The Haig-Simons Definition: Redefining the Concept of Income

Imagine you have a nice piggy bank where you keep all your pocket money. The leftovers, if you will, from when you need to use cash to shop at the local farmers' market or something like that.

At the beginning of the year, you count and find you have $50. Now, throughout the year, you add more coins and cash. Let's say by the end of the year, you've deposited $100 more into the piggy bank.

Meanwhile, you've also been using this money to buy things. Suppose you spent $30 this year.

The Haig-Simons definition of income is like taking a look at your piggy bank at the end of the year. It's not just the money you've received ($100) - it's also about how much the total value of your piggy bank has changed.

So, you'd count how much money you have left at the end of the year and compare it to what you had at the beginning. If you had $50 at the start and now have $120 ($50 start + $100 received - $30 spent = $120), according to Haig-Simons, your income is the $70 increase in your wealth ($120 now - $50 start = $70).

Thus, the Haig-Simons definition says that income is the change in your wealth from the beginning to the end of the year, plus what you spent during the year. It's not just about the money you receive — it's also about how your total wealth changes.

About the Haig-Simons Definition

The Haig-Simons definition of income is named after two economists, Robert Haig and Henry Simons, who developed the concept in the early 20th century.

Haig and Simons believed that income should be defined as the increase in an individual's ability to consume over a given period of time. This definition includes all forms of income, including wages, salaries, investment income, and capital gains.

The Haig-Simons definition of income has become a widely accepted framework for tax policy and economic analysis. However, it has also faced criticism and alternative definitions have been proposed. Despite its limitations, the Haig-Simons definition of income remains a significant concept in modern economics.

The Definition

Mathematically, the Haig-Simons definition of income can be expressed as:

Income = Consumption + ΔNet Worth

Where:

Consumption is the total value of all goods and services consumed during the period.

While ΔNet Worth (change in net worth) is the net worth at the end of the period minus the net worth at the beginning of the period.

This definition is much broader than the usual concept of income as money earned from work or investments. It considers any increase in economic power, regardless of the source, as income. This includes capital gains, whether realized or not. For instance, if the value of your stock portfolio increases, even if you didn't sell any stocks, that increase is considered part of your income according to the Haig-Simons definition.

Tax Policy

The Haig-Simons definition is important in the field of public finance, particularly when discussing optimal taxation and tax equity. It provides a theoretical framework that can inform tax policy design, ensuring that all increases in economic power are subject to taxation.

Put another way, the Haig-Simons Definition of Income is significant as it helps policymakers and economists understand the impact of income on individuals and the economy as a whole.

Here are a few ways the Haig-Simons definition impacts tax policy:

• Broadening the Tax Base — If policymakers were to adopt the Haig-Simons definition in its entirety, the tax base would be significantly broader. This is because all increases in economic power, not just received income, would be subject to taxation.
• Taxing Unrealized Capital Gains — The definition includes unrealized capital gains as income, which is a point of debate. Traditionally, tax systems have deferred taxation on capital gains until realization (when the assets are sold). If unrealized gains were taxed, it would represent a significant departure from current policy.
• Progressive Taxation and Wealth Inequality — The Haig-Simons definition provides a theoretical underpinning for progressive tax systems that aim to reduce wealth inequality. By recognizing increases in the value of assets as income, it could potentially lead to higher taxes on the wealthy, who tend to own a significant proportion of appreciating assets.
• Tax Complexity — If implemented, this definition would likely increase complexity in tax calculations. Valuing assets annually to determine unrealized gains could be a challenging task, and taxpayers might need to use complex methods or seek professional advice to accurately calculate their tax liability.
• Liquidity Issues — Taxing unrealized gains could lead to liquidity issues for taxpayers, who might owe taxes on income they haven't received in cash. This could particularly affect those who are asset-rich but cash-poor.

It's important to note that while the Haig-Simons definition is influential in academic discussions of tax policy, at the time of writing, no tax system has fully implemented it due to practical constraints and policy considerations.

Why You Need to Care

The Haig-Simons Definition of Income is a widely used and influential definition in tax policy and economic analysis, and it is significant in shaping our understanding of income and its role in the economy.