This article is a condensed version of a research paper that can be found here.
When looking at trends in household income, it is important that we make adjustments to the data so that they more accurately reflect reality. I recently wrote a scintillating essay on the best way to adjust household income growth to take inflation into account. The conventional approach understates the extent to which living standards have improved over the long run.
Incomes should also be adjusted for household size when looking at trends. It is important to adjust incomes for household size when analyzing trends in living standards because households are smaller today than in the past. The improvement in living standards since the 1960s is neglected if we ignore the fact that three people living together need less than four people.
Many analysts and commentators believe that adjusting for declining household size is wrong-headed if we are interested in assessing changes in living standards over time. They view shrinking households as a reflection of growing hardship. Given this trend, “adjusting” incomes to account for the drop in household size is perverse—it makes trends in living standards look better than they are when in actuality we should be making an adjustment in the other direction.
In contrast, the argument for size-adjustment is that the drop in household size either has nothing to do with economic trends or reflects the rising affluence of Americans. With increasing wealth, families have substituted more “stuff” for the children they would have had in the past. Greater wealth has also enabled more people to move out of their parents’ home, delay or forego having to live with a spouse or partner, walk away from unfulfilling relationships, and live without roommates.
Which side has the better case? It’s not even close.
From 1970 to 1990, household size shrank considerably, largely because fewer adults had children and those that did had fewer of them. But did the falling number of children reflect rising prosperity or rising hardship? One clue is provided by the fact that the number fell between 1970 and 1990 among both lower- and higher-educated Americans. If worsening economic conditions were leading families to have fewer children, we would expect that the decline in the number of children would be larger among less-educated adults. But the opposite is true: the more educated the person, the scarcer children became.
After 1990, the evidence also goes against the claim that diminished living standards have driven changes in household size. Household size actually rose a bit between 1990 and 2010. That means that during this period, adjusting for household size will tend to make income growth look smaller than it does without any adjustment, not larger. The increase in household size after 1990, however, is dwarfed by the decline in the preceding twenty years.
It is not necessary to adjust for household size to see that living standards have risen over time. No matter how you measure income or inflation, the middle class has become more prosperous over time. Similarly, poverty has declined. That’s not true of the official Census Bureau estimates, but all of the various attempts to correct the flaws of the official poverty measure show poverty lower today than in 1969. Nor have the earnings of middle-class or low-skilled men declined over this period, though they have not risen appreciably.
There is simply no evidence to support the idea that smaller households today reflect a deterioration in living standards rather than improved living standards. Therefore, the question is not whether we should adjust incomes for household size when looking at income trends, but how to do so.
When adjusting incomes to make households of varying sizes comparable, one could simply assume that a household of two people needs twice as much income as a single person living alone to have the same level of wellbeing. That’s clearly not right though. Two people living together do not have to pay rent to two different landlords. The most common way of adjusting is to simply take the square root of household size and then divide household income by this amount, which assumes that a household of four people needs twice as much income as a single person living alone.
Any number of alternative adjustments are possible. In the past, the Organisation for Economic Co-operation and Development (OECD) has counted additional adults beyond the first as 50 percent of a person and children as 30 percent of a person, then incomes are adjusted by this modified household size. An influential National Academy of Sciences (NAS) panel in 1995 proposed using an exponent between 0.65 and 0.75, instead of an exponent of 0.5.
In the context of falling household size and rising income, dividing income by the square root of household size generally will produce conservative estimates of income gains relative to the gains dividing by the NAS or OECD alternatives. The differences between taking the square root of household size and using the OECD or NAS approaches, however, are modest compared with the extremes of not adjusting incomes at all or simply dividing by household size.
In order to show the true increase in standards of living, income needs to be adjusted for household size. While the Census Bureau estimates suggest that median household income rose by just 10 percent from 1969 to 2013, dividing by the square root of household size and using the best inflation adjustment indicates the increase was 45 percent.
Scott Winship is the Walter B. Wriston Fellow at the Manhattan Institute for Policy Research. You can follow him on Twitter here.
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