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Measuring Poverty: A New Approach
nondiscretionary. Within the field of economic science, the assumption that all medical care expenses are nondiscretionary runs contrary to three decades of economic research. From the early work of Pauly (1968) and Grossman (1972) to later work by Newhouse (1993) and others, economists have viewed health as an economic good, responsive to both income and price changes. This consumer choice approach has dominated economic analysis of health care and a greatly enhanced analysis of health care expenditures. Although this research does not offer any firm conclusions about how health care should be treated in the context of poverty measurement, its basic premise is at odds with the panel's rationale.
The panel's recommendation is based on an approach suggested in a 1985 conference paper by David Ellwood and Larry Summers. In the decade since that paper was presented, there has not been, to my knowledge, a single critical evaluation or discussion of it in any major peer reviewed scientific economics journal. The paper's merits aside, its approach has not undergone the kind of assessment that science requires before a scientific consensus is reached.
The report argues that deducting out-of-pocket expenses removes medical care entirely from the calculation of poverty. The argument is not correct, as the following example illustrates. Consider two healthy families—the Smith family and the Jones family. Suppose the Smith family has an income that is $2,000 higher than the Jones's. The Smith family purchases a $3,000 health insurance plan while the Jones family purchases no health insurance. Both families are fortunate enough to have no additional out-of-pocket health expenditures during the year. According to the report's recommended treatment, the Smith family would be poorer than the Jones family. And it would be so only because it chose to spend its higher income on health insurance.
The panel also argues that, by excluding medical care from its list of basic goods, its treatment is consistent. However, for two reasons, this argument is less than satisfactory. First, the 15 to 25 percent add-on to the poverty threshold "for other needed expenditures" can be construed as building in an amount for medical care. In fact, the dollar value of this percentage—$1,800 to $3,200—is more than one-half the actuarial value of Medicaid for the noninstitutionalized population and close to the cost of a typical private insurance plan. Second, the panel could have obtained the same range for the poverty threshold by including medical care as a fourth basic commodity and basing the threshold on the 20th instead of the 30th percentile of the consumption distribution.
One final point about the panel's treatment of in-kind benefits is in order. Much of the impetus for changing the way in which resources are counted comes from the fact that the current method ignores the value of billions of dollars in noncash benefits for food, housing, and medical care that are spent on low-income families. The reader will be surprised to see that the panel,