All About Income
Dr. Katie Sauer
Metropolitan State University of Denver
(ksauer5@msudenver.edu)
Presented at
Junior Achievement’s Secondary School Personal Financial Literacy Workshop
in collaboration with
the Colorado Council for Economic Education
pay back debt
economy
taxes
income
spending
borrowing
insurance
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
3
How much are US median income and mean income?
median income = $49,777
mean income = $67,976
How much is Colorado’s 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.
It’s 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 &
salary
514.3
836.7
1,504.8
2,361.8
12.1
11.3
12.4
12.3
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
174.5
65.2
40.5
8.6
31.9
24.6
248.2
144.6
84.5
18.0
66.5
60.1
375.9
212.8
124.8
27.4
97.4
88.1
2.3
0.6
0.3
0.1
0.3
0.2
2.4
0.9
0.5
0.1
0.4
0.3
2.1
1.2
0.7
0.1
0.5
0.5
2.0
1.1
0.7
0.1
0.5
0.5
272.9
276.8
192.6
650.9
6.4
3.7
1.6
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 person’s 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
$99,995
Professional Degree
$125,622
Master's Degree
$71,236
Bachelor's Degree
Associate's Degree
Some college, no degree
High School Graduate (inc. GED)
9th to 12th grade
less than 9th grade
$60,954
$41,226
$38,676
$33,618
$24,686
$21,491
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 aren’t 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 don’t 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
Represents all possible
income-leisure tradeoffs
for a given wage rate.
$ from 90 hours
of work
$ from 40 hours
of work
$0
0
78
128
Weekly
168 Hours of Leisure
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 worker’s 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
Two potential
outcomes:
1. the wage falls,
the new workers are
hired
new wage
Labor
Demand
actual workers hired
more workers hired
Number of Workers
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
Bartender
Wage Rate
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
Let’s 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/