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December 06, 2010


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My thoughts:

The government and researchers have better data on income and not wealth (to my knowledge). So this is what gets published and talked about the most and what taxes are based off of.

I think that if you look at income compared to wealth you will find that they are very closely linked. Those who have high incomes, have high net worths. Sure there are bunches of people who go crazy and spend way too much money. But I bet if you look at good data of this, there will be a close correlation. Therefore, for the most part, it would be correct in saying that those with high incomes almost always have high net worths.

For example (#1): The average person making $250k+ a year has probably been making about $150k average over the past 15-20 years or more lets say. And let's assume they save a normal to large portion of their income, and invest in stocks. I think this would be the average example financial situation of someone making $250k+. This person would have a very high net worth.

Example (#2): Somebody makes $50k last year and $250k this year. Blows it all and then some on stupid stuff. Has negative net worth.

I think that when you average everyone together there are a lot more people similar to example #1 and a handful of example #2s.

So I agree that there is definitely a difference between income and wealth, and you are right it is often overlooked and/or simplified to mean the same thing. But high income = high net worth in most, but not all cases (on an average).

tl;dr: On an average: High income = high net worth

As a long time market researcher, I can confirm the first poster's hypothesis. Income level is collected on almost every survey, so that researchers can look for the effects of affluence.

There are two reasons that researchers ask about income, not net worth. The primary reason is that people do not know how to correctly calculate net worth, and many folks are not even familiar with the term at all, while income (usually household income) is easy to calculate and most people have that number already calculated in their head. When folks are asked about net worth, they usually guess wrong, studies that have been done on net worth have shown that people are not good at estimating it for a survey [These studies ask the respondent to estimate net worth, then ask the respondent multiple questions to create a net worth profile. The estimated versus calculated are not consistent enough to make estimated net worth a valid research question].

The second reason was stated well by the first poster - people with higher incomes, tend to be wealthier. On average it is a better surrogate for net worth, than asking a respondent to calculate net worth!

It is not that the research community doesn't understand finances, it is that the general population does not understand net worth well enough for us to successfully utilize it in survey research.

Income = incoming cash flow

Wealth = positive net worth

high income = rich

high net worth = wealthy

"In other words, "income" is what you earn"

Then why do they have that thing known as non-earned income. Of course, now I am the one just playing with semantics. On a further note, the expiration of Bush tax cuts is associated with one's Adjusted Gross Income (not their Income).

I think that's the problem with semantics, you can keep slicing the details finer and finer. The reality is most people feel that people who earn money upwards of around 250K are doing well enough (or should be doing well enough) to contribute more to the pie. semantics or no semantics.

Bruce --

I think you hit the nail on the head when you said (editted a bit):

"The reality is most people feel that people who earn money upwards of around 250K should be doing well enough to contribute more to the pie."

You said you didn't want to do politics, but you've already said it:
"The people using the terms understand the differences in meaning but are purposefully trying to bias the conversation."

Now, the only question is whether you'll keep trying to ignore what this means.

It's ashame they make it so confusing for people. Personal finance can get confusing normally let alone using terms in the wrong context. I am sure many of your readers have appreciated the clarification you have given.

I can think of two good reasons:

First good reason - everyone bases their opinions of appearances, and high income people often display what many think wealth looks like (nice cars/homes/etc). It's the reason the car dealer gave you a sidelong glance when you were looking at a $37k SUV when you were clearly dressed in used Corolla territory.

Second good reason - anyone who pays for studies that look at/measure financial data only cares how much people spend, and that is more strongly linked to income than net worth. That's why Thomas Stanley's research was so revolutionary - he was one of the first to use net worth as the selective criterion for his behavioral research, not income.

C'mon--anyone making that income is more likely to be wealthy. And for the purposes of a trashy article in the popular press--does it really matter?

"The people using the terms understand the differences in meaning but are purposefully trying to bias the conversation."

I think you hit the nail on the head with this.

James- excellent insights! The other piece of this that drives the conversation is that all this talk is about trying to decide how to address tax legislation. As the current tax regime is designed around taxing income rather than wealth, the policy choice at hand is whether or not to extend the Bush deficit bombs (others refer to them as tax cuts). Since the delineation of the policy choice is based on income, income becomes the proxy variable to argue about the slightly more esoteric notion of "wealth."

Then James' points kick in and boom, we conflate income with wealth, even though they are highly positively correlated.

FMF - welcome to my frustration when people refer to money as wealth.

If people make 250K+ and are still not rich, it's really their problem - spending too much.

Especially when you talk about politicians, these misstatments are intentional and for political purposes. No excuse for the personal finiance writer but for the rest it is very intentional. They are atempting to tie the term "rich" to the income level (either $250,000 or a million) since taxing income is the prefered way to levy taxes in this country. We do not tax wealth in America, we tax income (either salary, interest or capital gains). But if you have $100 million in you mattress (a very large lumpy mattress for that matter), this is wealth that you will pay no taxes on. If you make $250,000 in income but have zero savings, you will pay a fairly high tax bill. So when we talk about raising or lowering taxes on income then it is politically expediant to say you are taxing the rich even though their personal net worth is not at issue. In a partisan political fight their must be villians and the over $250,000 income crowd is the villian in the current tax fight.
To be honest if you make over $250,000 a year and have low net worth shame on you. You should pay thru the nose on taxes!

I believe FMF is correct when he says that most people don't understand the difference between income and wealth. If you are not one of those that lives below their means in order to build wealth I don't think you understand it. If you don't have the patience/knowledge to spend years building wealth I don't think you "get" how it works. I think most people are hoping to either get rich quick or they ignore the future.

According to Yahoo Finance, Warren Buffett made $175,000 last year in salary. This should prove to anyone that "High Income" and "High Net Worth" are not the same - his salary from Berkshire doesn't even push him into the top tax bracket!

While I agree that income and wealth are two different things, your definition of "rich" seems like it includes high-income earners as well as the wealthy: "...abundantly supplied with resources, means, or funds..."

Making $250K/year sure sounds like being abundantly supplied with funds to me.

Political logic.

People making more money than you are rich and people making less money than you are poor.

If the president makes $200k a year and congressmen make $150k, people making $250 k a year are rich.

I see your point, FMF, but I do think there is a real distinction between someone who has no savings and a low income, and spends all of their money on a 1 room apartment and a 10 year old car, and someone who has no savings, but drives a BMW, travels the world, and is paying the mortgage on a million dollar house. Sure, in terms of 'net worth' these people are equivalent, neither being rich, but one is 'rich' in terms of their lifestyle and their opportunities and their possessions, and one is not.
As RB Boren suggested, it would be possible to talk about wealth vs. rich instead of rich vs. high income and communicate the same thing. Honestly, many of the 'rich' people who declare bankruptcy go on to continue living a 'rich' lifestyle because they have the potential for a much higher income. I think that matters as we talk about tax rates, or ethical lifestyles.

I'd say on the surface level it is semantics, but the effect is much worse than that. When people speak with authority about a topic and most people listen attentively... especially on TV - this is where I worry about misinformation. If they are using the wrong terms, then okay we'll just make fun of them and groan. It is the people listening who are going to think that you must have a high income to be wealthy, and that's what makes me sad.

Anecdotally, I was managing to "save" money by paying off debt when I was 25. I had been laid off for several months and took a pretty crappy job because I knew I couldn't wait anymore. This job paid under $20K / yr, and I paid off $4000 worth of CC debt doing it in under a year. Now I've grown my income since then (and sadly grown into it a bit too), but the point is that although I've never hit a six figure INCOME I do feel wealthy. We've read TMND, we've read FMF's stories about millionaires who never made six figures.. but the view will always be that an income like 250K is necessary to be rich. It is very unfortunate.

Maybe a real life example will help people understand better.

My mother makes a high income (6 figures) yet I am pretty sure she has a negative net worth. She owes more on her house than it is worth and has quite a few maxed out credit cards. I honestly don't know how it got that bad, but thats how it is. She drives a nice car, but not a luxury car and her home isn't anywhere near a mansion. She wasn't able to contribute to my college education (which is fine with me, I get by on my own) even though her high income tells the FAFSA that she could cover the entire thing.

She is the perfect example of a high income that did not lead to a high net worth. This is definitely due to poor decisions and I do not support it in any way, but there is definitely a distinction between a high income and net worth.

Nice tirade. ;) Yes you're right that income and wealth are different concepts.

Its just a convenient assumption that is right most of the time and sloppy journalism (the norm). The press routinely makes generalizations based on assumptions. This is just one of them.

High income people are usually 'rich'. For households income >$200k median household net worth is >$1.1M and mean >$3M. So its a 'safe bet' (better than 50/50) that people making $200k are also millionaires.

There is such a high correlation between high income and high net worth that I think using that assumption that high income means high net worth is mostly excusable. Most people with very high incomes also have very high net worth. SO high income generally indicates wealth. Yes theres exceptions obviously. Yes its technically not the same.

The opposite is not true as much, so many high net worth people do not necessarily have high incomes. However the news articles aren't making that implication.

If you make a very high income then you are either rich already, soon to be rich, handling your money poorly or your income is a short term aberration.

Also there are various definitions of "wealth" and "rich" and many people would consider $250k to qualify for either.

Building wealth is a lifestyle. But it can be much easier than people think. So many people save up 5-10 percent of their income a year and try to get huge returns from the stock market or other investments that are risky. Not the best way. I have heard of people financing their own purchases, and learning how to transfer wealth back into their own banking systems instead of hoping to cover their financing dollars spent with risky returns.

I believe there is a correlation with income and wealth, but I agree with the author that the terms are being misused and the result is somewhat misguided legislation. The politicians and public are really talking about discretionary income. And this is where the problem is - income does not equal discretionary income.

You need to take into account the cost of living in the area for the basics - no one needs a new BMW, but they do need car insurance, a home, food, etc. These things all cost significantly more money in more affluent areas. These affluent areas traditionally attract higher-income earners because they can afford it. But most of these higher-income earners wouldn't earn the same high salaries if they didn't live there. Things like the mortgage interest deduction help align taxation more with discretionary income. Things like the AMT force taxation more towards actual income. The fact is that it's hard to own a house in California and NOT be subject to AMT.

Yes, some make 6 figures and spend more because they have more. But sometimes they spend more because the same thing costs more. If you looked at a 70-year-old 1500 square foot "starter home" in the Bay Area, it can easily cost $800K, in relatively mundane San Mateo (forget about Palo Alto or Menlo Park). This mortgage costs over $4K per month, even with a 20% down payment. This same house might cost $200-$300K in a nice suburb in some other state.

Let's take the example of someone making $250K in Omaha and another making $250K in San Francisco. One could argue that the $250K earner in Omaha should be taxed the same as the $250K earner in SF, but that's a political debate. What I can tell you is that the Omaha resident is going to have way more discretionary income than someone making the same salary in San Francisco. The Omaha resident will be far "richer" by almost any financial measure...and this has nothing to do with better or worse financial decisions.

Speaking of semantics - calling them "tax cuts". If legislation doesn't happen - some people will see tax increases. So, that's what this is, a tax increase on high earners.

Again, it's just a way to slant the discussion in the way you want people to respond. It's easier to spin - "don't extend tax cuts" than it is "tax increases".

To the comments on the original point. It's obvious that a $250K/year earner is more likely to be "waelthy" than someone earning $50K/year, but it IS an oversimplification. As others point out, the income -> wealth flow isn't as obvious as some would make it.

And finally, an additional comment. It's put the way it is, because it's very hard to sell this, "I want to take a meaningful amount more from people whose skills and talents are most valued in the marketplace, and rather than allow them the courtesy of enjoying the fruits of their valued and skilled labor, I'd like to give their earnings away to people who lack the skills and/or work ethic to make themselves valued in the marketplace".

could we agree that "current law is for taxes to increase on all households, particularly the wealthiest, and congress is debating changing current law to extend or make permanent the tax rate cuts under president Bush"? From the perspective of current law, we are debating cutting taxes-ballooning the deficit by some 2 trillion dollars over the next 10 years. From the perspective of an individual tax payer, we're discussing whether their taxes will increase next year. Fair enough?

Also, I absolutely want to take a meaningful amount more from people whose skills and talents are most valued in the marketplace and give them to people who lack the skills and/or work ethic to make themselves valued in the marketplace," (although, to be honest, I think its 99% skills, 1% work ethic)-I've worked minimum wage jobs, and my current middle class job is A LOT easier). I want to do this, because I think that the marketplace is a good way to maximize value for the national as a whole, but does not particularly reflect moral excellence or worth. Social safety nets like medicaid, social security, medicare, or nutrition assistance programs are an ethical response to the free market which sorts out winners and losers based on qualities that have nothing to do with 'righteousness or just desserts'.

StL Pastor,

Fair point regarding the language, though since there seems to be consensus that the only "cuts" that may not be extended are for the highest tax brackets, we are really only talking about increasing the tax rates for high earners.

From there though, you fall into the same language-framing that spurred the original post. Continuing with our current tax rates (see how different that sounds?) would only "balloon the deficit" because of an implication that spending, as budgeted, CANNOT change. Why? It sounds better, surely, but it's not "true". The current deficit can be balanced by 2016, 2017, or 2020, while keeping in place the current tax rates, merely by allowing +0%, +1%, or +2% growht in outflows from the current levels. See link for more data.

Finally, you don't prefer the marketplace for "moral excellence or worth" - I agree. I disagree that government is the right place to look for those things. I can, and do, give to charities that flow >80% of donations to people in need. See if you can find out how effective government is with our tax dollars. Once you do, you'll understand why folks who absolutely support the idea of social safety nets might find fault with both the rhetoric and the fact, of additional taxes.

As per Doug - the language used of "tax cuts" is not correct. What is happening is the current tax code is changing such that taxes will increase for everyone on 1 Jan 2011. There is no cut if the current tax code is extended - people will merely pay the same amount of taxes on the incomes as shown in the current tax table. I find this sloppy and misleading. It's a framing of the perspective that is misleading and trying to appeal to emotion and class envy.

As for rich versus wealthy, I believe many people don't understand the difference. It's a matter of cash flow as well as net worth as the author of this blog mentions. The Millionaire Next Door shows people of both types: rich and wealthy. The rich are not necessarily wealthy, however the wealthy are usually rich. And one can be wealthy on a low income - it just takes time.

You're right, allow me to rephrase-all things being equal, increasing taxes will decrease the deficit, and if the tax cuts expire, the Federal Government will raise roughly 2 trillion dollars in revenue over ten years.
The problem with stopping the spending growth is that the increase in government spending is tied to increases in medical expenses for the elderly, and the increased cost of the military. Outside of these spending priorities, balancing the budget is easy. If you've looked at the NYT deficit calculator floating around, the easiest way to balance the budget is to quit paying doctors 10% more a year for the same services. Of course, that means paying the medical industry less, which is a hard slog, since neither Democrats nor Republicans are really interested in angering that lobby.

Greg said: "The fact is that it's hard to own a house in California and NOT be subject to AMT."

Houses in California are not that high in general. California is bigger than San Francisco. Houses in Sacramento median cost is down to $185k.

Even in high cost cities, AMT doesn't really have any direct relationship to the cost of a house. AMT does not explicitly exclude mortgage interest as long as the interest was paid for the purchase of a house. Now if you've got a giant HELOC to buy non house stuff or did a big cash out refinance then thats another matter.


You should refine your complaint further.

Our tax code is focused on WAGES. Money earned via the sweat of brow. True wealth means earning money on investments - typically capital gains or tax-shelters like muni bonds.

But cap gains = 15% (soon to be 20%) compared with 39% top rate on wages.

This is why I think taxes should be more heavily weighted towards consumption and not income.

And some logic here recall your Venn diagrams: all high net worth people are high income people; but not all high income people are high net worth people.

High income people that do not have high net worth could be relatively young people that recently became lawyers/doctors could have high incomes but large debt as well. They are not are rich and it is no fair to say that they can afford to pay more tax because they are wealthy (of course they are on their way to being wealthy if they save in the future). If high income people have low net worth because of high spending then a consumption tax will penalize them for their spending. On the other side if someone is high net worth and very frugal they would not pay much in consumption tax so I wonder if there was a way to structure taxes on net worth directly instead of using income as a proxy for net worth.

To understand why the terms are mixed up so often you have to look at the people making the comments. What is their reason or intent for making the statement. You are trying to educate folks and make them think - critically. However, most people are not like you. They are naturally inclined to try and convince, coerce, or aggravate people to their way of thinking. Well, maybe not all the time, some do it for entertainment value. However, unlike FMF, they rarely use objective reasoning and facts (at least not in context).

I think the most common reasons are #2, they understand the differences but are purposely trying to bias the conversation and #4, they think those who make a lot are wealthy. If you debate these folks on the facts and force the use of objective reasoning, their arguments will retreat to political ideology, class warfare, and name calling. But that is just my two cents.

I love Jim's idea of a consumption tax. It levels the playing field and does not penalize people who had to take on a lot of debt to get to their high level jobs. It also does not penalize people who live in high cost of living areas. It would also be easy to implement. I suppose some economist would say that would stifle spending and hurl the economy into a tailspin, but I like the idea a lot.

Salary itself does not tell the whole story but it is the easiest thing to measure, hence sometimes you've just got to start there.

I think the reason people use the terms incorrectly is the same reason most people never end up truly wealthy: they simply don't understand the difference. Once people realize that wealth is created by making more than what is spent, the difference becomes obvious.

I agree with most here that higher incomes are correlated with higher wealth, but having a low income does not exclude people from attaining a high net worth, although it does make it more difficult.

Now there is a way to tax wealth; it's called inflation. All of your dollar denominated investments, savings, etc all become worth less through inflation.

I'm with Cytoman on this one, not really sure its true or not, and dont really have the facts to back it up, but it seems like journalism is getting less and less informative and more biased/motivated. Weather it be politically motivated/biased or just plain ignorance, the fact is, it is published so it should have been filtered by an editor which one would think could catch the ignorant part. So journalism wise, I tend to think bias is the large factor unless the editors are as ignorant as the writers, which is a very real posibility as well.

When people discuss taxes they always refer in income wealth, not aquired wealth because taxes are based on income. DUH!

Dr Thomas Stanley (Of Millionaire Next Door / Stop acting Rich) has made a great career based on this very issue.
I agree with you that words have meaning. (I am a stickler to not call electrical outlets "plugs" for example.) The high earners are not rich by definition, only by audit/query to their actual wealth.
At every income level there's a bell curve of sorts for wealth. Rich $100K earners, poor $250K earners. This is not only possible, it's very common.

"When people discuss taxes they always refer in income wealth..."

After the dude spent an article venting his anger over word misuse, you came up with this beauty. What is "income wealth"? How do you refer in it? Geeez.

This is a pet peeve of mine as well, specifically when High Income is equated with Wealth/Wealthy.

But reading the definition of "Rich" again, I am compelled to say that High Income household are in fact rich -- they are "abundantly supplied with resources, means, or funds" (significant income stream), which matches your dictionary definition above; even though they may not have "wealth or great possessions".

(Then again, each person's definition of "abundant resources/means" may vary... but if abundant = "more then adequate", can we at least agree that $250K per year is more than adequate to live? And therefore "Rich"?)

If your income is $250K and you're not building wealth, then you are living "richly" indeed (even if it's leading you to bankruptcy -- oh the irony).

FWIW, I don't think for a moment that high-income or wealthy households should pay more taxes -- we don't charge people different prices for the same goods based on their ability to pay... why should they pay more than their per-capita share for government?

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