Difference Between Earned and Unearned Income

Edited by Diffzy | Updated on: September 21, 2022

       

Difference Between Earned and Unearned Income Difference Between Earned and Unearned Income

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Introduction

An individual can make money in two ways. Even though income often comes from the money people make by working, it can also come from other sources like allowances, awards, gifts, investments, and prizes. They earn an income when they work for someone or engage in some form of economic activity. This type of income is known as earned income. It is also known as factor income. It refers to the income received by factors of production (land, labor, capital, and enterprise). They may be received, as rent, wages, interest, and profits. As it is earned for contributing to the production process, it is also known as Bilateral income.

People also earn money without working or engaging in any economic activity. This type of income is called unearned income. It is also known as transfer income. It refers to the income received without rendering any productive service in return. It is a unilateral income.

Earned Income VS Unearned Income

Earned income is the income received for providing some beneficial service in return for receiving the income whereas, unearned income is the income received by an individual without rendering any fruitful service in return. Earned income of normal residents of a country is included in the national income, however, the unearned income of normal residents of a country is excluded from national income as it does not reflect any production of goods and services. Earned income is subject to payroll taxation while unearned income is exempted from payroll taxation.

Difference Between X and Y in Tabular Form

Table: Earned Income vs Unearned Income
Parameters of Comparison
Earned Income
Unearned Income
Definition
Earned income can be defined as the income earned for rendering productive services in the production process.
Unearned income can be defined as the income received without rendering any productive service in return.
Nature
It is included in both national and domestic income as it implies an addition to the capital stock of the economy.
It is excluded from both national and domestic income as it does not reflect any production of goods and services.
Concept
It is an earning concept
It is a recipient concept.
Recipient
It is received by factors of production i.e; land, labor, capital, and enterprise in the form of rent, wages, interest, and profits respectively.
It is generally received by households and the government.
Type of income
Bilateral income is received in return for performing economic activities
Unilateral income as it is received without providing any productive service in return.
Taxation
Payroll taxes are applicable on earned income.
Payroll taxes are not applicable on unearned income.
Alternative name
Earned income is also known as factor income as it is received by the factors of production for their contribution to the production process.
Unearned income is also known as transfer income as it is received without rendering any productive service in return.
Examples
Rent, wages, interest, and profits.
Old age pension, scholarship, unemployment allowances, pocket money, birthday gifts, etc.
     
     
     
     
     
     
     

What is Earned Income?

Earned income is the income received by performing economic activities in return for income received. It is received for providing factor services of land, labor, capital, and enterprise and is therefore known as factor income. As is received for contributing to the production process, it is a bilateral income. Earned income of residents of a country is included in both national income and domestic income of the country. A company's image is improved when most of its income is earned income.

Ways in which a person can earn earned income:

  1. Self-employment- An arrangement in which a worker uses his resources to make a living, is known as self-employment. Workers who own and operate an enterprise to earn their livelihood are known as self-employed. About 52% of the workforce of India belongs to this category. Self-employment is a major source of livelihood for both men and women. In the case of self-employment, a person makes use of their land, labor, capital, and entrepreneurship to earn a living. Examples: shopkeepers, traders, businessmen, etc. It is a major source of livelihood in both urban (43%) and rural (56%) areas. But in the case of rural areas, self-employed workers are greater as a majority of rural people are engaged in farming on their plots of land.
  2.  Wage employment- An arrangement in which a worker sells his labor and earns wages in return, is known as wage employment. Under wage employment, a worker is known as an employee (or hired worker) and the buyer of labor is termed as the employer. Workers do not have any other resources (land, capital, or entrepreneurship), except their labor. They offer their labor services to others and in return earn wages. Examples: a doctor employed in a hospital. Waged employment can be of two types:
  1. Regular workers-When a worker is engaged by someone or by an enterprise and is paid wages regularly, then such a worker is known as a regular salaried employee. Workers are hired permanently and get social security benefits (like pension, provident fund, etc.) Regular workers account for just 18% of India's workforce. Example: professors, teachers, civil engineers working in a construction company, etc. In urban areas, it is the second major source with 42% of the workforce. Urban people have a variety of employment opportunities because of their education and skills. In urban areas, enterprises require workers regularly. However, only 9% of rural people are engaged as regular salaried employees due to illiteracy and lack of skills.
  2. Casual workers- Workers who are casually engaged and, in return, get remuneration for the work done, are termed, casual workers. Casual workers are not hired permanently. It means, they do not have a regular income, protection or regulation from the government, job security (they are hired when work is abundant and fired during the dull seasons), social benefits (provident fund, pension), and are not allowed to form trade unions to address their grievances. Casual workers account for 30% of India's workforce. In the case of rural areas, casual workers account for the second major source of employment with 35% of the workforce. Casual workers in urban areas account for 15%.

Examples of Earned income

  • Wages and salaries- It is the income received for engaging in work (any form of economic activity), where people trade their physical labor in return for income. Wages are the remuneration earned by casual workers and salary is the income earned by the regular worker.
  • Mixed-income of self-employed-It is the income generated by own-account workers and unincorporated enterprises. It is the term used for any income that has elements of more than one type of factor income. The mixed-income arises from productive services of self-employed persons, whose income arises from productive services of self-employed persons, whose income includes wages, rent, interest, and profit and these elements cannot be separated from each other.
  • Rent- Rent is that part of income that arises from ownership of land and building. Rental income includes both actual rent (rent of let-out land) as well as imputed rent(rent of self-occupied houses). The imputed rent of the owner-occupied house is calculated based on the market rental value of the house.
  • Royalty- Royalty refers to income received for granting leasing rights of subsoil assets. (coal, iron ore, natural gas, etc)
  • Interest- Interest refers to the amount received for lending funds to a production unit. It includes both actual interest and imputed interest of funds provided by the entrepreneur. It includes only interest on loans taken for productive purposes. Interest income will not include:
  1. Interest paid by the government on public debt.
  2. Interest paid by one firm to another.
  3. Interest paid by consumers as such interest paid on loans taken for consumption purposes
  • Profit- Profit is the reward to the entrepreneur for his contribution to the production of goods and services. It is the residual income, that an entrepreneur earns after paying all the other factors of production.

What is Unearned Income?

Unearned income is the income received without rendering any productive service in return. It is a unilateral concept (one-sided concept). It is also known as transfer income. It is not included in national income as it does not reflect any production of goods and services. It can be received either within the domestic territory of the country or from abroad. Internal revenue service penalties may be avoided in the case of unearned income. However, a variety of taxes must be paid on unearned income and the amount is often high.

Types of unearned income/transfer income

  • Current transfer- Current transfers are made of income. They are generally regular and are meant for consumption purposes. Examples:
  1. Old age pension-old age pension is received by people who are unable to work and earn a living because of their old age. It is different from a retirement pension as an old-age pension is paid by the government to the citizens without receiving any productive service in return. It is not accounted for in national income.
  2. Unemployment allowance- Unemployment allowance is a monetary benefit received by unemployed persons from the government, former employer, or federal agency, during a part or whole of their unemployment period.
  3. Widow’s pension- Widow’s pension is a pension that a woman whose husband is no more receives from the government.
  4. Capital transfer- Capital transfers are made of the wealth of the payee. They are generally irregular and are used for capital formation purposes. Examples:
  • Investment grant- Investment grants are received by institutions from the government to finance the cost of acquiring fixed assets. Since there is no monetary benefit for the government in this, it is an unearned income on the part of the institution.
  • Capital gains tax is a tax levied on capital gains received from the sale of any assets.
  • War damages compensation- War damages compensation is the monetary compensation paid by one country to another to cover damages or injury inflicted on the country during the war.

Main Differences Between Earned Income and Unearned Income in Points

  • Earned income is the income received for rendering productive services in return while unearned income is the income received without rendering any productive service in return.
  • Earned income is bilateral income whereas unearned income is unilateral income.
  • Earned income is also known as factor income. Unearned income is also known as transfer income.
  • Earned income is an earning concept. Unearned income is a receipt concept.
  • Earned income is received by the factors of production while unearned income is received by households and the government.
  • Earned income is accounted for in both national income and domestic income while unearned income is not accounted for in both national income and domestic income.
  • Payroll taxes are applicable on earned income. Payroll taxes are not applicable on unearned income.
  • Examples of earned income are wages, salary, profit, etc. Examples of unearned income are gifts, old age pension, widow's pension, unemployment allowance, etc.

Conclusion

We have seen two different types of income in this article- earned income and unearned income. We have analyzed the differences between earned income and unearned income. Earned income is the income received in return for rendering productive services and unearned income is the income received without rendering any productive service in return. It may be received by engaging in self-employment or wage employment. Understanding the difference between earned income and unearned income is a crucial step toward financial planning and financial management.

Both types of income are widely received by people. People work to earn a living and receive a part of their income without working. In the case of earned income, a person must work hard, but in the case of unearned income, the person receives the income without performing any work. However, the tax on unearned income may be higher than the tax on earned income in some cases.

References

  1. Class 12 Sandeep Garg-Macroeconomics Textbook.

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"Difference Between Earned and Unearned Income." Diffzy.com, 2022. Thu. 08 Dec. 2022. <https://www.diffzy.com/article/difference-between-earned-and-unearned-income-544>.



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