Low income definitions
Low income cutoff (LICO)
Low income cutoffs (LICOs) are established using data from the Family Expenditure Survey, now known as the Survey of Household Spending. They convey the income level at which a family may be in straitened circumstances because it has to spend a greater proportion of its income on necessities than the average family of similar size. Specifically, the threshold is defined as the income below which a family is likely to spend 20 percentage points more of its income on food, shelter and clothing than the average family. There are separate cutoffs for seven sizes of family – from unattached individuals to families of seven or more persons – and for five community sizes – from rural areas to urban areas with a population of more than 500,000.
Calculation of low income cutoffs
The first step in the production of a set of low income cutoffs is to calculate the average proportion of income that a family spends on food, shelter and clothing. The 1992 Family Expenditure Survey found that, on average, families spend 44% of their after-tax income (and 35% of their total “before-tax” income) on these necessities. Then, 20 percentage points are added, giving 64% of after-tax income. This is done on the grounds that a family spending more than this proportion of its income on necessities is significantly worse off than the average family. The final step is to look at the distribution of income by expenditure and determine, using a regression line, the level of income at which a family tends to spend 20 percentage points more than the average on the necessities of food, shelter and clothing.
Updating and rebasing the low income cutoffs
There are two reference years that play a part in the calculation of a set of low income cutoffs: the base year and the income reference year. The base year supplies the average spent on food, shelter and clothing. This percentage is used to derive a set of cutoffs that are suitable for use with income data from that year. Cutoffs for other income reference years may be obtained by applying the corresponding Consumer Price Index (CPI) inflation rate to the basic set of cutoffs.
Using the CPI to update the cutoffs takes inflation into account, but does not reflect any changes that might occur over time in the average spending on necessities. To measure these changes, Statistics Canada has developed a new set of spending averages after each Family Expenditure Survey. These are referred to as “bases” because the average spending on necessities in that base year drives the calculation of the cutoffs. The two most recent base years are 1992 and 1986. Cutoffs based on 1992 are most commonly applied by data users and are available for the income reference years from 1980 onwards.
Low income rate
Low income rates can be calculated for persons or for families. In either case, the income that is compared to the cutoff is the income of the entire economic family. “Persons in low income” should be interpreted as persons who are part of low income families including persons living alone whose income is below the cutoff. Similarly, “children in low income” means “children who are living in low income families”. In other words, all members of an economic family have the same low income status, but they are counted separately when person-based low income rates are calculated.
To calculate the low income rates, the family size and community size are used to find the
appropriate cutoff. Then the family income is compared to that cutoff. If a family low income rate is being calculated, then the family is counted as being in low income if its income is less than the cutoff. If a person low income rate is being calculated, then all persons in the family are counted as being in low income if the family income is less than the cutoff.
Use of after-tax and before-tax LICOs
The average portion of income that families spend on food, shelter and clothing, which figures prominently in the low income cutoffs, is undoubtedly a useful gauge of economic well-being no matter which income concept is used. The choice of after-tax income or total income – or even market income for that matter – depends on whether one wants to take into account the added spending power that a family gets from receiving government transfers and its reduced spending power from paying taxes.
Statistics Canada produces two sets of low income cutoffs and corresponding rates – those based on total income (i.e. income including government transfers, before the deduction of income taxes) and those based on after-tax income.
The choice to highlight after-tax rates was made for two main reasons. First, income taxes and transfers are essentially two methods of income redistribution. The before-tax rates only partly reflect the entire redistributive impact of Canada’s tax/transfer system, by including the effect of transfers but not the effect of income taxes. Second, since the purchase of necessities is made with after-tax dollars, it is logical to use people’s after-tax income to draw conclusions about their overall economic well-being.
A note about the calculation of before-tax versus after-tax low income cutoffs: the derivation of each set of cutoffs is done independently. There is no simple relationship, such as the average amount of taxes payable, that distinguishes the two levels. Instead, the entire calculation of cutoffs is done twice – both on a before-tax basis and on an after-tax basis
Differences in after-tax rates and before-tax rates
After-tax low income cutoffs, and the resulting after-tax rates, have been published back to 1980. The number of people falling below the cutoffs has been consistently lower on an after-tax basis than on a before-tax basis. This result may appear inconsistent at first glance, since incomes after tax cannot be any higher than they are before tax, considering that all transfers, including refundable tax credits, are included in the definition of “before-tax” total income. However, with a relative measure of low income such as the LICO, this result is to be expected with any income tax system which, by and large, taxes those with more income at a higher rate than those with less. “Progressive” tax rates, as they are often called, make the distribution of income more compressed. Therefore, some families that are in low income before taking taxes into account are relatively better off and are not in low income on an after-tax basis.
The low income gap, previously called “low income deficiency”, is the amount that a low income family falls short of the relevant low income cutoff. For the calculation of this gap, negative incomes are treated as zero.
For example, a family with an income of $15,000 and a relevant low income cutoff of $20,000 would have a low income gap of $5,000. In percentage terms this gap would be 25%. The average gap for a given population, whether expressed in dollar or percentage terms, is the average of these values as calculated for each unit.