If anyone means to deliberate successfully about anything, there is one thing he must do at the outset: he must know what it is he is deliberating about. Otherwise he is bound to go utterly astray. Now, most people fail to realize that they don't know what this or that really is. Consequently when they start discussing something, they dispense with any agreed definition, assuming that they know the thing. Then later on they naturally find, to their cost, that they agree neither with each other, or with themselves. That being so, you and I would do well to avoid what we charge against other people.

—Socrates, in Plato's Phaedrus

A recent post of mine, How Do Households Build Wealth?, got a fair amount of attention (even a radio interview) because its takeaway graph seemed to surprise people (as it did me, when I put it together). Here it is again, presented more sensibly as a bar rather than an area chart.

Note: the revaluations shown here are not “realized” capital gains (which really only matter for tax purposes). They're changes in asset values. If your portfolio's value goes up by $20,000 this year, that bumps your net worth by $20,000 even if you don't sell any assets. Ditto your house, but without the second-by-second reporting of prices.

What surprised people: capital gains and losses completely overwhelm Saving (net or gross) when it comes to changes in Net Worth. Here's an even starker depiction, showing both magnitude and volatility:

I think these graphs are surprising to people because they don't understand what Saving means in the national accounts, or how it relates to Net Worth. Thinking of households, for instance, many might be surprised to find that:

Starting Net Worth + Saving ≠ Ending Net Worth

Household Saving ≠ Change in Household Net Worth

As you can see in the charts above, it's not even close. Why? In the national accounts, capital gains/revaluations aren't counted as part of “income.” It's no wonder the Saving/Net Worth equality doesn't balance; a whole bunch of household “Income” is missing from “Saving.” (Should capital gains be counted as Income and included in Saving? More on that below.)

The somewhat particular, stylized measure labeled “Income” in the national accounts serves an important purpose, but it also makes the word's meaning opaque and confusing to many. That's even more true of Income's residual, “Saving.” The estimable Nick Rowe went so far as to title a post “Why ‘saving' should be abolished.” Sez Nick: “it's the most confusing concept in macroeconomics.”

But it doesn't have to be confusing. The Integrated Macroeconomic Accounts of the United States (IMAs) — based on the modern international System of National Accounts (SNA) — calls out the particularity of “Income” by explicitly labeling the measure “Primary Income” (or more precisely, Balance of Primary Incomes). Drawing on that, the following chart may help render the relationships more transparent, adding a few named measures as aids to understanding.

Using these terms, here's how the national accounts tally up Income and Saving:

Primary Labor Income
+Primary Property Income
– Interest Paid
= Primary Income

+ Benefits & Transfers
– Taxes
= Disposable Income

– Consumption Expenditures
= Saving (net or gross of capital consumption/depreciation, your choice)

We could call this final measure Primary Saving, because it's a construct built from Primary Income. I discuss its meaning below.

This all balances, of course, but it's confusing at least in part because it combines sources and uses of funds into Income, rather than keeping them distinct so Sources = Income. (See Interest Paid and Taxes — both “uses.”) If you're not holding this whole construct clearly in your head when discussing Income and Saving — and likewise your fellow discussants — you (and they) are probably not adhering to Socrates' dictum.

A different approach may help. Below is a breakout of Comprehensive Income sources for U.S. households over the last half century, smoothed with rolling ten-year averages to hide confusing noise and make long-term trends apparent. This presentation alters one named measure in the IMAs: Primary Income is displayed before deducting Interest Paid; that's tallied with Uses, below. Interest Paid comprises 3–7% of Primary Income, 2–6% of Comprehensive Income. Note that everything balances. The spreadsheet's here. See the balance checks in rows 86–93.