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... because wealth is not income.
Here's how the story 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 Itself 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.
Wealth is not Income!
What would you think if a retired Major Leaguer who used steroids as a rookie complained about the usage of steroids in a sport? Do you look at the gas tank capacity when you buy a car? (Follow up: 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? Do you agree that wealth is not income?
Hint: I'm not. But seriously, income taxes are really damaging.