6549.0 - Household Income, Consumption, Saving and Wealth, A Provisional Framework, 1995  
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Contents >> Chapter 4. The current account

Overview

4.1. The current account is anchored to the notion of a household 'consuming' over a defined reference period. Consumption is a necessary activity in the sense that a household has needs and wants, the satisfaction of which is a condition of its existence (e.g. household members have to eat to stay alive). The definition of the household reflects this - i.e. a household comprises persons 'who make common provision for food or other essentials for living' (see Chapter 7).

4.2. Given this consumption, it is relevant to ask how it is to be 'financed'. What power or command over economic resources does the household have that will allow it to consume?

4.3. The need for some power or command over resources gives rise to the notion of a flow of income. This is usually thought of as a flow of cash income resulting from a contract or claim. It might be income from an employer/employee contract involving a wage as a return for work done or it might be a claim for a government pension.

4.4. However, as noted above, a household may be in receipt of income in forms other than cash receipts. For example, non-market activities such as unpaid household work generate an income-in-kind. One of the main tasks in developing a comprehensive measure of economic well-being has been to expand the definition of household income to cover a range of other receipts which significantly affect a household's capacity to consume and save.

4.5. Both gross income receipts and net income after compulsory direct taxes are paid to government are therefore measured in the framework.

4.6. The fourth component of the current account, i.e. saving, is a deferral of consumption in order to either create assets or reduce a previously incurred liability. As with consumption, saving requires income for its realisation.

4.7. The power over economic resources and the propensities to consume and save are therefore in a dynamic relationship. The extent of a household's power over economic resources limits its capacity to consume and save.

4.8. Where a household is unable to, or chooses not to, meet its consumption needs from its regular income sources it may decide to dissave (run down assets or incur a liability).


Current account dynamics

4.9. An understanding of the relationships between the diverse flows in the current account is crucial to the formulation of a measure of economic well-being.

4.10. Formally, and in very simplistic terms, income (Y), consumption (C), direct taxes (T) and saving (S) may be expressed in a current account by the equation:

        Y = C + T + S where
        Y comprises all regular, recurring receipts (before the intervention of taxation);
        C comprises current consumption of non-durable goods and all services;
        T comprises direct taxes, compulsory fees and fines, and
        S comprises the difference between Y and (C + T).

4.11. In a strict accounting convention using an 'income and outlay account', income equates to current receipts; consumption, direct taxes and saving equate to current disbursements (see Table 3.1). Current receipts (Y) will always equal current disbursements (C + T + S) in the reference period.

4.12. Gross income can be replaced by an alternative measure of a household's regular resources available for consumption by deducting direct taxes from the receipts side of the accounts to produce a measure of disposable income. This disposable income (y) is then defined as:
        y = Y - T = C + S.

4.13. These measures of gross and disposable income will be useful for different analytical purposes.

4.14. Disposable income may prove to be greater or less than consumption in any given reference period. If disposable income is greater than consumption, then saving is a positive flow that moves into the capital account. Where consumption is greater than disposable income, then the saving is negative or a dissaving. This means that, during the reference period, households have financed some of their consumption by drawing on the capital account. This drawing may have comprised a running down of past savings by taking cash out of the bank, or by selling financial assets or non-financial assets. Alternatively, the extra funds may have been gained by incurring a liability in the form of a loan. Both the drawing on assets and the incurring of liabilities are activities that take place in the capital account and are described in Chapter 5.

4.15. The following sections in this chapter discuss, in some detail, the main concepts of income, consumption, taxes and saving that make up the current receipts and disbursements model of the current account. More formal definitions and classifications of the components are set out in Chapters 8 - 11.


Income

4.16. Income is an extremely difficult concept to define and agree upon. The term is sometimes used loosely to refer only to the main component of income for most households - i.e. wages and salaries or business income. Others use the term very widely to include all receipts including lump sum receipts and receipts that draw on the household's capital.

4.17. Classically, income has been defined as the sum of consumption and change in net worth in a period. This is known as the Haig-Simons approach. (See Simons (1938) in Atkinson and Stiglitz (1980), p 260.) This approach has not been adopted in the ICW framework in its pure form because it does not distinguish between current and capital receipts. This division into current and capital receipts is crucial to the ICW framework which aims at distinguishing between the day-to-day 'living well' and the broader 'getting rich' aspects of household finances.

4.18. Therefore, for the ICW framework, a definition of income is needed that will describe those receipts on which individuals/families/households depend for their day-to-day living. It should therefore cover only those receipts which the household sees as regular flows which it can expect to continue to receive at least in the short term and which do not draw down the capital of the household.

4.19. In particular, the definition of income needs to distinguish these receipts from those lump-sum, one-off receipts that are classified as capital transfers received in this framework and which are considered to form part of additions to stocks of household assets. To make this distinction, receipts that are classed as income must be received on a regular and recurring basis.

4.20. Income receipts also need to be differentiated from money drawn from the sale of, or running down of, household assets or from the incurrence of liabilities. (One exception to this rule is the treatment of benefits from superannuation/pension schemes as income. This is discussed in more detail in Chapter 8.)

4.21. With these requirements in mind, and taking into account the expanded concept of income to include income-in-kind, income is defined as follows:

      "Income comprises those accruing receipts (in cash and in kind) that are of a regular and recurring nature and are received at least once a year. It excludes any receipts that result in a running down of assets or an incurring of a liability."

(While this definition differs from the Haig-Simon definition commonly used, it is not incompatible with that definition in the broad scheme of the ICW Framework. The irregular and/or non-recurring receipts that the ICW definition of income excludes are accounted for in the Capital Account and Other Changes In Stocks Account. They are later combined with income in the broader measure of economic well-being - see Chapter 6.)

4.22. Income covers both cash and in-kind receipts and these may or may not be acquired via the market place. It comprises primary income, property income, transfer income and other non-market income.

4.23. Other non-market income includes the value of unpaid household work and other household services including those provided by the use of the owner-occupied dwelling and household consumer durables.

4.24. Conceptually, income in the ICW is net of expenses incurred in deriving this income. However, for practical reasons, the deduction of these expenses may need to be limited to situations where the expenses are widely recognised by taxation laws and are of a considerable size. Such limiting operational criteria mean that, in practical terms, there will be some likelihood of being able to collect reliable data on income after expenses.

4.25. Therefore, operationally, it will often be easier to collect business and rental income net of expenses than it will be to collect, for example, wage and salary income net of employee costs such as transport, dry cleaning, etc.

4.26. Income is also net of depreciation of capital equipment used to generate income. Thus, income from unincorporated enterprises, for example, is net of both business expenses and depreciation. Similarly, estimation of the value of services provided to the household by household consumer durables should also take into account the depreciation of the capital items.

4.27. Income excludes intra-household transfers. This exclusion is applied because the household is the default statistical unit and the inclusion of these transfers would result in double-counting of income at the household level.


Consumption

4.28. Consumption is the process of 'using up' goods and services. However, there are different types of goods and different types of using up.

4.29. Goods may be non-durable consumer goods which are immediately used up in the process of satisfying needs and wants (e.g. food). They may be consumer durables that are used up over a longer period during which time they provide a service to the household (e.g. car, refrigerator).

4.30. In the ICW the definition of consumption, in terms of goods, is limited to the using up of non-durable goods that have a single use or otherwise very limited life.

4.31. In terms of services, the classification of consumer durables as capital goods allows for recognition of the durable goods as assets rather than consumption items. They provide services to the household that could otherwise have to be purchased in the market place. These services may contribute significantly to the economic well-being of the household and are included, along with purchased services, as consumption in the ICW framework. The services are net of depreciation of the durable goods.

4.32. Consumption, therefore, may take the form of:

      • final consumption expenditure, which describes the 'using up' of those services and non-durable items that are acquired via the market place in return for cash;
      • in-kind consumption of services and non-durable goods which are acquired, without the intervention of money, from government, other households and private organisations, or from within the household;
      • other current regular transfers outlaid.

4.33. Final consumption expenditure includes the value of indirect taxes paid on the purchase of consumption goods. For some analyses it may be desirable to separate out these taxes from the rest of the purchase value of goods. (Such indirect taxes are currently imputed in the ABS fiscal incidence study where indirect taxes on all purchased items (both non-durables and durables) are combined with direct taxes, direct and indirect government benefits to measure the redistributional effects of government taxes and benefits on household income.)

4.34. In-kind consumption encompasses services and non-durable goods acquired both via the market place (e.g. free or subsidised car provided by employer), and without recourse to the market place (e.g. services provided by own consumer durables, unpaid household work, etc.). It also covers services and goods provided in-kind in the form of gifts, etc. from other households.

4.35. Other current transfers relate to compulsory inter-household transfers such as child support, voluntary cash transfers and gifts purchased within the reference period that are given to other households for their consumption.


Direct taxes, compulsory fees and fines

4.36. Direct taxes, compulsory fees and fines are defined as all direct compulsory transfers to government and all compulsory fees and fines paid to government. By far the major component of this group of outlays is the direct taxes which constitute a regular and recurring payment out of the household that reduces the amount of income available for consumption and saving.


Net disposable income

4.37. Net disposable income is defined as gross income minus the value of direct taxes and compulsory fees and fines. It represents that income available to the household for consumption and saving.


Saving

4.38. Saving is that part of current income (after direct taxes) that is not directly used up or transferred as part of household current consumption. Saving is therefore, in the current account, a derived item which depends on a knowledge of income, consumption and taxes for its derivation.

4.39. Saving may be either positive or negative in any reference period. Saving is positive when household disposable income is greater than the household consumption. In cases where household consumption is greater than the disposable income, then saving is negative i.e. a dissaving. (Because of the importance given to the distinction between positive and negative levels of saving, the term 'dissaving' will often be used in this paper to denote a flow of money from the household's capital to its current consumption.)

4.40. Households save out of current income for a number of reasons, for example:

      • to create an asset (often an income-producing asset);
      • to reduce or liquidate a liability; or
      • to provide for future consumption through future dissaving.

4.41. At present, two major uses of on-going saving for Australian households are the repayment of mortgage principal on their home and the contributions made to superannuation funds out of their regular income.





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