The High Court recently decided that when the Ministry of Social Development calculates a social security beneficiary’s income any mortgage and credit cards loans she received were not income. Quite right, but it took a tortuous path to come to the right conclusion.

Had the Court come to any other conclusion, those businessmen jailed for fraudulently booking their business loan receipts as income (to hide a deficit in their flow of current receipts) would have asked for their sentences to be quashed and for compensation for wrongful imprisonment. What it would have meant for the private and public accounts of the nation boggles the mind. There would never be a government ‘deficit’ and corporations would go happily into bankruptcy while showing a regular ‘profit’.

Mind you, that would have meant treating the provisions of the Social Security Act as the foundation of our economic and accounting conventions. Everyone knows that those who come under the Act are not treated as normal human beings like the rest of us.

Even so, the High Court reasoning indicates just how antiquated the law is. It also gives the column the opportunity to set out some standard definitions for wealth and income. Too frequently the two are confused – for instance allegations that there has been a long-term increase in wealth inequality are usually referring to income statistics because we do not have reliable long-term wealth data. That the commentator does not know the difference tells us they do not know what they are talking about.

I appreciate some may find the next few paragraphs a bit rough. You might skim read them or skip through to the next bold head.

First, your wealth is equal to the market value of your assets less any liabilities (debts) you owe. So it includes the value of an owned house less the mortgage on it. There are many other forms of wealth including deposits at the bank, money in your pocket, shares, your pension entitlements and even (strictly) the value of personal items such as clothes and household articles (although typically when wealth is being measured, they are omitted). Your liabilities include what is on your credit card, an overdraft, IOUs and so on, as well as the mortgage.

Note that wealth is a stock, an amount at any point in time. Income applies for a period.

Suppose that is a year. Then you have a stock of net wealth at the beginning of the year and a stock at the end. (They are not usually the same.) There has also been a flow of resources entitlements during the year, usually from wages and salaries, investment income and social security benefits.

The definition of income is the maximum you can consume in the period without diminishing the wealth at the end compared to the beginning. Typically one’s income does not equal one’s consumption. You may save a little (like pay down your mortgage or increase your deposits at the bank). Or, struggling with your living standard, you may dis-save, running down some wealth.

As I have said, the previous few paragraphs may have been a bit hard for some to follow. Now it gets simpler.

What is critical is that you cannot think about an individual’s (or a business’s) income without thinking about their wealth. That explains why receipts from a loan are not income. A loan does not affect the level of net wealth. The increase in assets is offset by an increase in liabilities.

As long and as difficult as this argument has been, it is nowhere near as complicated as the one that the judge and the lawyers got into. It took two days of hearings plus those of various tribunals that had gone before. The judge argued that the loans used by the woman to pay income related expenses could not be classified as income since they had to be paid back and were, therefore, essentially capital in nature, rather than income. That meant that she was funding her consumption by running down her net wealth.

You do not have to be an accounting genius to work out that a loan is not income. It is so simple, once you have mastered the definitions.

I cannot believe that those in the Ministry of Social Development which made the decision that loans are income are so stupid. Its accountants and economists must be hiding under their desks. If the MSD ran its own accounts according to the way it treated beneficiaries, it would soon be in financial disaster.

The Ministry seems to have got into this tangle because of the definition of income in the Social Security Act 1964, which I’ve appended below. Observe it does not mention wealth, that critical concept for understanding the notion of income.

That explains the tortuous confusion in the High Court proceedings where there was not a single mention of wealth. The social security beneficiary appealing the earlier definitions had a complicated and changing balance sheet (the account which sets outs one’s wealth) but it was not included in the proceedings.

The case illustrates how nineteenth-century is the thinking behind our social security legislation. The logic of a modern state (even a twentieth-century one) is that we should integrate our income-redistribution system (mainly the income tax and social security) using the same definition of income in all legislation.

Clearly the Social Security Act needs a major revision to abandon the narrow, judgmental, punitive nineteenth-century principles that underpin it or which have been used to interpret it. That would be transformational.

Appendix.

A person’s income is defined in Section 3(1) of the Social Security Act 1964 as follows:

(a) [Income] means any money received or the value in money's worth of any interest acquired, before income tax, by the person which is not capital (except as hereinafter set out); and

(b) includes, whether capital or not and as calculated before the deduction (where applicable) of income tax, any periodical payments made, and the value of any credits or services provided periodically, from any source for income-related purposes and used by the person for income-related purposes.

Comments (1)

by Rich on July 11, 2018
Rich

I think the government tends to regard (at least for tax) certain loans from related parties as being income, because they don't trust the party to enforce repayment. (say I had a company, it *lent* me $100k a year to be repaid with interest in 50 years time, I die penniless first and my erstwhile company is out of pocket, but I'm not around to care. Not allowed).

Also, in your (correct) definition, capital gains (including on ones own residence) are income - if my house increases in value by $100k, I could remortgage, spend the cash and my wealth would not have diminished, at least in nominal terms (I assume you mean nominal terms, else we would regard inflation as reducing the income of anyone holding cash?). But (because MPs and other make substantial such gains) these are not taxed?

 

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