower than Statistics Canada's Low Income Cut-Offs (LICO) are missing some key facts. Primary among them are that few Canadians who have low incomes today will have low incomes in a year. Even fewer still will have low incomes in five years. The blanket redistribution policies recommended by many analysts on behalf of those with low incomes are entirely inappropriate when one considers how quickly many people move out of their low-income status.

Income distribution is meaningless without time

There are some who decry the fact that the top 30 percent of families in Canada earned 59.4 percent of all pre-tax income last year (Emes and Walker, 2001).¹ Implicit in their argument is that Canadians in the lower- and middle-income brackets should earn more of the total economic pie than they currently do. The suggested solution to this "problem" is greater redistribution of income.

Unfortunately, their analysis fails to incorporate how circumstances change over time. Family and individual income is not static. We all experience fluctuations in our earnings. In general, we tend to earn less while we are students and first entering the workforce. Our earnings tend to rise as we gain job-related skills and experience, up to a point sometime prior to retirement at which our income generally drops.² This means that the individuals and families now in the bottom 30 percent, the middle 40 percent, and the top 30 percent of earners are not the same people who were in those brackets five years ago, or even one year ago. Thankfully, we live in a mobile society where diligence and education are rewarded with higher incomes. Unfortunately, many analysts ignore this important aspect of public policy.

Income mobility

A series of studies investigating how family and individual incomes change over time in Canada, the US, and Britain were summarized in The Fraser Institute's recent publication on tax reform, Flat Tax: Principles and Issues.

The main finding of the Canadian studies, undertaken by Statistics Canada over two- and five-year periods, was that there was a high degree of upward income mobility for those earning the least in Canada. Specifically, of those families initially in the bottom two quintiles in 1995, 24 percent found themselves at least one quintile higher by 1996. In other words, nearly one-quarter of families in the lowest two income groups had moved up at least one income group in a one-year period.

The level of mobility increases, as one would expect, as the period of analysis extends. Of those initially in the bottom two quintiles in 1995, 45 percent moved up at least one quintile over the five- year period of the study. In other words, in a mere 5 years, nearly half of all Canadian families in the bottom 40 percent of income moved up at least one income group.

Statistics Canada's latest study

More recently, Statistics Canada released "Experiencing Low Income for Several Years," an abridged version of a longer study appearing in Perspectives on Labour and Income. This study specifically looked at the percentage of families that had incomes below Statistics Canada's Low Income Cut-off, or LICO. LICO conveys the income level at which a family may need to spend a greater- than-average proportion of its income on the basic necessities, such as food, shelter, and clothing . It is not, by Statistic Canada's own admission, a measure of poverty.³

The study's findings corroborate the conclusions of previous studies investigating income mobility: specifically, the study found that between 1993 and 1998, 24 percent of people lived in a family with low income for at least one year (table 1).

This means, of course, that 76 percent of people did not experience low income at all between 1993 and 1998. More interestingly, only 8.4 percent of people lived in a family that experienced low income for a period of four years or more (table 1). Only 3 percent of people lived in families that experienced low income for six consecutive years.

These numbers reveal a very different picture of the magnitude of a permanent under-class in Canada than that presented by poverty advocates. To reiterate, low income does not represent poverty per se, but rather an income level at which a greater than average amount of income is spent on basic necessities.

The student factor

The Statistics Canada study also found that people between 18 and 24 years old who were students for at least one year between 1993 and 1998 were much more likely to have low incomes than their non-student counterparts (44 percent versus 24 percent). This is because students are busy attending school and cannot work the same length of time as non-students.

Redistributing income to this group is indefensible since we know that the returns to students from education are enormous. In fact, the study specifically states that having a post-secondary education is an insurance policy against low income. Nearly 90 percent of those with post-secondary education avoided low income between 1993 and 1998, while 73 percent of those without a high school education avoided low income. The study specifically concluded that those attaining higher education "probably move out of low income more quickly" than those without the extra training (Morissette and Zhang, p. 3.7).

Table 1: People with Low Income, 1993 to 1998
(Abbreviated from Study)

Low income trap: lone parents and unattached individuals

One of the study's more striking findings, which corroborates past research, is that lone-parent families and unattached individuals are more likely to have low incomes than their married counterparts. Roughly 8 percent of the population had low incomes for four or more years between 1993 and 1998. Thirty-eight percent of lone-parent families had low incomes for four or more years while 23.3 percent of unattached individuals experienced low income during the same period (table 1). Only 1.1 percent of couples with no children were low-income for four or more years during this period, and even when couples had children, only 5.6 percent had low incomes for four or more years. Clearly, people's decisions about marital status also influence their income status.

Conclusion

For the most part, low income is transitory. Families living on low incomes generally do so for short periods of time. When they assess public policy, analysts should heed Shakespeare's wisdom and consider the effect of the passage of time on people's circumstances. Policies that do so, and recognize that the population is dynamic and fluid will be more appropriate and more successful than policies that assume the population is stagnant and immovable.

Endnotes

1 Interestingly, these people never mention that while the top 30 percent of Canadian families may have earned roughly 60 percent of all pre-tax income, they paid 65.7 percent of all taxes.

2 The idea of incomes that fluctuate over people's lives was most concisely articulated by Nobel Laureate Milton Friedman in his work on the Life-Cycle Permanent Income Hypothesis. For a good summary of this theory, see Law and Clemens (1998).

3 For a discussion of poverty in Canada and a critique of LICO, please see Chris Sarlo's recent study for The Fraser Institute: Measuring Poverty in Canada.

References

Emes, Joel and Jason Clemens (2001). Flat Tax: Principles and Issues. Vancouver, BC: Fraser Institute. Internet at www.fraserinstitute.ca/publications/critical_issues/2001/flat_tax.

Law, Marc and Jason Clemens (1998). "The Life-Cycle Permanent Income Hypothesis: How We Spend." Fraser Forum (January).  Internet at www.fraserinstitute.ca/publications/forum/1998/january/terminology.html.

Morissette, R. and X. Zhang (2001). "Experiencing Low Income for Several Years," Canadian Economic Observer (May). Adapted from Statistics Canada (2001), Perspectives on Labour and Income. Ottawa, ON: Statistics Canada (March).

Sarlo, Chris (2001). Measuring Poverty in Canada. Fraser Institute Critical Issues Bulletin. (July). Available on the Internet at  http://www.fraserinstitute.ca/publications/critical_issues/2001/poverty/index.html.

Jason Clemens (jasonc@fraserinsti- tute.ca) is the Director of Fiscal Studies at The Fraser Institute. He has a Masters Degree in Business Administration from the University of Windsor.

Joel Emes (joele@fraserinstitute.ca) is Senior Research Economist at The Fraser Institute. He has an M.A. in Economics from Simon Fraser University.

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