9.1 Income Definition
The Haig-Simons definition of income states that it is equal to the value of consumption plus the change in net wealth during the year. This is similar to the economic definition of income as the sum of consumption and savings. Sometimes savings are referred to as net savings because the term can also be negative (i.e., representing a decrease in savings). \[\text{Income} = \text{Consumption} + \Delta \text{Net Wealth}\]
In the ideal case stated by Haig-Simons (1938), taxing should be based on a comprehensive measure of income. However, this is not always achievable. Income taxes currently include wages and salaries, rents, interest income, dividends, realized capital gains. Excluded income sources are fringe benefits (to earned income), gifts, imputed income (e.g., farmer consuming crop), accrued capital gains (i.e., unrealized). In addtion, interest on state and local government debt is excluded. This exclusion allows governments to borrow below market rates (e.g., 5.2% versus 8% if 35% marginal tax rate). To see the differences between the Haig-Simons definition and the current tax system, consider the following cases.
Case 1: Cullen owns stock that increased by $10,000 but he did not sell.
- Haig-Simons definition: Income
- Current tax system: Unrealized capital gains
Case 2: Dena lives in a house she owns and consumes its services
- Haig-Simons definition: Consumption of housing service and hence, part of income
- Current tax system: No tax and thus providing incentives to purchase assets producing non-cash returns to the owner
Case 3: Kenna inherits $50,000 from her aunt
- Haig-Simons definition: Increase in net wealth
- Current tax system: Not income since aunt paid gift/inheritance tax