Income (Economics)

Income, in economics, is the flow of money or other value that a person, household, business or country receives over a period of time, usually a month or a year. For individuals it includes wages and salaries, self-employment earnings, profits, interest, dividends, rent and government transfers such as pensions and benefits. For a whole economy, the total of incomes earned in production is national income.

Income is a flow, measured per period; wealth, or net worth, is a stock, measured at a point in time. The two are linked, because saved income adds to wealth and wealth produces income in the form of interest, dividends and rent. Income is central to economics because it limits what households can consume and save, and it is the base for most tax systems.

Think of a bathtub. Income is the water flowing in through the tap each month; wealth is the water already in the tub. A person with a big monthly salary but no savings has a strong flow and an empty tub. A retiree living off savings has a full tub but little coming in.

Money can flow in through different taps: pay from a job, profit from a business, rent from a flat, interest from a deposit, or a pension check from the government. Economists track each tap separately, because they behave differently when the economy changes and because governments usually tax them in different ways.

Classical economists matched each factor of production with a type of income, a grouping still used in national accounts:

• Labor income. Wages, salaries and benefits paid to employees, the largest share of national income in most countries.
• Capital income. Interest, dividends and retained profits earned by owners of capital.
• Rental income. Payments for the use of land and property; in economic theory, rent also means any return above what is needed to keep a resource in use.
• Mixed income. Earnings of the self-employed and small family businesses, which combine labor and capital returns.
• Transfer income. Pensions, unemployment benefits and other transfer payments, which redistribute existing income rather than reward current production.

The labor share, the part of national income paid to workers, has drifted down in the United States and several other rich countries since the 1980s, a trend studied by the OECD and the IMF.

Different income measures answer different questions. Gross income is everything received before tax. Disposable income is what a household can actually spend or save:

• $Y_d$ is disposable income.
• $Y$ is gross income from work and assets.
• $T$ is taxes and social contributions paid.
• $TR$ is transfers received from government.

A household earning 60,000, paying 14,000 in tax and receiving 2,000 in child benefit has disposable income of $60{,}000 - 14{,}000 + 2{,}000 = 48{,}000$. Disposable income is split between consumption and saving. To compare incomes over time, economists adjust for inflation: a 5 percent pay rise in a year of 3 percent inflation is roughly a 2 percent rise in real terms. At national level, gross national income and gross national product measure the income earned by residents, including income from abroad.

Economists disagree on exactly what counts as income. John Hicks, in Value and Capital (1939), defined it as the most a person could spend in a period and still be as well off at the end as at the start. The Haig-Simons definition used in tax policy counts consumption plus the change in net worth, which would include unrealized capital gains. Most real tax systems are narrower: income tax usually applies to realized gains only, and many countries tax wages, interest and capital gains at different rates. Theories of spending also distinguish current income from long-run income, as in the permanent income hypothesis and the life-cycle hypothesis.

How income is shared is one of the most debated subjects in economics. Income inequality is usually summarized with the Gini coefficient or the share received by the top 10 or 1 percent, and poverty lines are set in terms of income or consumption. Measurement is hard: surveys miss the very rich and under-record self-employment and informal earnings, tax data miss people below filing thresholds, and in-kind benefits such as public healthcare are often left out. Economists therefore combine surveys, tax records and national accounts, and results can differ depending on the method used.

• U.S. Bureau of Economic Analysis: Personal Income