Taxation without Legislation - Part II

Last week, in our exploration of the allegation that inflation has a larger impact on lower income households than on upper income households, we explored the characteristics of households by income quintile.  (Remember, a quintile represents 20% of the population and you may think of income quintiles as lower class, lower-middle class, middle class, upper-middle class, and upper class households.)  We made several conclusions and you are always able to review past “Tips” on our blog: http://mufinancialtip.blogspot.com/ . 

 

This week, we will look at consumer expenditures by expenditure category, as well as the proportions of consumers’ budgets being spent on items, by those same income quintiles.  This has the advantage of both being the next step in calculating differing rates of inflation by households’ expenditure allocations and it provides interesting insights to our country, in its own right. 

 

We, again, turn to the US Government’s Bureau of Labor Statistics.  The source is: http://www.bls.gov/cex/2009/Standard/quintile.pdf.  We have reproduced two tables.  The first provides the average dollar expenditure in broad categories of expenditures.  (More detail is provided in the original source.)  We have also calculated a table for the average percent of total expenditures that each quintile, on average, spends on each expenditure category.   It appears at the end of this “Tip”.

 

We draw your attention to the following summaries and we will refrain from talking about expenditures increasing with income, as they do in all cases with the exception of education and tobacco products.  For education, the large number of students with lower incomes, who are in the lowest income quintile, results in greater educational expenses for the lowest quintile compared to the second lowest.  For tobacco, between both the second lowest and middle quintiles and the fourth quintile and the highest quintile we observe average expenditures on tobacco decreasing.  These are noted by being in red font on the following table.  Where you see red, the good is called “inferior” as consumption decreases as income increases.  In contrast, when expenditures increase with income, economists call the good a “normal” good.

 

Item	All consumer units	Lowest 20 percent	Second 20 percent	Third 20 percent	Fourth 20 percent	Highest 20 percent
Average annual expenditures	$49,067	$21,611	$31,382	$41,150	$56,879	$94,244
Average Income	$41,875	$9,956	$27,275	$45,199	$71,241	$149,951
Food
Food at home	$3,753	$2,463	$2,999	$3,355	$4,316	$5,629
Food away from home	$2,619	$1,038	$1,569	$2,127	$3,206	$5,151
Alcoholic beverages	$435	$170	$250	$330	$541	$883
Housing
Shelter	$10,075	$5,392	$6,807	$8,804	$11,173	$18,185
Utilities, fuels, and public services	$3,645	$2,238	$3,069	$3,574	$4,172	$5,167
Household operations	$3,176	$1,330	$1,953	$2,428	$3,508	$6,645
Apparel and services	$1,725	$873	$1,161	$1,402	$1,848	$3,339
Transportation	$7,658	$2,855	$5,078	$6,717	$9,525	$14,105
Healthcare	$3,126	$1,628	$2,491	$3,069	$3,762	$4,677
Entertainment	$2,693	$1,015	$1,668	$2,106	$3,197	$5,474
Personal care products and services	$596	$268	$397	$496	$650	$1,167
Reading	$110	$48	$72	$91	$119	$217
Education	$1,068	$573	$369	$548	$881	$2,966
Tobacco products and smoking supplies	$380	$303	$413	$400	$439	$342
Miscellaneous	$816	$323	$522	$756	$921	$1,558
Cash contributions	$1,723	$559	$868	$1,435	$1,949	$3,801
Personal insurance and pensions	$5,471	$534	$1,694	$3,512	$6,664	$14,937

 

With regard to the importance of the expenditure category to consumers’ budgets, it is instructive to consider the proportion of each quintile’s total expenditures that are allocated to each category.  (This table is presented at the end of this week’s Financial Tip.)  The greater the proportion, we know that either the households, on average, receive greater satisfaction (utility) from that category of good, or the greater the necessity of that category to their livelihood.  Importantly, the greater the proportion of households’ budgets spent on a category, the more inflation in that category can negatively affect their total consumption and, hence, their satisfaction from that consumption.  (Economists call this Cournot Aggregation but we’ll leave Mr. Cournot out of this week’s tip.  We might reintroduce him, however, next week.) 

 

Consider this one other way.  If we tax a category of consumption, thus raising its price, on whom would the burden of tax fall?  For example, if higher income quintiles spend a larger proportion of their greater expenditures on alcohol (which they do), the burden of the tax on alcohol would be greater on them, when we compare them to lower income households.  (Note1: Most of these budget shares would be much greater for lower income quintiles, if we used household income as our denominator, instead of household total expenditures.  This would change some of the trends we observe both today and in the conclusion we draw next week.  Note2: We mention “income elasticity” a few times, below.  If the average percentage change in expenditures by category between quintiles is greater than the percentage increase in total expenditures between categories, economists call the good a “luxury” good in that expenditure range.  While we do not present an income elasticity table, we will highlight (in purple) the column following the column where the expenditure elasticity was found to represent a luxury between that column and the one adjacent to its left.)

·         Food expenditures increase with income, across both food categories.  As a percentage of total expenditures, however, food at home decreases as income quintile total expenditures increase while food away from home (eating out) generally increases as total expenditures increase.

·         The proportion of total expenditures spent on both shelter and utilities decreases with increases in income quintile, while expenditures on household operations shows a U-shaped pattern – at first decreasing and then increasing.

·         Expenditures on apparel, as a percentage of total expenditures, decrease as we move from the lowest to the second highest quintile.  We observe that the proportion increases, however, as we move from the second highest to the highest quintile.  (Income elasticity, calculated between income quintiles, indicates that apparel is a luxury good between these two income quintiles.)

·         Expenditures on transportation increase as a percentage of total expenditures for the first four income quintiles, and then decreases as we move to the highest income quintile. (Transportation is a luxury good, as we move between the first four quintiles.)

·         Healthcare expenditures, as a percentage of income, increase between the first and second quintiles and then progressively decrease as we move to the highest quintile.  (It is only a luxury good as we move from the lowest to the second lowest quintile.)

·         In general, the proportion of total expenditures spent on entertainment increases with total expenditures, except for the middle income quintile.

·         Interestingly, for personal care and reading the expenditure proportions are quite similar between income quintiles.

·         Education expenditures are greater, as a percentage of total expenditures for both the lowest and highest income quintiles. This is no doubt a reflection of students, with lower incomes, being in the lowest income quintile, as well as the age and family size characteristics of the highest income quintile. (It is found to be a luxury good as we move between the top four income quintiles.)

·         Tobacco, as a percentage of total expenditures, shows a steady decrease in the share of total expenditures, as we increase income quintiles.

·         Cash contributions are, generally, an increasing percentage of total expenditures, as we move up the income quintile ladder. Calculated elasticities of income for cash contributions indicate that cash contributions increase faster than total expenditures (thus, a luxury good in these ranges) between the lowest quintile and the second quintile, the second quintile and the middle quintile, and the fourth and fifth quintiles.

·         Dramatically, the proportion of household budgets spent on insurance and pension deposits increases with income quintile.  Clearly this reflects greater demand for insurance from larger family sizes, as well as greater income with which to save for retirement and insure against loss of life, health, or property.  (Pensions and Personal Insurance are highly income elastic as income increases.)

 

We understand this is a lot of information.  It can be quite instructive to compare your expenditures to your “membership” income quintile.  Moreover, when we observe the categories of expenditures where we see greater levels of income elasticity – those in purple – we know that when the economy is in good times and incomes increase, these categories of expenditures will grow the fastest.  Similarly, in a downturn, they will decrease the fastest.

 

You, however, are the only one who can control how much you spend and how you decide to ratchet up/down your expenditures as your income changes.  It is a fact of financial success that, if you do not ratchet up as fast during the good years, it is much easier to reach your financial goals, given the inevitable lean years when you must ratchet down.  (The human species, especially our politicians, have trouble acting on this fact.) 

 

Item	All consumer units	Lowest 20 percent	Second 20 percent	Third 20 percent	Fourth 20 percent	Highest 20 percent
Average annual expenditures	$49,067	$21,611	$31,382	$41,150	$56,879	$94,244
Average Income	$41,875	$9,956	$27,275	$45,199	$71,241	$149,951
Food
Food at home	7.65%	11.40%	9.56%	8.15%	7.59%	5.97%
Food away from home	5.34%	4.80%	5.00%	5.17%	5.64%	5.47%
Alcoholic beverages	0.89%	0.79%	0.80%	0.80%	0.95%	0.94%
Housing
Shelter	20.53%	24.95%	21.69%	21.39%	19.65%	19.30%
Utilities, fuels, and public services	7.43%	10.36%	9.78%	8.69%	7.34%	5.48%
Household operations	6.47%	6.15%	6.22%	5.90%	6.17%	7.05%
Apparel and services	3.52%	4.04%	3.70%	3.41%	3.25%	3.54%
Transportation	15.61%	13.21%	16.18%	16.32%	16.75%	14.97%
Healthcare	6.37%	7.53%	7.94%	7.46%	6.61%	4.96%
Entertainment	5.49%	4.70%	5.32%	5.12%	5.62%	5.81%
Personal care products and services	1.21%	1.24%	1.27%	1.21%	1.14%	1.24%
Reading	0.22%	0.22%	0.23%	0.22%	0.21%	0.23%
Education	2.18%	2.65%	1.18%	1.33%	1.55%	3.15%
Tobacco products and smoking supplies	0.77%	1.40%	1.32%	0.97%	0.77%	0.36%
Miscellaneous	1.66%	1.49%	1.66%	1.84%	1.62%	1.65%
Cash contributions	3.51%	2.59%	2.77%	3.49%	3.43%	4.03%
Personal insurance and pensions	11.15%	2.47%	5.40%	8.53%	11.72%	15.85%