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Gross Private Domestic Investment (GPDI) overstates growth of the nation's stock of capital because some capital wears out each year. Accountants refer to the decline in value of capital because of wear and tear or obsolescence as depreciation.
But actual depreciation data reflect rapid accounting write-offs to exploit advantageous tax treatments. The overstated "depreciation" computed by accountants is termed the capital consumption allowance by economists, but no better data are available.
Subtracting depreciation from Gross Private Domestic Investment yields Net Private Domestic Investment, an estimate of annual growth in a nation's capital. All else equal, depreciation reduces capital owners' wealth. Thus, one step in reconciling GDP and NI entails subtracting depreciation from GDP to compute Net National Product (NNP)[1]. Conceptually, NNP estimates how much we could consume in a given year while maintaining a constant stock of capital throughout that year.
Net National Product Net National Product (NNP) is the net value of an economy's annual output after adjusting for depreciation. Failure to consider depreciation would cause overstatement of the net value of production. In a sense, depreciation represents a "death rate of capital" that must be subtracted from the "birth rate of capital" (GPDI) to arrive at net capital formation.
One more adjustment is required to reconcile GDP and National Income. The funds paid for goods and the funds firms receive are not equal. Sales and excise taxes, collectively known as indirect business taxes, drive wedges between what consumers or investors spend and sellers' net receipts. For example, sales taxes must be subtracted from a buyer's payment for a new car before income can be distributed to auto workers or manufacturers. Consequently, indirect business taxes must be subtracted from Net National Product. We reconcile GDP and National Income only after making these and other miscellaneous adjustments, as summarized in Table 3.
The Value-Added Technique If National Income accountants relied primarily on income tax returns, calculating GDP would entail summing all declared incomes, and then adding indirect business taxes and depreciation. But this strategy depends on honest tax returns, and even the latest figures available would be relatively out-of-date because (a) tax returns filed on April 15 are for the preceding year, and (b) it takes time for the IRS to compile and interpret the returns. For these reasons and more, National Income is calculated primarily as a double check on GDP figures.
An alternative is to collect all sales figures for a year. Most firms are subject to taxes reported monthly to government agencies, so sales data are available on a regular basis. But what then? Merely summing all sales revenues entails double counting. For example, if USX's steel sales are added to Ford's sales, we count USX's output twice—when steel is sold to Ford, and again, when Ford sells new cars and trucks.
To avoid double counting, National Income accountants use the value-added technique. A firm's value-added is computed by subtracting from its sales revenue any purchases of intermediate goods from other firms.
This leaves only the value of the firm's own production—its value added.[2] National income accountants then sum the value added by each firm. Summing domestic values-added by all firms yields reasonably accurate GDP figures, after adjusting for such things as inventory changes, the imputed (estimated) rental values of owner-occupied housing, and the imputed values of food grown and consumed on the farm—or your home garden.
Disposable Personal Income
National Income (NI), GDP, Net National Product (NNP), Personal Income (PI), and Disposable Personal Income (DPI) tend to move together. Therefore, in future chapters we often use a single economic model to explain how all these data are determined. Nevertheless, understanding how they differ helps illustrate how macroeconomics is linked to everyday life. You already know that capital consumption allowances (depreciation) are subtracted from GDP to compute Net National Product (NNP), and that subtracting indirect business taxes (e.g., sales taxes) from NNP yields all income earned by suppliers of productive resources, or National Income (NI). More adjustments are needed, however, before arriving at household income before taxes (Personal Income) and the after-tax income households actually have left to spend (Disposable Personal Income).
Personal Income (PI)
National Income includes wages, interest, rent, proprietors' income, and corporate profit. Firms often serve as tax collection points; in fact, some people never see parts of the income attributed to them. For example, corporate taxes must be paid before stockholders have claims on corporate income; these taxes must be subtracted from National Income. Dividends are parts of stockholders' Personal Income, but corporate retained earnings (undistributed corporate profit) must also be subtracted from National Income. Moreover, all employers are legally obligated to match employees' Social Security contributions. National Income accounts subtract all Social Security taxes from NI on this journey toward Personal Income.
Personal Income (PI) is the money income received by households before they pay their personal taxes. In addition to household income earned but not received, two forms of income are received but not earned. A growing share of our National Income is devoted to government transfer payments (e.g., welfare payments). Many firms also engage in charitable activities. Funds transferred through either government or business to private individuals must be added to National Income. At this point, we finally arrive at the total amount of personal income households receive.
From PI to Disposable Personal Income (DPI)
You might think that Personal Income is the amount available for personal consumption and saving, but direct taxes on individuals must be paid from Personal Income.
Disposable Personal Income (DPI) is income households can choose to consume or save after subtracting income taxes from Personal Income.
Table 4 details the breakdown from GDP to DPI for selected years.
[1]Another adjustment entails adding foreign payments to resource owners based in the U.S., and subtracting payments of resource payments to owners based outside the U.S. On balance, these adjustments are relatively small for the United States. [2]Most foreign nations rely heavily on taxes on values-added by business firms. Many American economists favor replacement of U.S. corporate income taxes by value-added taxes—an idea that is regularly resurrected in Congress as one way to efficiently reduce federal budget deficits.
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