Defining Income H-S criterion Includes net additions to wealth All sources of potential increases in consumption (regardless of whether consumption took place) Subtracts losses
6 Defining Income • H-S criterion: – Includes net additions to wealth – All sources of potential increases in consumption (regardless of whether consumption took place) – Subtracts losses
Defining Income tems included in h-s Income H-S definition encompasses Items ordinarily thought of as income include wages salaries, business profits, rents, royalties, dividends and interest Employer pension contributions and insurance premiums Transfer payments like Social Security, Unemployment Insurances, and Welfare Capital Gains(whether they are realized or unrealized) Imputed rental income from durable goods
7 Defining Income: Items included in H-S Income • H-S definition encompasses: – Items ordinarily thought of as income include wages, salaries, business profits, rents, royalties, dividends, and interest – Employer pension contributions and insurance premiums – Transfer payments like Social Security, Unemployment Insurances, and Welfare – Capital Gains (whether they are realized or unrealized) – Imputed rental income from durable goods
Defining Income Problems Business expenses are often difficult to parse out into“ consumption"and“ costs of obtaining Income Unrealized capital gains and losses difficult to measure Imputed rental income from durables difficult to impute In-kind services(such as housework) difficult to value 8
8 Defining Income: Problems • Business expenses are often difficult to parse out into “consumption” and “costs of obtaining income” • Unrealized capital gains and losses difficult to measure • Imputed rental income from durables difficult to impute • In-kind services (such as housework) difficult to value
Defining Income Evaluating the H-S Criterion Clearly, arbitrary decisions need to be made on how to define income from a practical point of view H-S criterion appeal to Horizontal equity-people with equal incomes should pay equal taxes Neutrality -it treats all forms of income the same, and does not distort economic activity
9 Defining Income: Evaluating the H-S Criterion • Clearly, arbitrary decisions need to be made on how to define income from a practical point of view. • H-S criterion appeal to: – Horizontal equity – people with equal incomes should pay equal taxes – Neutrality – it treats all forms of income the same, and does not distort economic activity
Excludable forms of income Interest on state and local bonds Interest earned on bond issued by state or locality is untaxed(while interest earned on the bond of a private company is taxed) Investors are therefore willing to accept a lower before-tax rate of return on these bonds 10
10 Excludable Forms of Income: Interest on State and Local Bonds • Interest earned on bond issued by state or locality is untaxed (while interest earned on the bond of a private company is taxed). • Investors are therefore willing to accept a lower before-tax rate of return on these bonds