Issues associated with National Income accounting

Issues associated: National income accounting is like the financial diary that a government keeps to track how much economic action is happening in the country over a certain period. This “diary” includes details about the total money earned by local businesses, the paychecks going to both local and foreign workers, and how much everyone in the country is chipping in for taxes. It’s basically a way for the government to keep tabs on the overall financial health of the nation.

Problems in Income Method:

The following problems arise in the computation of National Income by income method:

Owner-occupied Houses: When someone rents out their house, they earn rental income. However, if they live in the house themselves, the value of their housing services is still considered in the national income. This is treated as if the owner is both the landlord and the tenant, with the imputed rent being the estimated amount the owner could have earned by renting out the property. The net rent is then calculated after deducting expenses.

Self-employed Persons: For individuals who are self-employed, determining the value of their various contributions (capital, land, labor, skills) is challenging. Their income is a mix of interest, rent, wages, and profits for the services they provide. Despite the difficulty in breaking down each factor’s value, their overall income is included in the national income.

Goods meant for Self-consumption: In less developed countries like India, farmers often keep a significant portion of their produce for personal use. The question arises as to whether this self-consumed portion should be included in the national income. The argument is that if the farmer were to sell everything, they would have to purchase what they need. Therefore, the value of the self-consumed produce is considered in the national income.

Wages and Salaries paid in Kind: Some employers provide wages and salaries in the form of non-monetary benefits like free food, lodging, and clothing. These in-kind payments are still included in the national income. This inclusion is based on the idea that if employees didn’t receive these non-monetary benefits, they would have received an equivalent monetary income and spent it on similar necessities.

Problems in Product Method:

The following problems arise in the computation of national income by product method:

Unpaid Services of Housewives:

Housewives perform a multitude of valuable services such as meal preparation, serving, tailoring, childcare, and more. Despite their significant contributions, these services are not considered in national income calculations, leading to an underestimation.
The reason for excluding housewives’ services is the challenge in assigning a monetary value to the love and affection they put into their domestic work, making it difficult to measure in economic terms.
Unlike services provided by paid servants, a housewife’s efforts go unrecognized in the national income, contributing to the overall underestimation of the country’s economic output.

Intermediate and Final Goods:

Estimating national income faces difficulties in properly distinguishing between intermediate and final goods, potentially resulting in the inclusion of a good or service more than once. This double counting leads to an overestimation of the national income.

Second-hand Goods and Assets:

The sale and purchase of second-hand goods and assets, such as old cars and houses, are excluded from national income, as they were already counted when initially manufactured or created.
While transactions involving second-hand goods are not included, the commission or fees charged by brokers in these transactions are considered in national income, representing payments for their services.

Illegal Activities:

Income generated through illegal activities like gambling and smuggling is not factored into national income, even though these activities fulfill certain consumer demands.
In countries where certain illegal activities are legalized, such as gambling in Nepal and Monaco, they are included in national income calculations.

Consumers’ Service:

Individuals in professions like acting, dancing, teaching, and others, who provide intangible services, face challenges in having their contributions included in national income despite fulfilling human needs and receiving payments for their services.

Capital Gains:

Profits from the sale of capital assets, known as capital gains, are not considered in national income calculations, as they are not directly tied to current economic activities.

Inventory Changes:

National income includes changes in inventories, whether positive or negative, as a reflection of the fluctuations in a firm’s production.

Depreciation:

Depreciation, representing the decrease in the value of assets over time, is deducted from Gross National Product (GNP) to calculate Net National Product (NNP), reflecting a more accurate national income figure.

Price Changes:

National income, measured at current market prices, is susceptible to changes in price levels. Economists adjust for these fluctuations by calculating the real national income at a constant price level using the consumer price index.

Problems in Expenditure Method:

The following problems arise in the calculation of national income by expenditure method:

Government Services:

When calculating national income through the expenditure method, a challenge arises in determining whether to include expenditure on government services. These services encompass various aspects, including police, military, administrative, and legal services. The question is whether these services should be considered as part of national income, treating them either as final goods or intermediate goods for further production.
Some argue that if services like police, military, legal, and administrative contribute to protecting lives, property, and liberty, they should be treated as final goods and included in national income. However, if their primary role is to facilitate the production process by maintaining peace and security, they may be considered intermediate goods and excluded from national income.
In reality, drawing a clear line between services that protect individuals and those that aid in production is challenging. Consequently, it is common practice to treat all such services as final goods and include them in national income calculations.

Transfer Payments:

Another consideration in national income calculation is the inclusion of transfer payments. These payments, such as pensions, unemployment allowances, subsidies, and interest on the national debt, are made by the government. Despite being government expenditures, they are typically excluded from national income as they don’t directly contribute to the current year’s production process.
For example, pensions and unemployment allowances are disbursed without individuals engaging in productive work during the year. Subsidies, while affecting market prices, do not add to production. Interest on the national debt is also considered a transfer payment, as it represents payments to individuals and firms for past savings without current productive work.

Durable-use Consumers’ Goods:

The treatment of durable-use consumer goods, such as cars, fans, and furniture, poses a dilemma. While these items are purchased in one year, they serve for several years. Determining whether to classify their expenditure as investment or consumption is crucial for national income estimates. Generally, the expenditure on these goods is considered final consumption expenditure, except in the case of a new house.
Investment expenditure is assigned to a new house because the rental income or imputed rent received by the house owner contributes to the investment made in the new property. On the other hand, spending on a car for personal use is deemed consumption expenditure, but if the car is used as a taxi, it is considered investment expenditure.

Public Expenditure:

Government spending covers a wide range of areas, from essential services like police and health to infrastructure development like roads and buildings. Distinguishing between consumption and investment expenditure is crucial. Expenses on education, museums, public health, police, parks, street lighting, and civil and judicial administration are typically categorized as consumption expenditure.
Conversely, expenditures on infrastructure projects like roads, canals, and buildings are considered investment expenditure. Notably, even expenses related to defense equipment, including salaries for armed personnel, are included in national income calculations despite being treated as consumption expenditure, as they are consumed during war due to destruction or obsolescence.