APPENDIX 3 EQUIVALISED DISPOSABLE HOUSEHOLD INCOME
Equivalence scales have been devised to make adjustments to the actual incomes of households in a way that enables analysis of the relative wellbeing of households of different size and composition. For example, it would be expected that a household comprising two people would normally need more income than a lone person household if the two households are to enjoy the same standard of living.
One way of adjusting for this difference in household size might be simply to divide the income of the household by the number of people within the household so that all income is presented on a per capita basis. However, such a simple adjustment assumes that all individuals have the same resource needs if they are to enjoy the same standard of living and that there are no economies of scale derived from living together.
Various calibrations, or scales, have been devised to make adjustments to the actual incomes of households in a way that recognises differences in the needs of individuals within those households and the economies that flow from sharing resources. The scales differ in their detail and complexity but commonly recognise that the extra level of resources required by larger groups of people living together is not directly proportional to the number of people in the group. They also typically recognise that children have fewer needs than adults.
When household income is adjusted according to an equivalence scale, the equivalised income can be viewed as an indicator of the economic resources available to a standardised household. For a lone person household it is equal to household income. For a household comprising more than one person, it is an indicator of the household income that would need to be received by a lone person household to enjoy the same level of economic wellbeing as the household in question.
Alternatively, equivalised household income can be viewed as an indicator of the economic resources available to each individual in a household. The latter view underpins the calculation of income distribution measures based on numbers of people, rather than numbers of households.
CHOICE OF SCALE
While there has been considerable research by statistical and other agencies trying to estimate appropriate values for equivalence scales, no single standard has emerged. In theory, there are many factors which might be taken into account when devising equivalence scales, such as recognising that people in the labour force are likely to face transport and other costs that can affect their standard of living. It might also be desirable to reflect the different needs of children at different ages, and the different cost levels faced by people living in different geographic areas. On the other hand, the tastes and preferences of people vary widely, resulting in markedly different expenditure patterns between households with similar income levels and similar composition. Furthermore, it is likely that equivalence scales that appropriately adjust incomes of low income households are not as appropriate for higher income households, and vice versa. This is because the proportion of total income spent on housing tends to fall as incomes rise, and cheaper per capita housing is a major source of economies of scale that flow from people living together.
It is therefore difficult to define, estimate and use equivalence scales which take all relevant factors into account. As a result, analysts tend to use simple equivalence scales which are chosen subjectively but are nevertheless consistent with the quantitative research that has been undertaken. A major advantage of simpler scales is that they are more transparent to the user, that is, it is easier to evaluate the assumptions being made in the equivalising process.
In this publication, the 'modified OECD' equivalence scale is used. The 'modified OECD' equivalence scale has been used in more recent research work undertaken for the Organisation for Economic Co-operation and Development (OECD), has wide acceptance among Australian analysts of income distribution, and is the stated preference of key Survey of Income and Housing (SIH) users.
DERIVATION OF EQUIVALISED INCOME
Equivalised income is derived by calculating an equivalence factor according to the chosen equivalence scale, and then dividing income by the factor.
The equivalence factor derived using the 'modified OECD' equivalence scale is built up by allocating points to each person in a household. Taking the first adult in the household as having a weight of 1 point, each additional person who is 15 years or older is allocated 0.5 points, and each child under the age of 15 is allocated 0.3 points. Equivalised household income is derived by dividing total household income by a factor equal to the sum of the equivalence points allocated to the household members. The equivalised income of a lone person household is the same as its unequivalised income. The equivalised income of a household comprising more than one person lies between the total value and the per capita value of its unequivalised income.
Equivalised household income is an indicator of the economic resources available to each member of a household. It can therefore be used for comparing the situation of individuals as well as comparing the situation of households.
When unequivalised income is negative, such as when losses incurred in a household's unincorporated business or other investments are greater than any positive income from any other sources, then equivalised income has been set to zero.
GROSS INCOME AND EQUIVALISED DISPOSABLE INCOME
The SIH collects data on households' gross income. However, disposable income, that is, gross income less the value of income tax and Medicare levy to be paid on the gross income, is a better indicator of the resources available to a household to maintain its standard of living. Therefore, for this publication, estimates of income tax payable on gross income reported in the SIH are made by means of a tax model. The tax and Medicare estimates are subtracted from gross income to give disposable income, and the equivalence factors are applied to the estimates of disposable income. Person weighted measures of income distribution are then derived from the estimates of equivalised disposable household income. (Appendix 1 describes the difference between person weighted and household weighted measures.)
Means and medians of both gross income and equivalised disposable income are shown in some tables in this publication to allow users to see the differences between data as collected and data as standardised to facilitate income distribution analysis. The following table shows the differences in income measures when calculated from data at different stages in the progression from gross household income to person weighted equivalised disposable household income.
A5. From gross income to person weighted equivalised disposable income
Equivalised disposable household income per week
Gross household income per week
|Percentile boundaries and percentile ratios |
|P10 ||$ |
|P20 ||$ |
|P50 ||$ |
|P80 ||$ |
|P90 ||$ |
|P90/P10 ||ratio |
|P80/P20 ||ratio |
|All households ||$ |
|One family households |
|Couple family with dependent children ||$ |
|One parent family with dependent children ||$ |
|Couple only ||$ |
|Other one family households ||$ |
|Multiple family households ||$ |
|Non-family households |
|Lone person ||$ |
|Group households ||$ |
|na not available |
The first column in the table above shows measures calculated from gross household income, as collected in the SIH. The next column shows estimates of income tax to be paid on gross income, with the third column giving the resultant disposable household income.
Individuals with higher incomes will normally be expected to pay higher income tax than individuals with lower incomes, but this relationship is not as strong for households. A household with relatively high income may comprise only one individual with high income or it may include a number of individuals with relatively low income. The disposable income in the first situation will be lower than that in the second situation, and will result in a reranking of the households in the formation of percentiles. Therefore a household may fall into a different percentile in an analysis of disposable income compared to an analysis of gross income.
As would be expected, the difference between disposable income and gross income increases as income levels increase. At the upper boundary of the tenth percentile (P10), there is little difference, that is, the income tax to be paid by households with the lowest levels of gross income is negligible. In contrast, there is more than $550 per week difference between the P90 value for gross household income and the P90 value for disposable household income.
Disposable income relates to the household as a whole and the percentiles and means are calculated with respect to the numbers of households concerned. These are referred to as household weighted estimates. Equivalised disposable household income can also be household weighted (see the fourth column in the table), but since it can be viewed as a measure of the economic resources available to each individual in a household, income measures for equivalised estimates are generally based on numbers of people rather than numbers of households (see the fifth column in the table). This is referred to as person weighting and ensures that people in large households are given as much weight in the distribution as people in small households. While the ranking underlying the formation of percentiles is the same for the household and person weighted estimates, the boundaries between the percentiles differ because household weighted percentile boundaries create subgroups with equal numbers of households while person weighted percentile boundaries create subgroups with equal numbers of persons. The extent to which the boundaries differ reflects the extent to which the average household size differs between percentiles.
The person weighted estimate of P10 ($274) is higher than the household weighted estimate of P10 ($253). This implies that the households with the lowest rankings of equivalised disposable household income tend to comprise a lower than average number of persons. In other words, the 10% of people with the lowest income make up more than the 10% of households with the lowest income.
For lone person households, the two measures of equivalised disposable income are the same as each other ($535) and are just a little higher than disposable income ($532). Equivalised disposable income for lone person households is approximately the same as disposable income, because the equivalising factor for such households is 1.0. The reason for the slight difference between them is that some households have negative disposable income and their values are reset to zero before equivalising is carried out.
For all other types of household composition, equivalised disposable income is lower than disposable income, since income is adjusted to reflect household size and composition. Mean equivalised disposable income for couple only households is the same for both the household weighted and the person weighted measures since there are always two and only two persons in such households. For most other multi-person households, person weighted mean income is lower than the household weighted mean. This implies that, within each type, larger households tend to have lower equivalised household income.