Adjusting Poverty Thresholds When Area Prices Differ: Labor Market Evidence

Overview The decision whether and how to adjust poverty thresholds for area differences in prices depends, among other things, on the reasons that prices differ across metropolitan areas and what one believes a threshold ought to measure. 1 If one starts with the premise that a poverty threshold ought to provide the same purchasing power across markets; that is, enable one to buy the same bundle of well defined housing and non‐housing goods regardless of location, then full indexing to an appropriate price index is in order. If one shifts away from an emphasis on equivalent purchasing power for a fixed set of goods and services to the broader concept of equivalent individual or household well‐being (utility), full indexing to area price‐level differences does not follow. First, when faced with different relative prices, households adjust their consumption bundles away from those goods and services with relatively high prices and toward those with relatively low prices. 2 For a given level of well‐being, household will purchase different bundles of goods and services in Peoria than in New York City. Second, area amenities that enhance utility increase the price of land (and hence housing rents and prices), while at the same time decreasing equilibrium wages for any given level of prices. Absent full accounting for area amenities, area wages should not and do not generally increase one‐for‐one with area prices. That is, in a log wage equation absent control for amenities, the wage‐price elasticity Θ, measured by the coefficient on lnP, is below unity. Across labor markets, real wages (W/P) and purchasing power do not equalize but, at the margin, utility does. If wages across markets were somehow administratively indexed fully with respect to P, wages would be above equilibrium in high amenity cities and below equilibrium in low amenity cities. The appropriate index for area wages (and, arguably, for adjusting poverty thresholds) is not a price index but an area wage index for workers of similar skill in jobs with similar tasks and working conditions. This is the " adjustment " that is produced more or less automatically through market forces. 3 Similar reasoning applies to the question of whether and how to adjust poverty thresholds for price (or wage) differences. As carefully shown in Glaeser (1998), if there is sufficient mobility among the population receiving transfers (and there may not be), marginal utilities of income should equalize 1 Throughout the …