Individual Income and Expenditure
( Originally Published Early 1900's )
By the annual income of a person is meant the net sum of his wages, gains and profits during a year, whether derived from his own labor, his business management, or the interest upon bis capital. To find its amount we must subtract from the sum total of moneys received by him in payment the amount which he has had to expend in order to transact his business and keep up his capital. It is therefore the sum total of the monetary flow to him, diminished by the flow from him for the purposes last mentioned. The amount fo be subtracted on account of business expenses and capital from the individual monetary flow is very different among different classes of persons: One whose sole occupation is to work for wages or a salary has no payment to subtract. His income is the same as the monetary flow to him. The other extreme is found in the case of men who transact business on a very large scale. They are continually, buying and selling, and their income may be only a very small fraction of their transactions so small a fraction, in fact, that it may be completely swallowed up by an unexpected rise or fall of prices.
27. The question what payments are to be considered as necessary to the continued transaction of business and the preservation of capital, may be a difficult one in special. cases; but the guiding principles may be made quite clear. In estimating net income it might be claimed that we should subtract from the total receipts of the individual the amount necessary for his own sustenance. But this would be wrong in principle, because the very object of determining income is to learn how much the person can afford to expend on his own sustenance without encroaching upon his reserve of capital or diminishing his power to carry on business. Hence we must leave unsubtracted all that he expends in improving his capital or increasing his business.
As one example let us take the case of a merchant. At the end of a year he finds that he has sold goods to a certain amount. The principal items which he has to subtract from this amount in order to obtain his income are these.
I The prime cost of the goods he has sold.
II. Bent of storehouse, insurance, and other expenses attendant upon the simple preservation of his stock in proper condition for sale.
III. Wages to clerks and others engaged in selling goods or transacting his business.
IV. Stationery, postage, losses from bad debts, and other miscellaneous items incident to the transaction of business.
After subtracting these and any other items necessary to the conduct of his business from the sum total of his sales, the remainder will represent his net income.
In the case of a manufacturer the same items will occur with some modifications and additions. Instead of the item "prime cost of goods sold" he will have the prime cost of all the raw material manufactured- and sold. He will also have the very important item " wear and tear of machinery and other forms of fixed capital." This item is necessarily somewhat indefinite. If his machinery has been going during the whole year without any repairs, it must have deteriorated, and the amount of deterioration must be estimated as best he can. If he has made large improvements in his factory, and paid for them out of his profits, such payment should not be subtracted, but should be considered as an investment of his surplus income.
In the case of great changes in price the question will some-times arise, What is to be considered as the measure of the capital kept up? Suppose a merchant to find at the end of the year that although the actual stock of goods on hand is nearly the same as at the beginning, yet their prime cost is greater, and their cost if purchased now would be double. Is he to consider this increase of value as a profit earned and applied so as to double his, capital? We reply, Not if the rise in prices is the result of a general increase in the scale of prices arising from a diminution in the. absolute value of the dollar. In this case there would be no increase of his actual capital, but only an apparent increase arising from his measuring his capital by a depreciated standard. If, however, the rise of prices is confined to the particular stock of goods he deals in, and grows out of some scarcity in the supply, the greater value would represent an actual increase of his capital, and might be counted as a profit, and therefore as an addition to his income.
In other cases we have to consider whether an expenditure was incident to the transaction of business, or was applied to the sustenance of the person or his family. For example, if a physician who receives annually $3000 in fees has to pay out $500 of this amount on account of a horse and buggy in which to visit his patients, his net income is only $2500. But if he should visit his patients on foot and employ the horse and buggy to give his wife and family a daily airing, we should regard that expenditure as coming out of his income, and say that his net income was $3000. The difference in the two cases is that in the one the horse and buggy are supposed to be used for business purposes and not for enjoyment, whereas in the other they are used for enjoyment.
Corporate Income. Another difficult case arises when we consider the income of companies. The preceding rules apply to any legal person. A railway or manufacturing company may have its own independent income. Such income, in the regular course of business, is supposed to be divided at stated times among the shareholders as dividends, and thus to become a part of their regular incomes. But very often the profits gained by the company, instead of being so divided, are employed in increasing the capital or enlarging the business of the company. In such a case are the stockholders to be regarded as in receipt of an income from their shares? If so, how is the amount to be determined ? Since they get nothing at all from the company, it might seem that the profits of the latter should not be reckoned as income to them. On the other hand, if they have a right to their prospective share of these profits, and this prospective right has a market value, they should be considered as in receipt of an income equal to the increase in the market value of their shares arising from the increase of the capitals owned by their company.
Expenditure of Income. The income determined in the preceding section is a certain amount of money which the individual can expend at his own pleasure without diminishing his productive power. There are two distinct ways in which he can spend it.
I. In sustenance for himself, his family and friends.
II. In increasing the amount of capital which he possesses.
We have found his net income by subtracting from the total monetary flow to him the total payments necessary to the transaction of his business and the preservation of his capital. The remainder is expended in the two ways just mentioned. We have then three great classes of payments made by him, namely :
Payments on account of business and capital ;
Payments for sustenance ;
Payments in increase of capital.
These together make up the total monetary flow from him, which is equal to the flow to him, as has already been shown. These flows are illustrated in the diagram opposite. From society to the merchant goes a flow of currency for the purchase of goods. From the merchant goes one flow to the jobbers who supply his goods, another to his clerks, and an-other to capitalists who perhaps own his warehouse or have loaned him money. These flows represent what he pays out on account of business. The dotted line to producers of capital represents that portion of his flow which he expends in increasing his capital. He may merely increase his stock of goods, and then, so far as he is concerned, the producers of his capital are the jobbers themselves. If he builds a new store with his profits, these producers will be bricklayers, carpenters, and mechanics. The heavy dotted line represents his payments for the sustenance of himself and family. The sum total of the five flows from him makes up the single flow from society to him.
There are two laws of income which are fundamental in economics. In applying the term " law" to these propositions, it must not be understood that they are absolutely true, irrespective of the interpretation which may be put upon them. They are rather to be regarded as approximations to general truths which require, however, to be interpreted in each particular case. The first law which we shall consider may be expressed in the following form :
As a general rule the income which an individual gains is equal to the value which he adds to the sum total of production through the use of his own faculties and capital.
There is perhaps no proposition in political economy which runs counter to common ideas more than this. It is a familiar fact that the largest incomes are gained by men whose function in production appears to the superficial observer quite insignificant. From the point of view of the average man the labor is the sole measure of the product, and the man who without labor gets a portion of the product gets it without rendering an equivalent service.
Since the first impulse of the student ought to be to point out certain obvious limitations to this law, we may begin by considering them. The first question will be what contribution to production is made by a man who makes a fortune merely through opérations in the stock market. The answer is that so far as this man's interests are concerned, the case is truly an exception. If the operations were merely speculative—that is, if there has been no real change in the value of the stock—the people with whom he has been dealing have lost an equal amount. Therefore the algebraic sum total of the gains of all the classes engaged in these speculations will be zero. Now, as already pointed out, we are in political economy principally concerned with sums total and not merely with the interests of this or that individual. Hence this error will not affect the sum total.
Let us suppose, in the second place, that our operator has purchased a stock supposed to be worthless and, having held it a year or two, it has without any effort on his part become of great value. This means that it has become useful to mankind while he was the owner. In order, therefore, that the law may be correctly applied we must include in production all increase of value produced by any circumstance whatever, and must credit this increase to the owner of the object whose usefulness was enhanced. This remark applies to all cases of the ownership of land, real estate, machinery, ores, etc., the value of which may change without the application of labor, merely through the movement of population and the action of supply and demand. The law must therefore, in order to be correct, be understood in some such form as this : The total income of the community comprises all the values produced by its labor plus all the increase in the value of fixed property brought forth without labor minus all the decay in value which has occurred. Leaving out speculative operations, gambling, etc., which mere-IT change the ownership of property, every man's income is then the measure of what he adds to the total production.
The most simple consideration by which the law can be illustrated is this : no person can gain income except by selling to. some other person something which this other person for the time being considers to be an equivalent. Take for instance the case of a railroad manager who is worth many mil-lions of dollars. If he has not gained this fortune by knocking people down and picking their pockets, or by burglary, which of course we assume, then he must have gained every dollar through some person paying a dollar for his services. All his millions have been gained from the millions of people who travel on his road and the thousands who purchased its stock, and every one of these millions and thousands paid his dollars because he thought it advantageous to himself so to do. He was either gaining an advantage or saving himself from a disadvantage. He either reached his place of business betimes in the morning, or lie was saved the expense of having to stay in the city overnight, or of hiring a carriage to take him home.
SECOND LAW OF INCOME. The entire amount paid by the purchaser for any commodity may be considered to be divided as income among the persons who have been instrumental in the production of that commodity, each man's share being his compensation for the labor expended and capital employed in such production.
We, may show this most easily by a diagram of the flow pertaining to an expenditure of $100 in the purchase of boots. Let us suppose that the raw material, principally leather, which the, shoemaker consumed in making the boots cost $40; and that he had to pay $20 to an assistant and $5 to the owner of his shop as rent. This would leave $35 as his own income from the boots.
The payment made to his assistant and shop-owner may, for simplicity, be considered as made solely on account of their services. In the case of the Wearers owner the services did not of boots merely consist of labor, but principally of the interest on ioo the capital he had invested in the shop. We may, if we choose, consider the income from capital as a separate item, but there is no need of our doing it now:
We have left the $40 which the shoemaker paid to the leather-dealers for raw material. This is divided in the same way between the owner of a shop, the dealer's clerks; the tanner from whom he purchased his leather, and himself. The division which we assume is shown on the diagram as $3 going to one party, $7 to another, and $20 to the third, while $10 is kept as his own income.
The $20 which he pays the tanner is divided according to the same system. In each class of persons represented by the circles is given their portion of the money. Following . the flow to the bottom, we see that the division of the $100 contributes incomes as follows :
To the shoemaker $35 To the journeyman shoemaker 20 To the owners of shops 8 To the leather-dealer 10 To the leather-dealer's clerks 7 To the tanner 5 To the producers of bark 5 To the tanner's assistant 5 To the dealer in hides, his clerks, the railway owners, the drovers, and the cowboys, each $1, making 5
Total.. . $100
An 'important question may arise at this point. The money paid to the purchaser did not divide itself in this way in a continuous stream, because the chances are that the shoemaker paid the wages and rent, and purchased his leather, before he sold his boots. The same thing may be true all the way down the diagram, so that we are apparently tracing the process in a reverse order. If the boots had all burned up before they were purchased, the greater part of the persons represented would have received their income.
But this does not contravene the law laid down. It still remains true that the. income of the shoemaker is found by subtracting the $65 which he had previously paid out from the $100 which he received. The same is true all the way down, so that the numbers still correctly represent incomes.
On the other hand, when we consider the future we shall see that the money paid by the purchaser of the boots is a very necessary part of the future income of all concerned in producing them. The shoemaker cannot keep up his purchase of leather or his payments to others unless he can sell his products. Moreover, as a general rule, so long as he continues his sales he will continue his purchases. Thus the interdependence of the varions incomes is a necessary result of the case.
The following important corollary may be deduced from the preceding law : When the price of goods rises, it is certain that some one concerned in their production is receiving an in-creased income for his services, and vice versa.
The division of this increase of income among the different parties concerned is partly a question of interpretation. If, next month, the shoemaker gets $120 for the same boots which he sold for $100 the present month, we may consider that increase of income as confined to himself, because he got his leather and employed his help at old prices. But the general fact will be that he could not command this increased price unless leather became dearer. Therefore in the future he must pay the higher prices, and thus the increased income will be divided among most or all of the producers.
The results of the above two laws may be combined in the following conclusions
I. Every mass of finished or unfinished products may be regarded as the joint work of the various persons whose services were necessary to the production.
II. The value of all such products in the country may be divided among the producers into shares, each, share being a part of the income of the person who contributes that share to the product.
III. CONVERSELY, we may consider every man's income to represent his contribution to the sum total of the product, and to measure his right to take an equal value of the products of others from that sum total.