INFLATION, PENSIONER LIVING STANDARDS AND POVERTY

INFLATION, PENSIONER LIVING STANDARDS ANDPOVERTY*

Russell Harvey and Richard Hemming*

I. INTRODUCTION

In Britain it is common practice to define a household as poor if itsresources are below what would be received if that household had torely on supplementary benefit (SB). SB is a means-tested benefit whichmakes up the incomes of those not in full-time work to a needs levelwhich depends upon family composition (the scale rates) and includesfull housing costs. The scale rates are now at roughly twice their realvalue of 1948, when national assistance (renamed SB in 1966) wasintroduced. National assistance was initially set at subsistence level;SB provides for more than mere subsistence, having become increasinglygenerous as general living standards have improved in post-war Britain.

A household is typically regarded as living in poverty if its nominalincome, after allowing for all taxes paid and benefits received, lesshousing expenditure, is below the appropriate SB scale rate. Beckermanand Clark (1982) have estimated that over the period 1974-76 therewere 912,000 poor households in Britain. These households contained1.67 million individuals, and around 765,000 of these were retirementpensioners. Over the same period there were roughly 8 million retire-ment pensioners. A large proportion (9.6 per cent) of the retired werepoor, and a much larger proportion (45.8 per cent) of the poor wereretired. The reason that so many of the retired are poor, despite thefact that they will often be entitled to SB, is that the take-up of SBamong retirement pensioners, at only slightly over 50 per cent, is low.If take-up were improved then poverty in retirement would be corres-pondingly reduced. However, this would only be true if the use of SBas a poverty standard can be defended.

Poverty estimates of the type reported above are widely criticized.The most commonly heard objection is that SB scale rates are simplyinadequate; SB will only support a living standard which by currentconventions should be regarded as quite intolerable. We are not goingto consider this issue. Instead, attention is to be focused on anothershortcoming, suggested by Beckerman and Clark. They accept that

*IFS research on the indexation of social security benefits was financed by SSRC GrantNo. HR7128. We are grateful to the Editors for detailed comments on an earlier version ofthis paper.

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poverty should be assessed by reference to the SB scale rates. However,in recent years social security benefits have been uprated every Novemberto reflect price inflation over the previous 12 months.' The povertystandard is therefore fixed in nominal terms between upratings.Beckerman and Clark have recommended that this standard be amendedto take account of within-year inflation, and they index SB betweenuprating dates. This produces a 70 per cent increase in the number ofpoor households. The purpose of this paper is to examine the impactand validity of this procedure in the case of retirement pensioners.

H. THE BECKERMAN-CLARK PROCEDURE

Beckerman and Clark justify their adjustment for within-year inflationthus: '. . . even if the scale rate is raised in, say, November, of anyyear, to take account of inflation ince the previous adjustment ofthe rate, and if all recipients of Sùpplementary Benefit and otherrelated programmes benefit from the increases, they may still fallbelow the poverty line in the following months in so far as their incomesdo not then rise in line with the cost of living' (Beckerman and Clark,1981, Annex B, p. 85). Their procedure is straightforward, and it isdemonstrated in Fig. 1. The unbroken line represents the nominalSB scale rate for a particular household. A household whose net income,less housing expenditure, is a constant Y1 between November 1976and November 1977 will be poor throughout the benefit year 1976-77;

NetIncomeLessHousingExpendi-tu re

Y2

May 1977

November 1976

November 1977

SB scale rate

Fig. 1. Adjustment for within-year inflation: SB indexed from November 1976.

'November increases are announced in the previous March. Upratings are therefore basedupon an estimated annual inflation rate, and any shortfall or overgenerous award can be com-pensated for in the following year.

INFLATION, PENSIONER LIVING STANDARDS AND POVERTY 197

if net income less housing expenditure were Y2, instead the householdwould not be poor at all over the same period. The broken line isdrawn on the assumption that price inflation occurs at a constantmonthly rate, and, with SB indexed from November 1976, representsthe Beckerman-Clark poverty line. The household with constant netincome less housing expenditure Y2 will be poor between May andNovember, while with unindexed SB it was poor at no time duringthe benefit year. It follows that any judgement as to whether a house-hold is poor or not will depend in part on when in the year we comparetheir income with the modified poverty standard.

A procedure similar to this has been adopted in producing adjustedpoverty estimates which have been published by the Department ofHealth and Social Security (DHSS) in various issues of Social Trends,although they have now been discontinued. The DHSS amendedincomes rather than the SB scale rates for within-year inflation. Eachtype of income is inflated by an appropriate index to an end-yearvalue; for example, earnings are inflated using an industry and occu-pation specific index of earnings, interest income using an index basedon building society interest rates and social security benefits paid tothose not in receipt of SB are increased to their uprated (November)value. The end-year value of income is then compared with the pre-vailing SB scale rates. Recipients of SB are excluded from the compari-son, and cannot therefore be categorized as poor. The Beckerman-Clarkand DHSS procedures will clearly give rise to different adjusted povertyestimates - see Beckerman and Clark, 1981, Annex B, pp. 88-9 - butthe comments we are going to offer on the former apply equally to thelatter.

There are two reasonable lines of criticism which might be levelledat the above method of adjusting the official poverty line to takeaccount of within-year inflation. Periods of temporary poverty - forsome later months of the year - are most likely to be suffered by thosewho rely on social security benefits as their principal source of income.Retirement pensioners fall into this category. In applying the Beckerman-Clark procedure to determine how many pensioners suffer periods oftemporary poverty we are making the implicit assumption that pen-sioners spend all their income as they receive it. Such an assumptionmeans that the inflation-induced reduction in real living standard overthe course of a year is as large as it possibly can be. This implicit assump-tion may be inappropriate. Pensioners could be aware of the potentialdecline in their standard of living, and plan to avoid it. This can beachieved by saving part of their income when its real value is relativelyhigh, and drawing upon their accumulated saving when the real value oftheir income is relatively low, thus adjusting their standard of livingin some predetermined manner. Richer pensioners simply avoid anunplanned decline in their standard of living; those less well off can

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avoid periods of poverty; poor pensioners remain poor, but can avoidgreat depths of poverty.

The second line of criticism relates to the way in which the indexa-tion is done. Annual upratings are to compensate for inflation over theprevious 12 months. That upratings occur at all can be taken as an indi-cation that the maintenance of a real poverty standard is the officialintention. The fact that benefits are only adjusted once a year, foradministrative convenience, and that inflation is continuous, impliesthat the poverty standard can only be at the correct real level, from theofficial viewpoint, at one point in the year. Unfortunately, explicitstatements outlining the principles governing SB levels are notable onlyby their absence. To apply an adjustment for within-year inflation itis necessary to guess when in the year the intended real poverty standardis attained. Beckerman and Clark assume that this is the beginning ofthe benefit year. However, there are other possibilies. It is difficult tobelieve that the end of the benefit year is a serious possibility. But toassume the government's view to be that SB scale rates reflect theaverage official real poverty standard appropriate to the 12 monthsbetween upratings, and pensioners are expected to make the financialprovisions necessary to avoid declining living standards, seems perfectlyacceptable.

Because of the assumptions they make, the Beckerman-Clark proce-dure produces estimates of the number of poor which should be treatedas an upper-bound. Alternative assumptions about the relationshipbetween spending and income or the adjustment of the official povertystandard for within-year inflation will produce more moderate estimates.We are going to investigate the expenditure of retirement pensioners, inorder to determine the extent to which they manage to preserve theirstandard of living on a month-to-month basis in the face of a fallingreal income during each benefit year. If it turns out that retirementpensioners are fairly adept at avoiding a declining living standard,current income must be replaced by an alternative income conceptin assessing the extent of poverty among retirement pensioners.

III. PENSIONER EXPENDITURE

In the context of the conventional life-cycle model of consumptionplanning we are going to test what might be referred to as a 'smoothing'hypothesis. If real consumption expenditure - which we here treat asa measure of standard of living - tracks real net income the implicitassumption of Beckerman and Clark is justified. At the other extremeperfect smoothing occurs when real consumption expenditure is plannedto be constant. In between these extremes are two cases. In one realconsumption expenditure is planned to increase or decrease, but is inde-pendent of variations in real net income: we might call this smoothing.


In the other case there is some planning, to ensure, say, a minimum orthreshold standard of living, but some of the month-to-month variationin real consumption expenditure does reflect variations in real netincome.

The data we use come from the Family Expenditure Survey (FES)for the calendar years 1975, 1976 and 1977. The FES is a continuousenquiry into the income and expenditure patterns of private householdsin the UK, although a wide range of other household characteristics isrecorded. Each household is interviewed over a two week period. Alltypes of households are included in the sample of about 7,000, whichrepresents a response rate of approximately 70 per cent. Arounda quarter are retirement pensioners. However, the sample of pensionersmay not be representative of the pensioner population as a whole. TheFES sample excludes all pensioners resident in institutions, and non-response tends to increase with age: in 1977 23 per cent of the FESsample were pensioners while census data indicate that this figureshould be 29.5 per cent. Naturally sampling error and differentialnon-response weaken any conclusions based upon the FES sample,though we would judge that our conclusions may be only marginallyaffected as a consequence.

The idea behind our test of the smoothing hypothesis is that thecircumstances of pensioners interviewed in any particular month, sayMay 1976, are representative of those which would be exhibited bythe pensioners interviewed in any previous or future month if they hadinstead been interviewed in May 1976. Thus if the monthly averages ofincome and expenditure are computed for each of the 36 months thesecan be viewed as reflecting the pattern of monthly income and expen-diture for a representative pensioner household.

Before computing the monthly averages the following adjustmentswere made to the FES data. Housing expenditure tends to be non-discretionary since it is based on past decisions. This item of expenditurehas been subtracted from both income and expenditure. Similarlydurable expenditures, which on average are very small, tend to distortcbnsumption expenditure as an indicator of standard of living. TheFES does not furnish the information necessary to impute the serviceflow from durable expenditures so, like housing expenditure, durableexpenditures have been subtracted from both income and expenditure.It is well known that household expenditures on drink and tobaccotend to be understated in the FES. These were increased by 77.2 percent and 32.9 per cent respectively, reflecting the percentage differencebetween the aggregate expenditure on each implied by 1977 FES dataand more reliable National Income and Expenditure data for the sameyear. FES income and expenditure data are in nominal terms. Theyhave been converted to real terms using an index of pensioner non-housing non-durable consumption expenditure. This is a reweighted

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retail price index, the new weights for each year being derived fromthe FES expenditure data for that year.

In order to determine the typical pensioner expenditure pattern werun a regression of the form:

(I)where C. = real consumption expenditure in period t; )T* permanentincome, the constant level of real consumption expenditure which canbe sustained over the sample period; t = month of interview, indexedt 1 .. . 36, included to capture any trend in planned expenditure;

= real net income in period t; D = dummy variable equal to 1 whent 12, 24, 36 and O otherwise, included to control for abnormally highDecember (Christmas) real consumption expenditure; and e = randomerror term. In the absence of reliable information on the dynamics ofwealth holdings we assume that no wealth is consumed; we furtherassume that the monthly interest rate is not significantly different fromzero, so that permanent income is given simply by

36

= Y/36.t =1

Any of the following outcomes might reasonably be expected:

¡31 l ß = 0, ß = 0, ¡34 0 perfect smoothing

In fitting equation (1) to the FES data, single pensioners and pensionercouples are treated separately. Furthermore, low income pensioners -those with less than £2.50 a week in non-state income2 - who are atthe greatest risk of poverty are distinguished from pensioners as a whole.

Our results are reported in Table 1. In the case of all pensionerstaken together, the appropriate F-test implies that the smoothinghypothesis should be rejected at the 5 per cent significance level.3 Varia-tions in real consumption expenditure reflect variations in real netincome over the planning period, although the idea that real consump-tion expenditure is determined only by concurrent real income is

A figure determined partly by the need to maintain respectable sample sizes in eachmonth, usually not less than lo.

The F-test involves imposing the restriction that C is independent of variations in Ytaround *, except in December.

13>0,¡3>0, ¡320,

¡31 1, ¡32

(320,

= 0,

¡33=0, ¡340smoothing¡33>0, ¡340-rejection of smoothing and Beckerman-C1ark

(3 1, ß > O - Beckerman-Clark


TABLE 1Regression Results

Note: t-ratios in parentheses.

rejected.4 In the case of low income pensioners the picture is somewhatdifferent. For single pensioners the strong variant of the smoothinghypothesis is unambiguously accepted. For pensioner couples theestimate of ß is significantly different from zero, but only marginallyso, with the critical value of t being 2.04 at the 5 per cent significancelevel; furthermore the coefficient is very small and negative. We havetherefore decided that it is appropriate to accept the strong variantof the smoothing hypothesis for pensioner couples as well as singlepensioners. We have sought an explanation of the puzzling negativecoefficient, but have been unable to come up with anything satisfactory.

The hypothesis that retirement pensioners smooth their real con-sumption expenditure is in general rejected, but for a sub-group of lowincome pensioners the smoothing hypothesis provides a better descrip-tion of the evolution of real consumption expenditure than the naiveview that it bears a close relationship to real net income in each period.This suggests that when attempting to measure the extent of povertyamongst retirement pensioners, if account is to be taken of within-yearinflation it should also be recognized that a misleading picture may beprovided if income received in any particular week is compared withan indexed poverty standard. We go on to examine the impact on

4The F-test involves imposing the restriction that C depends only Yt except inDecember.

All Pensioners Low Income Pensioners

Single Couples Single Couples

t

0.83(25.1)

0.08(3.1)

0.85(24.8)-0.05(1.02)

0.97(23.8)-0.02

(0.74)

0.92(41.3)-0.003

(0.15)Yr Y 0.31 0.44 -0.40 -0.18

(2.46) (2.82) (1.24) (2.08)1.55 7.77 2.86 0.71

(5.17) (3.95) (3.23) (0.60)SE 1.63 3.16 1.38 1.35

16.03 26.50 11.9 19.05R2 0.66 0.47 0.25 0.15DW 1.83 1.78 1.58 2.33N 36 36 36 36

Source: Own calculations based on 1977 Family Expenditure Survey data.

poverty measurement of substituting a permanent income measurefor current income in such comparisons when pensioners are at riskof poverty.

IV. POVERTY MEASUREMENT

Our exercise in poverty measurement is based upon 1977 FES data.We examine how the estimated number of poor pensioners is affectedby alternative methods of adjusting the poverty standard for within-year inflation and alternative measures of income. Our results aresummarized in Table 2.

In Row 1 it is assumed that the appropriate poverty standard is theSB scale rate in force at the data of interview and that real consumptionexpenditure is unsmoothed. A household is poor if its nominal incomeless actual housing expenditure is below its SB scale rate. The resultsreflect the received wisdom about the retired: 21 per cent of singlepensioners are poor, while 9 per cent of pensioners couples are poor.In Row 2 it is assumed that the appropriate poverty standard should bethe SB scale rate indexed from the uprating month (November 1976),the Beckerman-Clark approach to capturing the consequences of within-year inflation.5 This has the effect of increasing the number of retired

'FES data refer to a calendar year. For households interviewed between January andOctober 1977 the SB scale rate is indexed from November 1976 to the date of interview. Forhouseholds interviewed in December 1977 toe SB scale rate is indexed from November 1977.

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TABLE 2Numbers of Poor Pensioners with Alternative Poverty Standards

and Income Concepts 1977

Poverty standard/income concept

Number of poor

Single pensioners Pensioner couples

1. Unindexed SB/current income 195 582. SB indexed from Nomvember 1976/

current income 326 1253. SB indexed from November 1976/

permanent income 303 1144. SB indexed through May 1977/

current income 211 705. SB indexed through May 1977/

permanent income 181 56

Number of pensioners 897 656


households in poverty by 78 per cent, with a greater impact on pensionercouples. In Row 3 it is further assumed that pensioners at risk ofpoverty smooth their non-housing non-durable real consumptionexpenditure. Poverty measurement is based upon a permanent incomemeasure which is the average monthly level of real income assumingthat social security income and non-state income is fully indexed inNovember 1 9776 This has the effect of reducing the number of house-holds in poverty by 7.5 per cent.

The large increase in the number of poor pensioner households inmoving from Row 1 to Row 3 of Table 2 results wholly from thechange of poverty standard. It has been suggested that the Beckerman-Clark poverty standard may be based upon a misinterpretation ofofficial intentions in setting the poverty standard, and as a consequenceis too demanding. As an alternative we suggested that rather thanassuming the real poverty standard to be correct only at the beginningof the benefit year, it might be assumed to be correct on average. Toreflect the new poverty standard, again with constant monthly inflation,the broken line in Fig. 1 should be shifted downwards, staying parallelto the original broken line, until it passes through the unbroken line atthe point marked May 1977. In applying this procedure we assume thatSB scale rates are at their correct real level in May 1 9777 With thecurrent income measure, in Row 4, the number of households inpoverty is only 11 per cent greater than in Row 1 (the unindexed,current income case). With the permanent income measure, in Row 5,the number of households in poverty is actually less than in Row 1.The impact of using permanent rather than current income is greaterwhen the SB scale rate is indexed through May rather than fromNovember.

V. CONCLUDING COMMENTS

This paper has addressed the problem of measuring poverty in aninflationary environment. The principle that poverty measurementought to take account of within-year inflation is one we accept. Whenthe inflation rate in Britain has been at its highest this has been accom-panied by some pressure for more frequent indexation of social securitybenefits. This pressure has been resisted. If the Beckerman-Clark

6Housing and durable expenditure is excluded from income in calculating average monthlyreal income, and durable expenditure is subtracted from the SB scale rate. Non-state incomeconsists mainly of part-time labour income and occupational pensions, which is a mixture ofincome which is indexed better, to the same degree, and less than social security income. Ourindexation assumption is arbitrary, but not necessarily wildly inappropriate.

households interviewed in January to April 1977 SB scale rates are deflated relativeto the nominal value in May 1977, and for households interviewed in June to December 1977they are inflated relative to the nominal value in May 1977.

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approach to investigating the effect of within-year inflation wereadopted one might conclude that this resistance was callous; it leadsto a near doubling of the number of poor and an increase in the depthof poverty for many. However, corrections to both the poverty standardand the income concept used by Beckerman and Clark fully offsettheir adjustment, producing lower estimates of poverty than whenthere are no adjustments. The extent to which our estimates shouldbe regarded as a serious challenge to the BeckermanClark results canoniy be gauged if one knows what is officially viewed as the appropriatereal poverty standard, and the extent to which low income householdscan arrange their financial affairs so as to avoid declining standards ofliving. Low income pensioners appear to be very successful at this. Thesame may be true of other groups, especially those at severe risk ofpoverty, and this should be investigated. But we cannot judge theextent to which this behaviour overcomes the poverty created bycurrent indexation practice unless the official view on the real povertystandard is voiced.8 Until this is done calls for more frequent indexationwill continue to be rejected, and such a decision would be difficultto criticize. A statement of the rationale for existing official indexationpractice should first be secured.

Institute for Fiscal Studies

REFERENCE

Beckerman, Wilfred and Clark, Stephen (1982). Poverty and Social Security inBritain Since 1961, Oxford University Press, London.

official view might be inferred from the DHSS indexation procedure, but Beckermanand Clark rightly point out that this could only be done if 'the income of those who are belowor in the region of the poverty line experience increases in various components of their netdisposable income that are really in line with the various indicators used to uprate these incomesto end-of-year values' (Beckerman and Clark, 1981, Annex B, p. 89). Furthermore, since theseadjusted estimates were last produced in 1980 (based on data for 1977) it is difficult to acceptthat this procedure embodied an official real poverty standard.

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INFLATION, PENSIONER LIVING STANDARDS AND POVERTY