Thursday, June 26, 2014

The purchase of the pebble

Yesterday I showed that gross corporate income is just a little less than twice the size of GDP:

Graph #1: Gross income to U.S. corporations is almost twice the size of U.S. GDP.
The gap between the red and blue lines is all corporate tax deductions.
Gross corporate spending is only slightly less than gross corporate income.

Corporate spending is bigger than GDP? How can that be?? Ha! I've been waiting for the chance to tell this story.

I go for a walk one day and find a pretty pebble. I clean it up and put it in my pocket.

Later I show the pebble to my friend B. B likes it, and offers me a dollar for it. Done!

B paints a little picture on the pebble and sells it to C for $2.

C puts it in a pretty box and sells it to Big D Stores for $3.

Customer E buys it for $4 and gives it to her boyfriend.

The "final spending" in that little scenario is the $4 that Customer E pays for the pebble. It's "final" because E is the consumer of the product. All the spending that came before was "intermediate" or preliminary spending -- the $1 and the $2 and the $3. There was $6 of preliminary spending and $4 of final spending, and a total of $10 in spending.

Why is "final spending" important? Look at the income generated in the scenario: I made a dollar, and B made a dollar, and C made a dollar, and Big D made a dollar. Four dollars of income was generated by the transactions. That's the same as the four dollars of final spending, Customer E's purchase of the pebble. That's why it's important.

But there was also $6 of preliminary spending in the scenario -- half again as much as the final $4 spending. The preliminary spending is much more than the final spending. That sort of thing is similar to what happens with corporate spending: the $6 is a tax deduction, and the $4 is taxable income. The numbers are different, of course. But the concept is the same.

I hope this puts your mind at ease.

Back in the late 1970s when I got my three credits in macro, they said GDP equals consumer spending plus business investment plus government spending plus net exports.

See it? GDP includes business investment, but not all of business spending.

Back in the late 1970s, they said the business investment part of GDP is called Gross Private Domestic Investment, GPDI. I don't know why I remember that, but I do. Anyway, if you take GDP and subtract out GPDI, you've taken the business portion out of GDP.

They told us (again, I don't know why I remember this) business investment is about 17% of GDP. That was a long time ago, of course; it could have changed by now. Here's what FRED has on it:

Graph #2: Gross Private Domestic Investment as a Percent of GDP
About 17%. A little higher since the mid-1970s. Call it 18%.

Anyway, we can subtract this business investment spending out of GDP. And then we can add the total corporate deductions of U.S. corporations. Businesses get a tax deduction for pretty much all of their spending. I'm using corporate deductions as a measure of total business spending.

It's crude, I know. But I don't know a better measure.

Doing the crude thing, this is what I get:

Graph #3: GDP (red) and GDP plus the rest of Corporate Spending (blue)

Graph #4: GDP as a Percent of "GDP plus the rest of Corporate Spending"
Okay. Now we're ready. Yesterday's post and this one are just some background info I wanted to pass along before we get to tomorrow's post.

See you tomorrow.

1 comment:

The Arthurian said...

That promise I made there at the end... I didn't get as far as I expected, in the follow-up post. There was a glitch in my numbers, or in my head, really. I split the follow-up into parts. The part that came out on the 27th doesn't really fulfill the promise.

More to come.