Earnings Capacity, Economic Status, and Poverty

Abstract

Whether or not a household is counted among the poor depends upon its annual money income. As a measure of economic status, however, annual money income has serious limitations. In this paper an alternative indicator of economic status, called earnings capacity, is developed. Earnings capacity is designed to measure the ability of a living unit to generate an income stream if it were to use its physical and human capital at capacity. Using this measure, the composition of the poverty population is estimated and compared to the composition of the poverty population according to the official definition. In addition, the socioeconomic and demographic determinants of poverty as measured by earnings capacity and by annual money income are compared and contrasted. The problem of accurately measuring the economic status of family units and individuals is of long standing in both poverty research and analyses of horizontal and vertical inequality. The standard indicator of economic status-annual family money income-is the basis both for the official definition of poverty in the United States and for nearly all studies of economic inequality. Yet the limitations of the money income measure as an indicator of both the command over goods and services and relative economic status are often noted. Annual money income fails to incorporate the value of human and nonhuman capital into the measure of economic status; it neglects the benefits of in-kind public Garfinkel is Professor of Social Work and Director, Institute for Research on Poverty, University of Wisconsin, Haveman is Professor of Economics, University of Wisconsin. * The research reported here was supported by funds granted to the Institute for Research on Poverty, University of Wisconsin-Madison, by the U.S. Department of Health, Education, and Welfare pursuant to the provisions of the Economic Opportunity Act of 1964. The opinions expressed are those of the authors. [Manuscript received August 1975; accepted January 1976.] The Journal of Human Resources ' XII ? I This content downloaded from 157.55.39.59 on Sat, 15 Oct 2016 04:15:01 UTC All use subject to http://about.jstor.org/terms 50 1 THE JOURNAL OF HUMAN RESOURCES transfers and public services and the tax costs required to finance them; it does not account for intrafamily flows of income and services or for differences in leisure time; and, for many units, it is dominated in any given year by transitory influences. In short, annual money income is a seriously inadequate indicator of the potential real consumption of a living unit; yet it is the indicator most widely used. In this paper, an alternative indicator of economic status is suggested and estimated empirically for the national population. This indicator-earnings capacity-is designed to measure the ability of a living unit to generate an income stream if it were to use its physical and human capital at capacity.' Using this measure, the composition of the poverty population is estimated and compared with the composition of the poverty population according to the official definition. Because of the characteristics of the concept, the poverty population defined by earnings capacity will be relatively more heavily populated by those with a low permanent income than will the poverty population defined by the intertemporally unstable concept of annual money income.2 Moreover, living units will not be included in the poverty population simply because they have relatively strong preferences for leisure rather than for money income.