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.