To calculate personal income from national income, two key components are typically excluded: corporate tax and undistributed profits. These represent income generated within the economy that does not directly flow to households.
Understanding National Income and Personal Income
National Income (NI) represents the total income earned by a nation's residents for their contributions to production, including wages, salaries, rent, interest, and profits. It's a broad measure of the economic activity and the income generated by the factors of production.
Personal Income (PI), on the other hand, measures the total income received by households and individuals from all sources, whether from current production or from transfer payments. It aims to reflect the actual income available to individuals for consumption and saving.
The transition from national income to personal income involves adjustments to account for the difference between income earned and income received by individuals.
Components Excluded from National Income to Calculate Personal Income
When deriving personal income from national income, certain elements of income generated within the economy are not directly distributed to households. These primarily include income retained by corporations or paid to the government before reaching individuals.
- Corporate Tax (Corporation Income Tax): This is the tax levied by the government on the profits of corporations. While these profits are part of the total income generated in the economy (and thus included in national income), the portion paid as corporate tax never reaches households as personal income. Instead, it is directed to the government.
- Undistributed Profits (Retained Earnings): Also known as corporate savings, these are the profits earned by corporations that are not distributed to shareholders in the form of dividends. Companies often retain these earnings for reinvestment, business expansion, or to strengthen their financial position. Since this portion of profit is not paid out to individuals, it is excluded from personal income.
Derivation of Personal Income
The process of moving from National Income (NI) to Personal Income (PI) typically involves the following adjustments:
| From National Income (NI) | Adjustment | Reason for Adjustment |
|---|---|---|
| Subtract: | ||
| Corporate Tax | - | Income earned but not received by households (goes to government). |
| Undistributed Profits | - | Income earned but not received by households (retained by corporations). |
| Add: | ||
| Transfer Payments | + | Income received by households but not earned from current production (e.g., social security, unemployment benefits). |
| Net Interest | + | Interest income received by households from government and consumers, which is not part of income earned from production. |
Practical Implications
Understanding the distinction between national income and personal income is crucial for analyzing the actual purchasing power and economic well-being of households.
- Impact on Individuals: While national income provides a broad measure of economic activity, personal income directly reflects the funds available to individuals for consumption and saving.
- Policy Considerations: Government policies regarding corporate taxation and dividend regulations can influence the flow of income from the national level down to individual households.
- Economic Analysis: Economists use both measures to gain a comprehensive understanding of an economy's performance and the distribution of its wealth.
For more detailed information on personal income and its components, you can refer to economic resources like Investopedia's explanation of Personal Income.
