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Low Income Cut-offs (LICOs)
Rebasing and Indexing the LICOs
Low income rate and low income gap
Use of after-tax and before-tax LICOs
Low Income Measures (LIMs)
Market Basket Measure (MBM)
Low income cut-offs (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 cut-offs 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.
The first step in the production of a set of low income cut-offs 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 43% of their after-tax income (and 35% of their total “before-tax” income) on these necessities. Then, 20 percentage points are added, giving 63% 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.
Over time, Canadian families have spent a smaller percentage of their income on the necessities of food, shelter and clothing. This relationship between families' income and spending is associated with a specific point in time, i.e. the year of the expenditure survey used to derive the cut-offs. That particular year is referred to as the base year for the set of cut-offs.
After having calculated LICOs in the base year, cut-offs for other years are obtained by applying the corresponding Consumer Price Index (CPI) inflation rate to the cut-offs from the base year - the process of indexing the LICOs.
To determine whether a person (or family) is in low income, the appropriate LICO (given the family size and community size) is compared to the income of the person's economic family. If the economic family income is below the cut-off, all individuals in that family are considered to be in low income. In other words, “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 cut-off. Similarly, “children in low income” means children who are living in low income families. Overall, the low income rate for persons can then be calculated as the number of persons in low income divided by the total population. The same can be done for families and various sub-groups of the population; for example, low income rates by age, sex, province or family types.
The low income gap is the amount that the family income falls short of the relevant low income cut-off. For example, a family with an income of $15,000 and a low income cut-off 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. For the calculation of this low income gap, negative incomes are treated as zero.
Statistics Canada produces two sets of low income cut-offs and their 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. Derivation of before-tax versus after-tax low income cut-offs are each done independently. There is no simple relationship, such as the average amount of taxes payable, to distinguish the two types of cut-offs.
Although both sets of low income cut-offs continue to be available, Statistics Canada prefers the use of the after-tax LICOs. The before-tax rates only partly reflect the entire redistributive impact of Canada's tax/transfer system. It is therefore logical that the low income rate is higher on a before-tax basis than on an after-tax basis.
For the purpose of making international comparisons, the LIM is the most commonly used low income measure. Unlike the low income cut-offs, which are derived from an expenditure survey and then compared to an income survey, the LIMs are both derived and applied using a single income survey. The LIM is a fixed percentage (50%) of median adjusted family income, where "adjusted" indicates that family needs are taken into account. See the paragraph Family size adjustment (equivalence scale) for more information.
The LIMs are calculated three times; using market income, before-tax income, and after-tax income. They do not require updating using an inflation index because they are calculated using an annual survey of family income.
Social Development Canada (formerly Human Resources Development Canada) has collaborated with the provincial and territorial ministries of social services to develop the Market Basket Measure (MBM) of low income. The approach is to cost out a basket of necessary goods and services including food, shelter, clothing and transportation, and a multiplier to cover other essentials. The results define thresholds that represent levels of income needed to cover the cost of the basket.
The same argument that can be made for using after-tax low income rates can be made for using after-tax income to compare to the MBM thresholds. That is, a measure of well-being should take into account what is actually available to spend. The income concept that is used for comparisons with the MBM thresholds goes even further than after-tax income by also subtracting from total income other non-discretionary expenses such as support payments, work-related child care costs and employee contributions to pension plans and to Employment Insurance.
Statistics Canada collects the data necessary to produce rates based on Social Development Canada's Market Basket Measure.