The Income approach

All spending ultimately translates into income. Thus, national output calculated by the expen­diture approach must equal National Income. National Income (NI) is computed by summing all payments to resource owners — wages, rents, interest, and profits. Although National Income conceptually sums workers' wages for labor, interest paid to capi­tal owners, landowners' rents, and entrepre­neurial profits, the limitations of accounting data cause NI to be measured as the sum of five slightly different categories: (a) wages and salaries, (b) non-corporate proprietors' income, (c) corporate profits before taxes, (d) rental in­come, and (e) interest. Table 2 presents pro­portions and trends in these income payments for selected years.

Wages and Salaries: This category covers not only money wages but also all employees'
fringe benefits (e.g., bonuses, stock options, health insurance, paid vacations, and firms' con­tributions to Social Security). Table 2 shows that wages and salaries increasingly dominate U.S.
National Income. The share of wages has risen from less than half of National Income in 1900
to roughly three-fourths today.

Proprietors' Income: National Income accountants split accounting profit into two categories: proprietors' incomes and corporate profits. Proprietors' incomes are received by sole proprietors, partnerships, certain profes­sional associations, and unincorporated farms.
Included in farm income is an estimate of the value of food grown and consumed on farms —
and or from home gardens. Although not mar­keted, this clearly represents production.

Much of this income category represents wages, interest, or rent that proprietors would have earned if they had not operated their own firms. Isolating this category according to purely economic concepts to identify opportunity costs is impossible, however, given the limitations of accounting data. Thus, we consider proprietors' income as "profit," but only for purposes of GDP accounting.

Proprietors' shares of National Income were falling until recently, declining from 17.3% in 1929 to only 7.8% in 1980. Wages grew in part when small family farmers were attracted by relatively more remunerative industrial jobs. A recent rebound in proprietors' shares may re­flect resurgent entrepreneurship,— or it may merely track growing tendencies for firms to rely less on career employees and more on in­dependent contractors, many of whom may only reluctantlybe self-employed.

Corporate Profit: Corporations use their ac­counting profit in three ways. First, they must pay corporate income taxes. Second, they may pay stockholders dividends from their after-tax income. Finally, remaining profits are kept in the firm as working capital or to finance either internal expansion or external acquisitions (mergers and takeovers ). Economists call profit kept by firms undistributed corporate profits; to ac­countants, they are retained earnings. Much of the category called corporate profit actually rep­resents the interest forgone had stockholders bought bonds instead of stock. Again, because isolating pure economic profit from opportu­nity costs is not feasible, the convention is to lump all corporate profits with proprietors' in­come in the accounting term "profit."

Proprietors' income has fallen as a per­centage of National Income, so you might ex­pect growth in the share accruing to corporations. A glance at Table 2, however, re­veals a trend for corporate profit to shrink rel­ative to National Income. What accounts for the rise in the share of wages and erratic declines in both corporate and proprietors' incomes? A par­tial answer lies in the fact that government out­lays as a percentage of total outputrose markedly during this century. Most govern­ment-provided services require substantial labor, so the share of wages and salaries has grown steadily.

Rental Income: Accounting rents are usually derived fromthe leasing of real property (such as land, houses, offices), but they can be obtained fromrenting any asset (e.g., videotapes or U-Haul trailers). Determining what part con­forms to economic rent as a payment solely for the use of land is impossible, so again we use ac­counting classifications. As you see in Table 2, rental income is now the smallest accounting cat­egory in National Income.

Interest: Interest is also rather self-ex­planatory —payments made for the use of bor­rowed capital (usually, financial capital). Interest payments are made by borrowers to banks or to holders of bonds, or by banks to their depositors. (Banks act primarily as specialized intermediaries. A bank arranges loans of its de­positors' funds to borrowers. Thus, depositors— not banks—are the ultimate lenders.) National Income accounting conventions treat interest paid to holders of government bonds as a transfer payment and exclude it from the interest component of National Income. If interest on government bonds were included, interest would have been roughly one-seventh of National Income in 1993.

RECONCILING GDP AND NI

Gross Private Domestic Investment (GPDI) overstates growth of the nation's stock of capi­tal because some capital wears out each year. Accountants refer to the decline in value of cap­ital because of wear and tear or obsolescence as depreciation. But actual depreciation data reflect rapid ac­counting write-offs to exploit advantageous tax treatments. The overstated "depreciation" com­puted by accountants is termed the capital con­sumption allowance by economists, but no better data are available.

Subtracting depreciation from Gross Private Domestic Investment yields Net Private Domestic Investment, an estimate of annual growth in a nation's capital. All else being equal, de­preciation reduces capital owners' wealth. Thus, one step in reconciling GDP and NI entails sub­tracting depreciation from GDP to compute Net Domestic Product (NDP). Conceptually, NDP es­timates how much we could consume in a given year while maintaining a constant stock of cap­ital throughout that year. Net Domestic Product (NDP) it the net value of an economy's annual output after adjusting for depreciation.

Failure to consider depreciation would cause overstatement of the net value of production. In a sense, depreciation represents a " death rate of capital " that must be subtracted from the " birth rate of capital " (GPDI) to arrive at net capital formation.

Another major adjustment is required to rec­oncile GDP and National Income. The funds paid for goods and the funds firms receive are not equal. Sales and excise taxes,collectively known as indirect business taxes, drive wedges between what consumers or investors spend and sellers' net re­ceipts. For example, sales taxes must be subtracted from a buyer's payment for a new car before in­come can be distributed to auto workers or man­ufacturers. Consequently, indirect business taxes must be subtracted from Net Domestic Product. We reconcile GDP and National Income only after making these and other miscellaneous adjust­ments, as summarized in Table 3.

If National Income accountants relied primar­ily on income tax returns, calculating GDP would entail summing all declared incomes and then adding indirect business taxes and depre­ciation. But this strategy depends on honest tax returns, and even the latest figures available would be relatively out-of-date because (a) tax returns filed on April 15 are for the preceding year, and (b) it takes time for the IRS (Internal Revenue Service) to compile and interpret the returns. For these reasons and more, National Income is calculated primarily as a double check on GDP figures.

An alternative is to collect all sales figures for a year. Most firms are subject to taxes re­ported monthly to government agencies, so sales data are available on a regular basis. But what then? Merely summing all sales revenues entails double counting. For example, if USX's steel sales are added to Ford's sales, we count USX's out­put twice: when steel is sold to Ford and again when Ford sells new cars and trucks. To avoid double counting, National Income accountants use the value-added tech­nique. A firm's value added is computed by subtracting from its sales revenue any purchases of interme­diate goods from other firms. This leaves only the value of the firm's own pro­duction: its value added. National income ac­countants then sum the value added by each firm. Summing domestic values added by all firms yields reasonably accurate GDP figures, after adjusting for such things as inventory changes, the imputed (estimated) rental values of owner-occupied housing, and the imputed values of food grown and consumed on the farm —from your home garden.

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