Wealth is Not Income

Two Wealthy Computer Guys

One of the mass illusions which has mesmerized the American people in recent memory is the conflation of income and wealth.  They are two topics that are, of course, intertwined (and correlated) – but not necessarily good proxies for each other.  Here’s how it generally goes:

News interviews small business owner, usually making a bit more than a ‘magic’ $250,000 income:

“This proposed tax increase is going to hit us hard and make it harder for us to create jobs in our business.”

News interviews billionaire:

“It’s time for our government to get serious about shared sacrifice.” (Yes, if you click the link, that’s Warren Buffett).

The Confusion is Confusing…

The funny thing about the whole income/wealth discussion is people don’t tend to make the same mistakes in other areas of life.  You know how much we love talking about cars here on DQYDJ, so ask yourself: when you shop for a car, do you look at the capacity of the gas tank, or do you look at the mileage per gallons?  99% of you are nodding your heads with me – those are two linked but not-quite-perfectly-related things.

Sure, we can do some funky math with either quantities – you can compute the range of a car using those two numbers, and you can convert income to an ‘expected wealth’.  But, hopefully you’ll agree, on the wealth side – accumulated resources are completely different than an incoming stream of resources (in our Four Pillars of Personal Finance article, we separated them as Assets and Inflows).  That’s right – that Billionaire interviewed on the news?  No matter how high you tax his income (even 100%!), he’s still going to have more money than you.  He’s already accumulated it.  If you wanted to knock Mr Buffett down to size, you’d have to implement a wealth tax – or jack up capital gains rates to a high level (and block loopholes to avoid capital gains taxes like borrowing versus assets).  Again, an income tax won’t do anything to the already rich.

A Lot of High Earners Aren’t Yet Rich!

The year was 2003 – Fortune Magazine coined a new term, the “High Earners, Not Rich Yet”s, or HENRYs.  Like Nascar Dads and Soccer Moms, they were thought to be a targetable demographic for get out the vote efforts – and they even made a bunch of appearances in 2008.  Look at any expensive metro area – Boston, New York, Washington D.C, Los Angeles, San Diego, San Francisco – and you’ll see the type.  High earning young professionals, perhaps with a few kids, that don’t have a net worth commensurate with their impressive incomes.  This is a group working hard, but perhaps not ‘saving smart’ (they don’t read DQYDJ…).  Remember – Economics is concerned with effects at the margins.  What group has the highest marginal cost from a new income tax?  People trying to earn their way to a high net worth with salary.  They can’t “stop” earning, like Mr. Buffett – they will bear the full brunt of any tax changes coming down the pipe.  The ultra rich can shift their earnings to different investments (and hire better accountants), but the HENRY couple living in Palo Alto and pulling in $300,000 a year can’t.  They don’t inspire a ton of empathy, sure – but don’t assume that an income tax hike is only going to affect ‘Wall Street’ or whoever the villain of the day is today.

So the next time you see “already rich, already famous” people talking about tax policy – don’t discount them out of hand, but consider the message carefully. The true effects should be easy to figure out.

What would you think if a retired Major Leaguer who used steroids complained about the usage of steroids in a sport?  Do you look at the gas tank capacity when you buy a car?  Can you quote it without looking it up?  Do you know the difference between income and wealth?  Do you think that I’m endorsing a wealth tax here?

Hint: I’m not.  But seriously, income taxes are really damaging.

 

Comments

  1. freeby50 says

    True. But wealth and income are very highly correlated. Most people with high incomes also have high wealth and vice versa. e.g. Warren Buffets income in 2010 was ~$62.5 million and his tax bill was ~$7M.

    • says

      Oh certainly, ‘high wealth’ people generally still have high incomes – I can’t disagree. However, it’s the ‘high income’ people who don’t always have the high wealth – anecdotes aside, that’s what the whole HENRY thing is referencing. High tax rates which strictly target income (with no regard to wealth) are certainly going to hurt accumulation by people who are “Not Rich Yet”, to play off the acronym (sort of DQYDJ’s specialty, right?).

      • freeby50 says

        But theres still a high correlation between high income people and high wealth. Most people with high income also have high wealth. Yes the so called HENRY’s are an exception but a minority. And the key there is the Y stands for Yet. Sure they aren’t high wealth YET but will be soon. I don’t think +2-5% tax rates will stop em.

        • says

          HENRYs being just one example – but the suburban middle class is a hole large enough to drive a truck through. I’d also mention young urban professionals (Yuppies? Bringing back the term!) like lawyers and doctors who come pre-burdened with loads of debt. I don’t think that $200,000 for an individual and $250,000 for a couple automatically comes with a net worth to match, especially factoring age into the equation. If Buffett and his ilk were being honest they would be championing a wealth tax, or a more onerous estate tax.

          You’ve got to admit bankrupt athletes is a funny one, though, heh.

  2. krantcents says

    When I started investing in income property, I was not making very much money. I was willing to sacrifice to reach my goal. I think you will find my rich people did exactly that.

    • says

      As an aside, did you do a lot of debt financing when you started buying properties? I’m curious if you were part of the “no debt” crowd or the “net worth calculation” one?

  3. says

    Working in my office you would be SHOCKED how many High Earners I come across that have relatively no assets to show for it (and vice versa of course, low earners who save/invest).

    Recently had a case 2 attorneys (one professor at top 10 school and one in private practice in NYC). Low 40s earning 700K combined. Around a Million in assets!

    The plan which we thought was an estate plan turned into a straight financial planning case showing what saving and investing and spending oh 5K or 3K a month less would do for their future.

    • says

      I believe you completely – as FI mentions though, tech seems to attract a different type. Individual engineers aren’t making $700,000, but I can’t think of one who didn’t have more than 1.5 times their salary by 40, haha. Thanks for sharing that one!

  4. says

    Great post. I deal with doctors all of the time. You think they would be loaded but they aren’t the majority of them earn a high salary and have a $1m house, a retirement fund, and a luxury car. No wealth whatsoever. It boggled my mine the first few times I encountered this because I would think they had more wealth but they just spend it all.

  5. says

    I find it refreshing to see a lot of high income earners rejecting the hyper-inflated lifestyle most perceive they are leading. In fact, at my work, most everyone wears the same clothes they’ve been wearing for the last 10 years or so. If you saw many of these people on the streets (like me), you might assume they were making minimum wage. Changing of the times? Probably not, but looks can be deceiving.

    • says

      Haha, minimum wage. Yeah, the Silicon Valley engineer dress code is world famous for… not existing. I know the type you’re talking about.

  6. MakintheBacon$ says

    I used to think the high income and wealth automatically went together. But now after reading a lot of blogs, I realize high net worth is the more accurate definition of wealth. I consider myself to be a modest earner but one who saves and invests.

    • says

      Unfortunately, modest earners who save and invest are carrying the largest of the load as a proportion of those earnings, eh?

      But yeah, I think you’ve got it covered – behind many high incomes are unimpressive (or even negative) net worths.

  7. 101 Centavos says

    This is one of the notions I remember being deal with on the Millionaire Next Door book. High income earners like doctors with terrible spending habits. A facade of wealth, and nothing much in the bank. On the other side, how about a small business owner living in a modest house, working crazy hours, but with a $1million income which is re-invested in the business? We all should have a hard time calling the latter “wealthy”.

    • says

      What’s that joke about doctors? (No offense to doctors!) “How do you make a lot of money without knowing anything about it?”. “Become a doctor”.

  8. Darwin's Money says

    I know a heck of a lot of people who make more than I do that don’t save much; they’re in debt in fact. People have a tendency to spend roughly up to what they make or more, perhaps hitting the 401k contributions along the way. But when we’re friends with dual earner couples making double or more what I make as a single earner and they haven’t put away a dime for their kids’ college or an emergency fund, it blows my mind.

    • says

      Yeah, at some point it’s like, “what are you spending it on?”. You’d think with neither earner idle as often it would be harder to spend it – but ‘lifestyle inflation’ is apparently a real thing. (Well, people have allowed it to be, anyway…)

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