November 18, 2006
Donald R. Byrne, Ph.D.
Edward T. Derbin, MA, MBA
Note: To print a hard copy of this newsletter, click on the following link for a PDF download…
THE RICH, THE POOR, AND THE WANNABEES:
A Study of the Distribution of Income and Wealth of the
To paraphrase a friend, the public’s perception of wealthy is the person who earns a dollar more than them, but never them.
The technical meaning of income, without any modifying words, is that it is the reward to productive resources for their current employment in the transformation process called production.
This occurs at a firm. The traditional names for each of the productive resource types are labor, capital, entrepreneurship, and land. A rich history of controversy has taken place over the centuries since Adam Smith wrote his Wealth of Nations in 1776.
argued that only land was productive in a net sense, only land ceated a surplus.
Marx and most socialists argued that only labor is productive in a
net sense. Only labor created surplus value. On this basis Lenin and his successors
Some Austrian school adherents enjoined Marx to argue he was wrong and that capital was productive (http://en.wikipedia.org/wiki/Austrian_School). Jean Baptiste Say put forth the idea that entrepreneurship was productive, and so it went and to some even currently, they continue one tradition or another (http://en.wikipedia.org/wiki/Jean-Baptiste_Say).
The modern discipline of Economics recognizes that all of these resources are productive (land, labor, entrepreneurship and capital) in a net sense and that production is a combination of all resources in a process called production that transforms these resources into useful goods and services.
THE DISTRIBUTIONS OF INCOME AND WEALTH
Income Distribution – What is it?
The traditional income distribution, as presented by the U.S. Census Bureau, divides the population into households and then divides those households into five equal quintiles, from the lowest income households to the highest. Each quintile then has an upper and a lower threshold that is estimated by the Census Bureau. The much-ballyhooed “middle class” is represented by the middle quintile.
The approach we will take is to present some current data of which few people are aware. It comes from various sources such as the Census Bureau, Bureau of Economic Analysis, Internal Revenue service, etc.
We will be focusing on the
term income, but much of the time the word income is used it has a modifier
that changes its meaning (income) significantly. It leads to another
Of course, income is not wealth. The distribution of wealth is different than is the income distribution. In fact, income is a flow of rewards to productive resources over a period of time for participating in production process. Wealth is a stock of assets measured at a point in time. A person or household can have a very high income but have little wealth. Conversely, a person can have great wealth but in a relative sense, receive little income. In this article, we will confine our discussion to income.
The Census Bureau and the distribution of Household MONEY income
Household income includes all the income received by the entire household that was measured during a census. The Ten Year census is an enumeration while those in between the decennial censuses use smaller statistically determined samples. Households include family households and non-family households.
Again, the definition of income in the census data is referred to as money income.
The Bureau of the Census uses a "money income" concept as the basis for its per capita income estimate. Money income is the sum of all sources of cash income including wages and salaries, income earned through self employment and farming, interest, dividends, and rental income, social security payments, disability payments, pensions, alimony and child support, winnings from gambling, and other cash income sources.
Household income is the sum of money income received in a calendar year by all household members 15 years old and over, including household members not related to the householder, people living alone, and other nonfamily household members. Included in the total are amounts reported separately for wage or salary income; net self-employment income; interest, dividends, or net rental or royalty income or income from estates and trusts; Social Security or Railroad Retirement income; Supplemental Security Income (SSI); public assistance or welfare payments; retirement, survivor, or disability pensions; and all other income.
The New Paradigm approach to these issues considers the distribution of real income as well as money income. Real income is the amount of goods and services that your money income will buy. Remember that the household is not only the supplier of productive resources, but it is also the consumer of some of the goods and services produced.
As competition increases and puts downward pressure on the price of goods and services, a given amount of household income can buy more goods and services as prices fall.
(Deflation --- not necessarily a bad thing…restructuring)
If two workers were in the same household earning $11.50 per hour each in wages only and working a standard 2,000 hours per year each, this would place them at just about the median in the income distribution, which is close to $46,000.
The thresholds dividing each twenty percent of households from the next quintile (from lowest to highest) are rather surprising to most who view them for the first time. Usually, most think they seem very low based on their intuition. For example, you find that some households with two public school teachers in major metropolitan areas receive money income that places them in the top 20% income earner bracket.
Contrary to the
often-repeated statement that the middle class is disappearing, rest-assured
there will always be a middle class – statistically speaking. The middle
quintile represents the income range above which are 40% of the households and
below which are 40% of the households. This is true in the
Quintiles: Dividing the population into five equal segments
(Population) Median: The halfway point in measured population; the median, in terms of the quintiles would be the midpoint of the third quintile – again, the third quintile represents the middle class.
A recent study by the Dept. of Labor indicated that the average compensation of a laborer is about $27 per hour. Now be careful here because that includes non-wage compensation of individual workers (pension contributions by the firm, health care insurance costs paid by the firm, etc.). Because these non-wage benefits are often treated preferentially for tax purposes, they have a higher after tax value than the usually fully taxable wage income.
A number of sources point out that the typical in-house UAW production worker at the three traditional nameplate American auto firms (GM, Ford, and Daimler-Chrysler) costs a total of $ 130,000 per year, or about $65 per hour (estimate of the Wharton School of Business of the University of Pennsylvania). The auto firms that are transplants from other parts of the world, have a $25-30 per hour total labor compensation advantage over the traditional big three American firms, much of that advantage is in significantly lower non-wage compensation. That is still approximately a total labor compensation package of $60,000 per year and appreciably higher than the median compensation level per worker throughout the rest of the economy.
INCOME LEVELS AND POVERTY
The Census Bureau publishes different estimates of poverty, based upon 15 different definitions of income.
Bureau of Economic Analysis
Disposable personal income: Total after-tax income received by persons; it is the income available to persons for spending or saving.
Note that the first definition of income used is money income. It is before taxes but includes some money transfer payments (see box above). It then alters the definition to generate the other 14+ definitions. The closest definition to disposable personal income as defined in the National Income and Product Accounts is definition number 14. The poverty rate consistent with that definition of income is 8.4% of the total population living in such households.
Note also that as the definition of income is refined to include deductions for most taxes and additions for most transfer payments and non-wage compensation, the poverty rate falls from 19.1% until definition 15, which indicates a poverty rate of 7.5%.
Many critics argue that illegal income or legal income not reported would lessen the poverty rate even further if such income was in fact included.
RELATIVE VERSUS ABSOLUTE POVERTY
When poverty is discussed
in this context, it is not the absolute abject variety you would find in the
Example: Family A has five members: two children, their mother, father, and great-aunt.
Their threshold was $22,509 dollars in 2003. (See poverty thresholds for 2003)
Suppose the members' incomes in 2003 were:
First child: 0
Second child: 0
Total family income: $25,000
Compare total family income with their family's threshold.
Income / Threshold = $25,000 / $22,509 = 1.11
Since their income was greater than their threshold, Family A is not "in poverty" according to the official definition.
The income divided by the threshold is called the Ratio of Income to Poverty.
Family A's ratio of income to poverty was 1.11.
The difference in dollars between family income and the family's poverty threshold is called the Income Deficit (for families in poverty) or Income Surplus (for families above poverty)
-- Family A’s income surplus was $2,491 (or $25,000 - $22,509).
LIFETIME AVERAGE VERSUS ANNUAL ESTIMATES OF INCOME
According to Joseph Campbell, in his article Poverty: A bias toward exaggeration, published in May 2003:
Even if reported income accurately identified the poor, the division of total income into quintile shares, ranging from the lowest fifth of all households to the highest, would be misleading. This is because households are constantly moving from one quintile to another, up and down the income scale. But, like single frames from an action film, the quintile charts reveal none of this economic dynamism.
They show that in both Canada and the United States, the top fifth of all households receive some 45 percent of the income and the bottom fifth less than five percent. What's more, the percentages have not changed much over half a century. This suggests that the economy is rigidly unfair because the poor never seem able to escape scarcity and the rich cling tenaciously to affluence.
the percentages of total income don't change much, the people behind them
rarely stop changing. The
INCOME AND ITS RELATIONSHIP TO EDUCATION
The Big Payoff: Educational Attainment and Synthetic Estimates of Work-Life Earnings
Issued July 2002
One of the interesting things that the Census Bureau does is to relate educational attainment to income achievement.
The correlation is clear: they are positively…and highly related.
The world of high-tech needs labor that is increasingly educated and trained; this is what is meant by the concept of human capital, embodied in the individuals that supply the productive resources.
We always tell our students that the university is a capital goods firm. Human capital is an increasingly important and recognized form of capital accumulation. In the National Income and Product Accounts, it is buried and is not shown as part of Gross Private Domestic Investment. Yet as a nation, we spend more on education than on defense. Unfortunately, it is written off as a business expense if the employee’s firm pays for it. It is shown in Personal Consumption Expenditures if the household pays for it. It is buried in Government Consumption Expenditures and Gross Investment if government pays for it by taxing the public and/or borrowing the funds to finance education. That is not to say the delivery system is above criticism. The intention is there even if the execution is not always delivered effectively and efficiently.
Sources: NCES, "Common Core of Data," surveys and unpublished data.
Digest of Education Statistics: 2005
All Educational Institutions (public and private)
All Elementary and Secondary Schools
All Colleges and Universities
For fiscal year 2004, Defense spending totaled $437 billion.
To see the relationship between income and education a little more clearly, go to the rows where it shows the ages from 45-54 years of age. This age group includes a group called tenured workers. Note that you as you scan to the right, as the level of educational attainment is rising so is the median income for that age group.
SAVINGS AND ITS RELATIONSHIP TO INCOME
While we’ve already noted that there is significant confusion in measuring income and poverty, there are also misperceptions in how we view and measure savings. Much political hay has been made over the negative household savings rate in 2005 as seen in the National Income and Product Accounts. Yet, the household savings rate as seen in the Flow of Funds Accounts, measured by the Board of Governors of the Federal Reserve System shows a higher and positive savings rate for the same period by treating consumer durables as investment, and not as consumption (as the NIPA treats them). Consumer durables have a life of three years or more and therefore are treated as investment by the Flow of Funds Accounts, not as expense.
Taking the Courtenay Stone approach illustrated in the box above, if we added only the surplus for the Social Security System in 2005 to the Personal Savings as reported in the Flow of Funds Accounts, this would elevate the savings rate even higher.
Illustration…expanding upon the BEA numbers
BEA – NIPA
Table 2.1. Personal Income and Its Disposition
Personal saving $(34.8) billion
Personal saving as a percentage of disposable personal income* (0.4)%
*$9,036 billion disposable personal income
Federal Reserve – FOFA (Flow of Funds Accounts)
From NIPA above:
$(34.8) billion (Personal saving)
+ $210.2 billion (Net investment in consumer durables)
= $175.4 billion (Personal Savings…Flow of Funds)
Personal saving (Flow of Funds) as a percentage of disposable personal income* 1.9%
Social Security and Medicare Boards of Trustees
A SUMMARY OF THE 2006 ANNUAL REPORTS
From FOFA above:
$175.4 billion (Personal Savings…Flow of Funds)
+ $162.4 billion (Net increase in assets…OASI)
= $337.8 billion (Personal saving…with OASI)
Personal saving (with OASI) as a percentage of disposable personal income* 3.7%
THE THEORY BEHIND THE NUMBERS – DIGGING INTO THE ACCOUNTS
Production and income are two sides of the same coin, so to speak. Production is the transformation of productive resources (labor, capital, entrepreneurship, and land) into goods and services to satisfy consumption needs and nonconsumption spending for capital accumulation, collective consumption and investment by government and exports to the rest of the world.
Income is the reward to the resources employed by a firm in the transformation process called production. These activities are measured by the Bureau of Economic Analysis (http://bea.gov/), which is a division of the Department of Commerce of the United States Government (http://www.commerce.gov/). The measurements are reflected in the National Income and Product Accounts (NIPA) and are generated quarterly and summed up annually.
The economic activity of the economy is measured at market prices. Activities that do not flow through the market are nearly always left out since very few imputations are made. This means that the work done within the households by a member of that household are not counted. The only major exception is the imputation of owner occupied housing. Its rental value is estimated and added to the rent of houses rented (this is recorded as part of Net Rent in the NIPA).
When members of the household enter the labor force, activities formerly undertaken within the household such as child care, housekeeping, etc. are now counted if the services are purchased in the market. Should a participant in the market economy leave and return to housekeeping duties, the activities are no longer measured. In effect, what are measured are just the economic activities flowing through the market economy.
Since the total production of the economy is measured at market prices, a level of ambiguity arises. If what is measured is all the domestic production, whether produced by our resources employed here or foreign resources employed in this country, it is called Gross Domestic Product (GDP). This excludes the estimate of production and income of our resources employed abroad. If some of our resources are employed outside the country, their production and income is counted in the host country’s GDP.
When the production and income of all of our resources are counted whether employed inside our country or outside in another country, it is called Gross National Product or GNP. This measure does not count the production and income of foreign resources employed here. The accompanying page from the NIPA shows the distinction.
BEA - NIPA
Table 1.7.5. Relation of Gross Domestic Product, Gross National Product, Net National Product, National Income, and Personal Income
It starts with GDP and subtracts an estimation of production of foreign resources employed in the U.S, and then adds an estimation of the production and income of our resources employed in the rest of the world. This is accomplished with lines 1 through 4.
A second ambiguity arises in that total production includes investment in expanding the stock of capital goods as well as replacing the stock that wears out and becomes obsolete. This is usually termed depreciation but is now called Consumption of Fixed Capital. When this subtraction is made from GNP, the remainder is termed Net National Product or NNP. It is what is left for consumption and non-consumption spending after a provision is made for replacing the stock of capital used up in the production process.
In recent years a change has been made in distinguishing between Net National Product and National Income. The editors of this newsletter believe this was a profound mistake and should be reversed. As you can see by looking at the GDP table, a Discrepancy is subtracted (possibly added) to arrive at National Income. This verges on the edge of misleading the users of the NIPA.
What was formerly done since the inception of these accounts in the 1930s was to estimate which taxes were passed forward and inflated market prices, thus overstating GDP, GNP, and NNP.
All taxes for any purpose by any level of government are ultimately borne by households and only households no matter what is statutorily mandated. Firms are places where production occurs and only that. Some taxes are passed forward to consumers when it is possible, and the rest are passed back to the resource (labor, capital, entrepreneurship and land) in the form of lower disposable income. Remember that households play two roles: they are both the productive resources and the consumers. Which taxes are passed forward and which backward depend upon the price elasticities of the supply of resources. That differs from industry to industry and from firm to firm. In Public Finance Theory, this is referred to as the shifting and incidence of taxes.
From the inception of these accounts, until it was changed recently, the NIPA argued that the bulk of sales, excise, and property taxes were passed on in the form of higher prices to the consumers. Hence, they inflated prices. Taxes are neither production nor income and hence had to be subtracted from NNP to properly estimate the National Income, which is the aggregation of all household income earned in the production process.
It is the argument then that firms no longer can pass on such taxes. That may be true in markets that have become very competitive, but is certainly not the case in markets that are not very competitive or that have become increasingly cartelized such as the oil industry.
National Income is the aggregate of rewards that resources earn by supplying their resources to the firm in the production process. Payment is usually in cash but can be in kind such as room in board for farm workers or resident hall advisers at colleges and universities. It is the sum of wages, now called Compensation to Employees, Profits of both corporations and unincorporated enterprises, Net Rent and Net Interest.
BEA - NIPA
Table 1.12. National Income by Type of Income
Notice that coming from GNP, National Income is deduced. It is also directly measured from independent sources. The two results should be the same, but because the huge task and many resources wanting to avoid indictments for illegal activities and wishing to evade taxes, they make it certain that significant discrepancies will occur.
Other conventions lead to some peculiars treatments, especially in the case of interest treatment. Remember that income, unqualified, means one thing only in economics. It is the reward for the current offering of resources in the production process. If interest is paid on debt for which there is no underlying resource, it is not income, but rather a transfer payment. Hence, it is argued that most of the federal government debt, which was incurred many years in the past, no longer reflects a productive base, as in the case of such things as past wars and recessions A similar argument is used for a good deal of consumer debt. The net result is that Net Interest in the NIPA seems far smaller that what is paid in interest on debt (public and private). Other peculiarities can be viewed in preceding table.
N.B. (Note well…)
Line Item 19 (Table 1.12. National Income by Type of Income), TAXES ON PRODUCTION AND IMPORTS:
Taxes are not income, nor are they production; hence they are not part of National Income. Line Item 19 should be moved back up to where the “Statistical Discrepancy” is between Net National Product and National Income of Table 1.7.5. Relation of Gross Domestic Product, Gross National Product, Net National Product, National Income, and Personal Income (Line Item 15).
BEA – NIPA
Table 1.7.5. Relation of Gross Domestic Product, Gross National Product, Net National Product, National Income, and Personal Income
Other adjustments are made to National Income, bringing you from National Income to Personal Income.
Another major adjustment occurs that brings us to Disposable Personal Income, usually shortened to Disposable Income.
BEA – NIPA
Table 2.1. Personal Income and Its Disposition
Disposable Personal Income ends up in two parts. Personal Outlays are subtracted from Disposable Personal Income to leave Personal Saving. Personal Outlays consist mostly of Personal Consumption Expenditures. Recall call from PCE (Personal Consumption Expenditures) that it is comprised of Services, Non-durables and Durable Consumer Goods. The latter has lives estimated to be on the average of at least 3 years or more. In the durable consumer goods category are light vehicles (passenger cars, light trucks and SUVs), major appliances (washing machines, refrigerators, etc.) and furniture.
Personal Saving is then divided by Disposable Personal Income, giving us the Personal Savings rate.
An important point must be made here.
This measure of personal saving is a very narrow measure of savings. Long-lived durable consumer goods are subtracted to arrive at saving. This in accounting terms borders on an absurdity. It should be recalled that in their formative years, the NIPA was heavily influenced by the growing acceptance of the Keynesian demand side macro. In the Keynesian framework, aggregate demand called the tune. Consumption and investment were two parts of aggregate demand, so why the concern over long-lived consumer goods? Demand is demand!
Again, as we noted previously, the alternative to this treatment of consumer durable goods is found in the Flow of Funds Accounts generated quarterly by the Board of Governors of the Federal Reserve System. Remember that in the Flow of Funds Accounts that consumer durables are treated as investment – not expense.
WHO PAYS THE TAXES?
Effective Federal Tax Rates:
Who pays the taxes…
Who pays the taxes…
Internal Revenue Service
US Department of Treasury
SOI Tax Stats - Individual Statistical Tables by Size of Adjusted Gross Income
Who Pays The Most Individual Income Taxes?
April 1, 2004
Some further food for thought…
“Taxpayers who rank in the top 50 percent of taxpayers by income pay virtually all individual income taxes. In all years since 1990, taxpayers in this group have paid over 90 percent of all individual income taxes. In 2000 and 2001, this group paid over 96 percent of the total.”
“The share of taxes paid by the bottom 50 percent of taxpayers will fall from 4.1 percent to 3.6 percent.”
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