When you leave out major sources of income, surprise, surprise, you estimate that income is lower than it really is.

What about the “other 99 percent,” whose income supposedly rose by only 0.4 percent from 2009 to 2012? Piketty and Saez compare real incomes at different income levels without including Social Security, unemployment and disability benefits, food stamps, Medicaid, etc. Government transfers totaled $2.3 trillion in 2012, up 24.6 percent in real terms from 2007 and up 68 percent since 2000. Because Piketty and Saez estimate only pre-tax, pre-transfer income, they also ignore $149 billion in Treasury checks to lower-income families from refundable tax credits. They’ll also ignore huge Obamacare subsidies next year.

This is from Alan Reynolds, “The Truth About the 1 Percent.”

Reynolds cites this recent paper by Emmanuel Saez, an economics professor at UC Berkeley. And, sure enough, Saez confirms that he left out huge components of income of the bottom 99 percent:

We define income as the sum of all income components reported on tax returns (wages and salaries, pensions received, profits from businesses, capital income such as dividends, interest, or rents, and realized capital gains) before individual income taxes. We exclude government transfers such as Social Security retirement benefits or unemployment compensation benefits from our income definition. Non-taxable fringe benefits such as employer provided health insurance is also excluded from our income definition. Therefore, our income measure is defined as cash market income before individual income taxes.

This is ironic in light of the measures that many critics of inequality advocate. As I wrote in 2008:

Interestingly, because of the way incomes are often measured, many of the policies that various redistribution advocates propose would, in fact, increase measured inequality. These policies include: 1) increasing marginal tax rates on high incomes and/or 2) increasing the Earned Income Tax Credit.

The first policy–increasing marginal tax rates–would increase measured inequality as long as the supply curve of high income earning labor is even slightly upward-sloping. [DRH note: I no longer think this is a necessary result; it depends on both labor supply elasticity and labor demand elasticity.] The reason is that an increase in the marginal tax rate would discourage work. This reduction in the supply of labor would drive up the before-tax pay of the highest earners. All other things equal, their after-tax pay would decrease and after-tax inequality would fall–but measured inequality would rise. One can easily imagine advocates of such a policy promoting even higher marginal tax rates on high earners on the grounds of “we didn’t increase taxes enough to have an effect.” Of course, the ironic result would be a further increase in measured inequality.

The second policy, increasing the Earned Income Tax Credit (EITC) by raising the upper end of the income range over which people qualify, could have a similar effect to increasing marginal tax rates. Those at the new upper end would likely cut their work hours–and, therefore, their pay–to get the marginal subsidy for not working. Assuming this effect were not enough to cause a noticeable effect on wage rates, before-tax incomes of the newly qualifying EITC recipients would fall. Of course, they would be better off in income terms, but if the measure of income does not include the tax credit, measured inequality would increase. Just as in the case of increases in marginal tax rates, one can imagine advocates of an EITC increase calling for further increases on the grounds that the previous increases were not large enough.