All About Income

Dr. Katie Sauer

Metropolitan State College of Denver (ksauer5@mscd.edu)

Presented at Junior Achievements Secondary School Personal Financial Literacy Workshop in collaboration with the Colorado Council for Economic Education

pay back debt economy taxes income spending

insurance

borrowing

saving & investing human capital

human capital

Session Overview I. Intro to Income II. Two Main Determinants of Income - human capital - state of the economy III. A Simple Model of the Labor Market IV. Tax System

I. Intro to Income How much income does the average US household earn in a year? - statistics will be found for median or mean income Median Income: - rank all households by income

lowest household income

household in middle = median household

highest household income

Mean Income: - add up all household income - divide by number of households

How much are US median income and mean income? median income = $49,777 mean income = $67,976

How much is Colorados median income? $55,930

2009 data:

US Census Bureau http://www.census.gov

The Wage is Right! http://econoclass.com/wageisright.html Summary: This series of short classroom games encourages students to apply the supply and demand model to labor markets. The games are patterned after The Price is Right, a long-running game show on CBS that asks contestants to guess the prices of various goods. In this version, students guess the earnings of different occupations and predict which will grow the fastest. Its a fun way to acquaint students with different occupations and help them understand how earnings are related to training, talent, and other factors.

How to find recent data on income and occupations: From the Bureau of Labor Statistics website: http://bls.gov/

From the Subject Area tab: - click on Pay and Benefits - the Wages by Area and Occupation link will lead you to information to update the wage game data - click on Employment - the Employment Projections link will lead you to information on employment trends (fastest growing/declining occupations, etc)

Income comes from other sources than working.

Table 4.4 Personal income, 1988, 1998, 2008 and projected 2018: Sources of Personal Income Billions of current dollars Percent distribution Category 1988 1998 2008 2018 1988 1998 2008 2018 Personal income $ 4,253.7 $ 7,423.0 $ 12,100.7 $ 19,129.6 100.0 100.0 100.0 100.0 Compensation of employees 2,967.2 5,020.1 8,052.8 12,404.8 69.8 67.6 66.5 64.8 Wage & salary disbursements 2,452.9 4,183.4 6,548.0 10,043.1 57.7 56.4 54.1 52.5 Supplements to wages & 514.3 836.7 1,504.8 2,361.8 12.1 11.3 12.4 12.3 salary Proprietors' income 341.6 627.8 1,072.4 1,647.7 8.0 8.5 8.9 8.6 Rental income 40.6 137.5 64.4 146.2 1.0 1.9 0.5 0.8 Personal income on assets 769.3 1,283.2 2,037.6 3,543.3 18.1 17.3 16.8 18.5 Personal interest income 639.5 933.3 1,208.5 2,194.9 15.0 12.6 10.0 11.5 Personal dividend income 129.7 350.0 829.1 1,348.3 3.0 4.7 6.9 7.0 Personal current transfer receipts 496.6 978.6 1,869.1 3,005.2 11.7 13.2 15.4 15.7 Federal social benefits 377.5 716.8 1,378.6 2,196.5 8.9 9.7 11.4 11.5 State & local social benefits 98.5 235.8 455.8 757.5 2.3 3.2 3.8 4.0 Other, from business (net) 20.6 26.0 34.7 51.2 0.5 0.3 0.3 0.3 Less: Social insurance contribution 361.5 624.2 995.7 1,617.6 8.5 8.4 8.2 8.5

Employment Projections Program, U.S. Department of Labor, U.S. Bureau of Labor Statistics

How is income spent?

Table 4.4 Personal income, 1988, 1998, 2008 and projected 2018 Billions of current dollars Category 1988 1998 2008 2018 Use: Personal income Personal consumption Personal taxes Personal interest payments Personal transfer payments To government: Federal State & local To the rest of the world (net) Personal savings

Percent distribution 1988 1998 2008 2018

4,253.7 7,423.0 12,100.7 19,129.6 100.0 100.0 100.0 100.0 3,353.6 5,879.5 10,057.9 15,293.5 78.8 79.2 83.1 79.9 505.0 1,027.1 1,457.3 2,596.6 11.9 13.8 12.0 13.6 96.8 25.4 14.8 2.8 12.0 10.6 272.9 174.5 65.2 40.5 8.6 31.9 24.6 276.8 248.2 144.6 84.5 18.0 66.5 60.1 192.6 375.9 212.8 124.8 27.4 97.4 88.1 650.9 2.3 0.6 0.3 0.1 0.3 0.2 6.4 2.4 0.9 0.5 0.1 0.4 0.3 3.7 2.1 1.2 0.7 0.1 0.5 0.5 1.6 2.0 1.1 0.7 0.1 0.5 0.5 3.4

Employment Projections Program, U.S. Department of Labor, U.S. Bureau of Labor Statistics

II. What determines income from working? A. Human Capital B. State of the Economy

A. Human Capital encompasses a persons knowledge, ability, and skills. Most human capital is built through education and training. Generally speaking, higher human capital is correlated with higher income. - accountants typically make more money than bank tellers

Educational Attainment--People 25 Years Old and Over, by Total Money Earnings in 2008
Doctorate Degree Professional Degree Master's Degree Bachelor's Degree Associate's Degree Some college, no degree High School Graduate (inc. GED) 9th to 12th grade less than 9th grade $71,236 $60,954 $41,226 $38,676 $33,618 $24,686 $21,491 $99,995 $125,622

US Census Bureau / BLS: 2009 Current Population Survey, Annual Social and Economic (ASEC) Supplement Table from PINC-03

Investing in human capital has a high opportunity cost: When students are in class they arent being productive in the economy. Increasing human capital can have large benefits: - higher paycheck - better society - productive workers

Individuals, firms and governments are willing to pay the cost of investing in building human capital because they expect to see benefits in the future. Governments fund public education because a better educated population contributes to faster and sustainable development. Firms invest in employee training because they expect to cover the costs through higher profits from higher worker productivity. Individuals spend time and money on higher education because they expect to earn higher wages.

A degree or certification can signal that someone has likely built their human capital. There may not be a return on education if - it is of low quality - the knowledge/skills learned dont match market demand - there is slow economic growth (low demand for new workers) - workers are paid the same regardless of skill (centrally planned economies, bureaucratic systems)

Unemployment Rates by Educational Attainment (people age 25 and older) Less than High School

High School

Some college or AA

4 year degree or higher

www.bls.gov

B. The state of the economy affects income When the economy is doing well, firms are hiring, people find it relatively easy to find jobs. The type of jobs needed in the economy change over time as the structure of the economy changes. If you are skilled in a sector that becomes obsolete, you will need to acquire new skills to work in a different sector or you will be unemployed for a long time.

The US Business Cycle for the Past 50 Years

Data source: Bureau of Economic Analysis

III. A Simple Model of the Labor Market The market wage is determined by the supply and demand for labor. A. The Supply of Labor (workers) Because time is limited, many individuals face a tradeoff between working and not working. - all time spent not working will be called leisure Economists call this the leisure-labor tradeoff. We often analyze it in terms of income earned vs time spent not working.

Income Earned theoretical maximum income $ from 90 hours of work

Represents all possible income-leisure tradeoffs for a given wage rate.

$ from 40 hours of work Weekly 168 Hours of Leisure

$0 0 78 128

For a given wage, individuals have different preferences over income and leisure. Person who prefers more income and sacrifices leisure.
Income

Person who prefers more leisure and sacrifices income.

Income

Preference Curve Preference Curve Hours of Leisure Hours of Leisure

When the wage increases, people typically respond in two ways: 1. As the wage increases, the opportunity cost of leisure also increases so people work more. - for every hour you are *not* working, you are forgoing more money 2. As the wage increases high enough, the individual has more money and begins to value leisure more and thus works less. We can illustrate this effect with a labor supply curve.

The Labor Supply Curve

http://en.wikipedia.org/w iki/Labour_economics

As the wage rate increases, first people choose to work more hours, then they choose to work fewer hours.

B. The Demand for Labor (firms) The demand for labor is known as a derived demand because labor is not needed unless there is demand for the product being produced. When a firm hires a worker, the firm incurs a cost but also receives a benefit. - the cost of the worker is the wage - the benefit of the worker is the output the worker produces times the price the firm can sell that output for Ideally, a firm would pay a worker a wage that is equal to the value of the workers output.

If the wage were less than the value of output a firm could get from hiring another worker, the firm would want to hire another worker. If the wage were more than the value of output a firm could get from its workers, the firm would want to fire a worker.

In general, the lower the wage, the more workers a firm could hire.

Wage Rate

As the wage rate falls, a firm can hire more workers.

Labor Demand Number of Workers

C. Putting Supply and Demand Together The supply and demand for labor interact to determine the market wage for various occupations.
Wage Rate Labor Supply

market wage

Labor Demand actual workers hired Number of Workers

Ex: The demand for dental services has remained pretty stable while many new dental hygienists are graduating.
Wage Rate Labor Supply New Labor Supply market wage new wage Labor Demand actual workers hired more workers hired Number of Workers

Two potential outcomes: 1. the wage falls, the new workers are hired

Wage Rate Labor Supply New Labor Supply market wage

2. dental offices are already hiring the number of hygienists that are needed, new hygienists are unemployed

The wage may or may not fall.

Labor Demand actual workers hired hygienists who want to work Number of Workers

Ex: Professional Engineer vs

Wage Rate Labor Supply Wage Rate

Bartender

Labor Supply

Labor Demand Number of Workers

Labor Demand Number of Workers

Often times firms will pay a wage that is above the market wage. - attract better workers - reduce turnover Sometimes workers unionize and collectively bargain for wages that are higher than the market wage.

IV. Tax System Policymakers have two considerations when it comes to taxes: efficiency and equity

A. Taxes and Efficiency The primary goal of a tax is to raise money for the government. There are many ways to raise a given amount of money. Tax system A is more efficient than tax system B if it raises the same amount of money but at a lower cost. - minimize administrative burden, while collecting money

B. Taxes and Equity Equity has to do with how the tax burden is distributed. - much disagreement! The Benefits Principal of taxation is the idea that people should pay taxes based on the benefits they receive from the government. - gasoline tax - national defense - park fee The Ability-to-Pay Principle of taxation is the idea that people should pay taxes according to how well that person can shoulder the burden.

C. The Cost of Taxes Taxes exert a cost on the economy. (fiscal drag) 1. taxes reduce your purchasing power 2. taxes cause people to change their behavior 3. taxes can cause deadweight loss 4. taxes discourage investment 5. taxes discourage work

D. Taxes That Individuals Pay 1. Federal Taxes Income Tax Payroll Tax The Social Security tax is also called the FICA (Federal Insurance Contributions Act) tax. (6.2%) The Medicare tax is used to provide medical benefits for certain individuals when they reach age 65. (1.45%) Estate Tax Gift Tax Gasoline Tax (18.4cents per gallon)

Federal Income Tax: Here are the tax brackets for a single person for 2010: Marginal Tax Tax Bracket Rate over but not over 10% $0 $8,375 15% $8,375 $34,000 25% $34,000 $82,400 33% $82,400 $171,850 35% $171,850 $373,650 38% $373,650

Marginal Tax Rate 10% 15% 25% 33% 35% 38%

Tax Bracket over but not over $0 $8,375 $8,375 $34,000 $34,000 $82,400 $82,400 $171,850 $171,850 $373,650 $373,650

Lets suppose you are single and make $50,000 in 2010. You pay different tax rates on different portions of your income: - On the first $8,375 of your income you pay 10% in taxes.

Marginal Tax Rate 10% 15% 25% 33% 35% 38%

Tax Bracket over but not over $0 $8,375 $8,375 $34,000 $34,000 $82,400 $82,400 $171,850 $171,850 $373,650 $373,650

- The next bracket contains $34,000 - $8,375 = $25,625 of income. You pay 15% tax on $25,625 of your income.

Marginal Tax Rate 10% 15% 25% 33% 35% 38%

Tax Bracket over but not over $0 $8,375 $8,375 $34,000 $34,000 $82,400 $50,000 $82,400 $171,850 $171,850 $373,650 $373,650

- The next bracket contains $50,000 - $34,000 = $16,000 of income. You pay 25% tax on $16,000 of your income.

The total amount you pay in taxes: (0.10)(8,375) + (0.15)(34,000 8,375) + (0.25)(50,000 34,000) = 837.5 + 3843.75 + 4000 = $8,681.25

The marginal tax rate is the extra taxes paid on an additional dollar of income.

If you currently earn $50,000 and then you earn one extra dollar of income, that dollar is is taxed at a rate of 25%. Your current marginal tax rate is 25%.

The average tax rate is the total taxes paid, divided by total income.

8,681.25/50,000 = 0.1736 x 100% = 17.4%

2. Colorado State Taxes for Individuals Income Tax (4.63%) Sales Tax (2.9%) Consumer Use Tax (purchases that did not include Colorado sales tax internet, mail order, phone) (2.9%) Estate and Trust Income Tax (4.63%) Gasoline Tax (22cents per gallon) Cigarette Tax (4.2cents per cigarette, 2.9% per pack, 40% on other tobacco products) Alcohol Tax (8cents per gallon beer/cider, 7.33cents per liter wine, 60.26cents per liter of spirits)

3. Local Taxes and Fees Motor Vehicle Registration Property Tax City Sales Tax

4. Special District Taxes RTD levies a sales/use tax of 1.0% . The Football District has a 0.1% sales/use tax. The Scientific and Cultural Facilities District has a 0.1% sales/use tax.

E. How your taxes are spent 1. Federal

http://www.whitehouse.gov/taxreceipt

2. Colorado

http://www.colorado.gov/taxtracks/