Income

EMPIRICAL SIGNIFICANCE

BIBLIOGRAPHY

Income is often defined as the amount of money received during a given period of time by a person, household, or other economic unit in return for services provided or goods sold. Although this is certainly a serviceable definition, working economists need a more precise one. Many economists use a comprehensive definition of income attributed to Robert Haig and Henry Simons, that income is equal to a person’s (household’s) consumption plus the increase in his or her net worth (Haig 1921, p. 7; Simons 1938, p. 50). The two definitions differ in several respects; most notably, the informal definition refers to money received, whereas the Haig and Simons concept refers to changes in net worth.

There are important distinctions between money received, as in the informal definition of income, and changes in net worth, as in the Haig and Simons definition. For example, person A may give person B a dozen eggs for performing a service, and suppose person B uses the eggs to make breakfast. Because no money has changed hands in this example, there is no income according to the informal definition of income. In terms of Haig and Simons’s definition, however, person B’s income has changed his consumption; therefore, his income has increased by the value of the eggs. In other words, barter income is included in Haig and Simons’s income. To take another example, suppose a person buys a stock for $100 and its value increases to $150; unless he sells the stock, no money is received and his income from this asset is zero ($0.00). In terms of Haig and Simons’s income, however, his or her net worth has increased by $50, and thus there is income of $50 though no money has changed hands. In other words, accrued capital gains are included in Haig and Simons’s income.

It is useful for analytical purposes to distinguish between sources of income. Thus, economists, journalists, and policy makers often talk about wage income, dividends and interest income, transfer payments, and so on. Labor income is the income generated from working for a set wage, including tips and fringe benefits. Financial income is the income obtained from financial markets, which includes accrued capital gains, interest income, dividends, and retained earnings. Retirement income refers to pensions and retirement transfers. Government income refers to government transfers such as social insurance payments. Other sources of income include bequests, prizes and awards, and alimony payments received.

EMPIRICAL SIGNIFICANCE

Defining income is important to the analysis of public policy. Using a measure that is not comprehensive could alter the outcome of the policy, and as such may result in poor decision making. For example, if a tax administration such as the U.S. Internal Revenue Service taxes only wage income at a single rate, then the burden of such a tax would take a higher proportion of the total income of low-income households than high-income households, because low-income households obtain a greater share of their income from wages than do high-income households. Another area of research is in the distribution of income and income inequality.

Table 1 shows the distribution of income by source for a variety of countries. The similarities in the shares of income by source among these countries are noteworthy.

Although there appears to be considerable variation in income from employment, which varies from a low of 46.86 percent in France to a high of 75.61 percent in India, income from employment and taxes and social security contributions (payroll taxes) shows much less variation, with the smallest share being 65.64 in Mexico and the highest share being 82.25 percent in Japan. Many economists believe that tax policy may explain the relative shares of gross income from benefits. Because benefits such as contributions to retirement accounts and health insurance are generally not taxable, one would expect that people living in high-tax countries such as France would prefer to receive income in the form of untaxable benefits rather than taxable sources such as wages; in contrast, in low-tax countries such as India, people would prefer to receive income as wages. This pattern is borne out in the table.

SEE ALSO Inequality, Income; Interest Rates; National Income Accounts; Policy, Fiscal; Profits; Stocks and Flows; Taxes; Wages

BIBLIOGRAPHY

Birdsall, Nancy. 2006. Rising Inequality in the New Global Economy. International Journal of Development Issues 5 (1): 1–9.

Haig, Robert M. 1921. The Concept of Income: Economic and Legal Aspects. In The Federal Income Tax, ed. R. M. Haig. New York: Columbia University Press.

Piketty, Thomas, and Emmanuel Saez. 2006. The Evolution of Top Incomes: A Historical and International Perspective. American Economic Review 96 (2): 200–205.

Simons, Henry C. 1938. Personal Income Taxation. Chicago: University of Chicago Press.

Taylor, Lester D. 1971. Saving Out of Different Types of Income. Brookings Papers on Economic Activity 2: 383–407.

Mark Rider

Income

What It Means

Income is the money that individuals and businesses bring in during a given period as a result of work or investments. If, for example, a person is paid $50,000 per year as a computer programmer, she is said to have an annual income of $50,000. If the company that employs her brings in $1 million on top of the expenses it incurs during the year (these expenses would include costs such as office rent, maintenance, equipment purchases, and salaries), its income for that year is $1 million.

Income is either spent, invested, or paid to the government in the form of taxes. The U.S.-based computer programmer in the above example, for instance, might pay $15,000 of her salary to federal, state, and local governments in the form of income tax (a percentage of personal income that is owed to the government, and that varies depending on the size of the income). Money collected through income taxes provides governments with a large share of the expenses they need to operate. Of the $35,000 that remains, the computer programmer will use a large portion to purchase the food, clothing, and shelter that she needs to live. If any money remains after this, she might spend it on movie tickets, a new car, or graduate business courses; or rather, she might invest this leftover income, with the hope of increasing her income further. Whenever she purchases basic necessities or luxuries, she is contributing income to another person or business (a grocer, a landlord, a clothing store, a movie theater, a car dealership, a university). When she invests the money in a bank account that pays interest, or in the stock market, where she buys a portion of company ownership that stands to increase in value if the company succeeds, she increases the income of the bank or company to whom she is contributing her money at the same time that, if all goes well, she increases her own.

Because income drives the overall economy in this way, economists and government agencies pay detailed attention to the incomes of people and businesses, and they classify incomes in a number of different ways that lead to further understanding of how the economy works. One way they classify income is called the gross domestic product (GDP). Because spending by one person represents income to another, adding up either side of the transaction should yield the same amount. GDP is either the total amount of spending or the total amount of income generated in the economy over a year, and it represents the total size of the economy.

When Did It Begin

Today in capitalist countries (those nations in which individuals are allowed to own property and businesses and freely seek profit) people and companies are rewarded with incomes in proportion to such qualities as their capacity for hard work, their natural and cultural advantages, their performance on the job, and luck. This was not always the case.

The oldest and most common form of economy (examples of which still exist today in undeveloped countries) is what is known as a traditional economy. In a traditional economy people usually hunt and gather for food, and the proceeds are not kept by individuals but are divided up on the basis of traditional hierarchies. By 3000 bc a new economic model had allowed for the development of some of the great civilizations of the ancient world (for example, Egypt and China). This new form of economy, called a planned or command economy, was one in which a strong central ruler, such as a pharaoh or emperor, organized all wealth and income for his own benefit or the benefit of a small elite group of society. This allowed for more organization of resources like land and labor and, accordingly, a much larger ability to create wealth and undertake the vast projects necessary for the building of large cities and impressive monuments. Such great achievements were, again, enjoyed primarily by only a small portion of society. Ordinary people still had little power to produce incomes that benefited themselves.

This began to change in Europe during the sixteenth through eighteenth centuries, when their planned economies began to move toward capitalism. During this time the European nations that we know today were being formed out of smaller and more numerous preexisting kingdoms. These centralized governments (of France, England, and Germany, for example) needed to raise vast amounts of money in order to compete with one another militarily and politically, and capitalism provided a more efficient means of wealth creation than planned economic systems. Individual freedom did not emerge instantly; ruling elites still controlled a large part of the incomes produced by the capitalist system. Nevertheless, the notion that each individual has the right to work or otherwise produce an income strictly for his or her own benefit is a product of the rise of capitalism.

More Detailed Information

For most individuals income is the amount of money they are paid by their employers, prior to making any tax payments. Other people bring in income by investing money in ways that collect interest (fees paid by people who borrow money) or dividends (profits made in the stock market) or by renting out property. A company’s income, by contrast, is not simply the amount of money that it brings in through its normal business activities but the amount of that money that is left over after it has paid its expenses.

Economists classify income in numerous ways for the purposes of analysis. One way of doing so is by determining to what use people put their incomes. The uses to which income can be put include buying goods and services, paying taxes, and making investments. The amount of one’s income that is left over after paying income taxes is known as disposable income. The amount that is left after food, shelter, and clothing have been purchased is what is known as discretionary income. Discretionary income is used to buy goods and services other than these basic necessities.

When trying to understand what is happening at the national level, economists break income down into personal income (that which is acquired by households) and business income (that which is acquired by companies). The combination of these two quantities yields a figure called the national income, or the amount of money brought in by all people and businesses during a given time period.

Another useful way of looking at income is to consider the difference between money, or nominal, income (the value of a person or company’s income in actual currency, such as the dollar) and real income (the value of an income in terms of what it can purchase). Money income and real income represent different values chiefly because the prices of goods and services tends to rise over time. Thus, $10 in 1990 bought more than $10 in 2000.

Income is also commonly classified according to its source. Earned income is the wages and salaries that people are paid in exchange for their work. This represents about two-thirds of the U.S. national income. Unearned income makes up the other one-third, and it is derived from interest, rent, business profits, and other sources whose common characteristic is that they all represent money that is received for reasons other than straightforward labor. For example, interest is a fee paid for the use of money; rent is a fee paid for the use of property; and business profit is money that is acquired through combining all of a business’s resources to create value.

Yet another important way of evaluating income is to consider how it is distributed, or spread out over a country’s population. An economy’s health depends not simply on the total amount of income produced in a country but on how it is distributed. If, for example, an increasing amount of income goes to a very small minority in a nation, while the middle class holds a diminishing share of overall wealth and the number of poor people grows, the economy may not thrive over the long term. Economists therefore ask a variety of questions about how the national income is divided up among citizens. How much of a nation’s income goes to the rich, the middle classes, and the poor? What is the median individual income in a country (the income figure below which half of the population earn and above which half of the population earn), and how do the various portions of the population measure up against that median? How wide is the gap between the incomes of the rich and the incomes of the other classes in society?

Recent Trends

In 2005 the median income for American households was around $46,000 a year. This means that roughly half of the families in the United States made less than $46,000 and roughly half made more than $46,000. Adjusting for inflation (the general rising of prices that makes money worth increasingly less over time), American household incomes rose gradually but steadily, with some interruptions, between 1967 and 2005. In terms of what the dollar was worth in 2005, a typical American family made about $35,000 in 1967 (in actuality, the income would have been roughly six times smaller, around $6,000; it took about six dollars to buy in 2005 what one dollar could buy in 1967).

The small size of this increase (from $35,000 to $46,000) was at odds with the fact that the American economy as a whole had grown dramatically during that time. Additionally, individuals were making substantially more in 2005 than they had in 1967, and women had entered the workforce in large numbers in the intervening years, which would seem to result in households that would make twice as much as they had in earlier times.

But while the proportion of wives in the workforce more than doubled, the proportion of married couples within the general population declined dramatically at the same time. Around 40 percent of households in the late 1960s consisted of a married couple with children (the highest-earning type of household), but by the late 1990s these families only accounted for about 25 percent of American households. The U.S. population by 2005 consisted of a larger proportion of smaller households with only one income-earner, so most families were not considerably better off than they had been 28 years earlier, even though some families (especially those with two income-earners) were prospering far more than was possible in earlier eras.

INCOME

Income is an important concept in economics as well as accounting. Accountants prepare an income statement to measure a company's income for a given accounting period. Economists are concerned with measuring and defining such concepts as national income, personal income, disposable personal income, and money income versus real income. In each field the concept of income is defined in slightly different terms.

For accounting purposes, income is distinguished from revenues. A company's revenue is all of the money it takes in as a result of its operations. On the other hand, a company's net income or profit is determined by subtracting its expenses from its revenues. Thus, revenues are the opposite of expenses, and income equals revenues minus expenses. When looking at a company's income statement, it is easy to distinguish between revenues, which appear at the top of the statement, and net income, which appears at the bottom. In other contexts, however, it is easy to confuse the two through improper usage. It is misleading to refer to revenues as income, for a company with revenues of $1 million is much different from a company with net income of $1 million.

For personal income tax purposes, gross income is money received by an individual from all sources. Many of the items that the Internal Revenue Code defines as income and that are called income on tax form 1040 are actually revenues, such as dividend income, investment income, and interest income. The Internal Revenue Code also provides for exclusions and exemptions as well as for nontaxable types of income to arrive at the concept of taxable income.

While accountants measure a single company's income for a specific accounting period, economists are concerned with the aggregate income for an entire industry or country. In looking at an entity as a whole, economists define its gross income as the total value of all claims against its output. That is, when goods are produced and services are rendered by the entity, workers, investors, the government, and others have a claim against those goods and services. Workers are paid wages or salaries, investors receive interest payments for their investment, and the government collects taxes. The total value of these claims represents the entity's gross income and is equal to the total value added through activities that have contributed to the production of the entity's goods and services.

In looking at the economy as a whole, economists view gross national income as the total of all claims on the gross national product. These include employee compensation, rental income, net interest, indirect business taxes, capital consumption allowances, incomes of proprietors and professionals, and corporate profits. National income includes all compensation paid to labor and for productive property that is involved in producing the gross national product. In addition, about 20 percent of national income includes such items as depreciation or capital consumption allowances, indirect business taxes, subsidies less surpluses of government enterprises (such as the U.S. Postal Service), and business transfer payments to employees not on the job.

Personal income includes all payments received by individuals, including wages, transfer payments such as sick pay or vacation pay, and the employer's contribution to Social Security. Personal income differs from national income in two important aspects: (1) some national income is received by entities other than individuals, and (2) some individuals receive personal income from social insurance programs that are not connected with producing the current gross national product.

Disposable personal income is the amount of personal income that remains after an individual's taxes have been paid. It is estimated that approximately 70 percent of the gross national income ends up as disposable personal income. The remaining 30 percent includes such items as depreciation, retained corporate profits, and the government's net tax revenue.

Economists also distinguish between money income and real income. While money income is measured in terms of the number of dollars received, real income is measured by the purchasing power of those dollars. After all, what is important is not how much money you earn, but how much you can buy with that money. Economists use a deflator based on a price index for personal goods and services to calculate an individual's real income from his or her money income. Since rising prices reduce the dollar's purchasing power, real income provides a truer measure of buying power than does money income.

See also: Revenue

INCOME

By working and being productive, households earn an income and businesses make a profit. The total amount that households and businesses receive before taxes and other expenses are deducted is called aggregate income. The amount of money that is left after taxes and other expenses have been deducted from one's pay is called disposable income. Discretionary income is what consumers (households) have to pay for the goods and services they desire. This article will focus only on households and how they consume their income. Households spend most of their discretionary income on consumption. Some consumers spend even more than their current discretionary income on consumption by borrowing. Consumption consists of almost everything that consumers purchase, from durable to nondurable goods as well as all types of services. The only exception to this rule is the purchase of a new home: It is counted as an investment because homes tend to appreciate in value.

Households (individuals) cannot spend all their earnings on consumer goods and services. Part of the income each household receives must be used to pay different kinds of taxes, such as income taxes to federal, state, and local governments. Most state and local governments also impose sales taxes. In addition to paying income and sales taxes, households may also have to pay property taxes to local governments. After paying taxes and spending income on consumables, some households put aside money as savings to be used for consumption at a later time.

Earnings differ among individuals and households because of several factors: (1) inborn differences, (2) human-capital differences, (3) work and job performance, (4) discrimination, (5) age, (6) labor mobility, (7) government programs and policies, and (8) luck.

Inborn differences are those characteristics that one is blessed with, such as strength, energy, stamina, mental capacity, natural ability, and motivation.

Human-capital differences reflect how people invest various amounts of both their physical and mental capacities toward the achievement of specific goals.

Work and job performance indicates how individuals differ in their preferences regarding the trade-off between work and leisure. Those who wish to work more usually receive a higher income; others prefer more leisure at the cost of earning a lower income. People also prefer different types of jobs. These specific job choices will affect the distribution of income.

Discrimination is treating people differently solely on the basis of factors unrelated to productivity.

Age affects earnings significantly. Most individuals earn little before the age of eighteen. Earnings tend to increase as workers gain experience and their productivity increases.

Labor mobility, which is the willingness to go where the jobs are or to move wherever the company has a need, enhances an individual's income potential. Immobility limits workers' response to changes in wage rates and can contribute to an unequal distribution of income.

Government policies and programs, such as benefit programs and the progressive income tax, reduce income inequality. The minimum wage may also increase income inequality.

Luck plays a role in determining the distribution of income, but choices are perhaps the most important factor.

bibliography

Mings, Turley (2000). The Study of Economics: Principles, Concepts, and Applications (6th ed.). Guilford, CT: Dushkin Publishing Group.

Gregory P. Valentine

INCOME

The return in money from one's business, labor, or capital invested; gains, profits, salary, wages, etc.

The gain derived from capital, from labor or effort, or both combined, including profit or gain through sale or conversion of capital. Income is not a gain accruing to capital or a growth in the value of the investment, but is a profit, something of exchangeable value, proceeding from the property and being received or drawn by the recipient for separate use, benefit, and disposal. That which comes in or is received from any business, or investment of capital, without reference to outgoing expenditures.