The Income Method measures national income from the side of payments made to the primary factors of production in the form of rent, wages, interest and profit for their productive services in an accounting year. Thus, national income is calculated by adding up factor incomes generated by all the producing units located within the domestic economy during a period of account.
The resulting total is called Domestic Income or Net Domestic Product at FC (NDPFC)- By adding net factor income from abroad to domestic income, we get National Income (NNPFC)- Mind, in income method national income is measured at the stage when factor incomes are paid out by enterprises to owners of factors of production—land, labour, capital and enterprise.
Since net value added by an enterprise is the result of services of factors of production, therefore, the same is distributed in the form of money income (rent, wages, interest, etc.) among factors of production. Hence, value of national income method should be the same as the one calculated by value added method.
Following are the main steps involved in estimating national income by income method:
- Identify enterprises which employ factors of production (land, labour, capital and enterprise).
- Classify factor payments into various categories like rent, wages, interest, profit and mixed income (or classify factor payments into compensation of employees, mixed income and operating surplus).
- Estimate amount of factor payments made by each enterprise.
- Sum up all factor payments made within domestic territory to get Domestic Income (NDP at FC).
- Estimate net factor income from abroad which is added to Domestic Income to derive National Income.
- Only factor incomes which are earned by rendering productive services are included. All types of transfer income like old-age pension, unemployment allowance, etc. are excluded.
- Sale and purchase of second-hand goods are excluded since they are not part of production of current year but commission paid on sale of second-hand goods is included as it is reward for rendering productive services. Likewise, sale proceeds of shares and bonds are not included.
- Imputed rent of owner occupied dwellings and value of production for self-consumption is included but value of self-consumed services like those of housewife is not Included.
- Income from illegal activities like smuggling, black-marketing, etc. as well as windfall gains (e.g., from lotteries) are excluded.
- Direct taxes such as income tax which are paid by the employees from their salaries and corporate tax, which is paid by the joint stock company from its profit, are included. But wealth tax and gift tax are excluded since they are deemed to be paid from past savings and wealth. Similarly, indirect taxes like sales tax, excise duties, which tend to increase market prices, are not included.