Scott Sumner  

News flash: College students come from middle-aged parents

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Over the years I've done many posts pointing out that income distribution data doesn't mean what people think it means. I spent the first 8 years of my adult life in the bottom 20%, and more recently I've been in the top 20%. Roughly 73% of Americans spend at least part of their lives in the top 20%. This year I'll be in the super rich class (as I sold a house in Boston with a big capital gain), but next year my income will drop by 70%. And yet none of this tells us anything interesting about my economic situation.

Consider this typical press report about University of Michigan students:

Just 16 percent come from families in the bottom 60 percent of earners combined. The median income of parents of students at the university is $156,000, roughly three times the median income of Michigan families.
Now there is no doubt that students at an elite school like Michigan tend to come from richer than average families. How could it be otherwise? But the specific data here is almost meaningless. The bottom 60% of the income distribution is heavily dominated by both retired people and younger versions of me. Lots of 24-year olds and lots of 80-year olds make below average incomes. And guess what, very few Michigan college students come from families headed by either 24-year olds or 80-year olds. They tend to come from families headed by 50 year olds, that is, people near the peak of their earning years. Often with two earners.

This confusion over income distribution data has affected our tax debate. Consider this typical article:

On the income distribution charts at the center of tax overhaul plans, Courtney Mishoe knows she's doing well. She works as a tax manager at a firm in the Atlanta suburbs. Her husband is a police officer. Together they make more than $180,000 a year. They are solidly in the upper middle class. But they have a mortgage and three kids, including one in day care and another in high school with plans to go to college. It all adds up. They depend on tax deductions to make their budget work. "I don't feel wealthy,"
Yes, $180,000/year is far above average for household income, it's even well above average for middle aged two income couples. But in a sociological sense a cop and a tax manager are not "rich". To claim they are is to suffer from innumeracy. When most Americans hear the term "rich" they have something else in mind:

Screen Shot 2017-11-10 at 2.24.38 PM.png

In Alpharetta, many people said they could not determine how they would make out under a confusing plan littered with caps and phase-ins.

As he ate lunch at Alpha Soda, a popular local restaurant, Chris Krogh said he hadn't followed the debate closely but was troubled by what he heard. Krogh runs a custom cabinetry business and depends on homeowners as customers.

"I always thought Republicans were supposed to be good on the tax breaks," he said.


Here's what I think is going on here. The GOP is buying into the progressive's view of income inequality. They feel under pressure to avoid tilting the tax plan toward "the rich". In trying to avoid doing so, they'll end up imposing higher taxes on some members of the upper middle class. That may or may not be a good idea, but it's not how upper middle class Republicans envisioned the term 'rich', or how they envisioned the GOP. There are likely to be some disappointed GOP taxpayers.

PS. It is certainly fair to argue that by global standards the American upper middle class is rich, but that's not the issue being debated. It's also true that by global standards most of America's poor don't deserve any of the welfare programs that progressives advocate.

PPS. Here's another way of thinking about the tax debate. Under Reagan (and Clinton), the GOP seemed to be proud of its supply-side ideology. Supply-side economics seemed "progressive", as the entire world was trending in a neoliberal direction. Now the GOP seems slightly embarrassed by its supply-side ideology. Once a party becomes embarrassed to hold a particular political view, it's only a matter of time before they stop holding that view. The Democrats are winning the tax fight; they just don't know it yet.


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COMMENTS (18 to date)
Jared writes:

"To claim they are is to suffer from innumeracy."

No, no no no, no. The only people suffering from innumeracy are the subjects of the article, who are quite rich. They are rich even for five person families *in their town* according to the 2016 ACS.

Upper middle class is a term to make people who are rich on labor income feel good about not being the aristocrats on Downton Abbey. Any meaningful concept of middle class is economic, grounded in the income distribution, and not too far from the central tendency of said distribution. You wanna age adjust it? Groovy. But those people are still rich, you're rich, and so am I.

(Btw, this pisses me off extra, I suspect, because the rest of the time I walk around making other people read your posts for a dose of reality. Just sayin'.)

Floccina writes:

I think of this sort of thing when people imply that poverty causes poor school performance. As with many in the 1950/60s, when I was in the early grades my father was just starting his career (he was a low ranking fireman) and as was common back them already had 5 children. We were living in a small Triple-decker apartment in a not good part of the city, but by the time I was in college he was doing well (fire chief). So would people now judge those many of us in similar situations as doing well in school because we were affluent kids or despite being poor.

Do the early years matter more or less that the latter years the other way around? Or is it something else that causes the correlation between affluence and success school? A poverty of the mind?

ZC writes:

@Jared

They're not rich. They have a decent income, but they're financially stressed because because they have a mortgage for 3x their income, 72-mo payments on two new cars, and are rocking brand new iPhones amongst other luxuries. They and couples like them are often innumerate, and financially illiterate. Just like the federal government, it's not an income problem, it's a spending problem.

Scott Sumner writes:

Jared, So next time a Democratic politicians talks about the need to tax the rich, ask him what he means. Ask this question:

"So you keep talking about "the rich". What exactly do you mean by rich people? Are you talking about people making $90,000 a year, like big city cops, firemen, nurses, etc.?"

See how the politician responds.

As I said in the post, America's upper middle class are rich by global standards. No dispute there. But it's simply not true that American society regards these sorts of people as rich. They don't.

You said:

"You wanna age adjust it?"

I don't want to age adjust it, I want to throw out the entire meaningless concept of income. Consumption is what matters.

Alec Fahrin writes:

Economic efficiency and fairness argue that the amount of taxes should match one’s ability to pay/how much they benefit from public goods.
Therefore, Jared, age does matter. A family of three with a mortage who earn 180,000 a year may already be paying too much tax. Or maybe not enough. I don't know. But what matters is if we should tax a family like the one referenced in the article the same amount as a retired couple of 75 years old earning the same income. There situations differ significantly, and yet the GOP is raising taxes on their main constituents to the benefit of those who are far wealthier.

You seem to be saying yes. I’d disagree.

Miguel Madeira writes:

I think that "rich" has more to do with "wealth" then with "income" (or perhaps this is my Portuguese-speaking mind, because in Portuguese "rich" and "wealth" are cognates: rich=rico; wealth=riqueza; income=rendimento)

Chris writes:

Would be interested to see what median income looks like if you consider not just current income but the maximum income a person has ever had in their lifetime I guess you would have to control for age as well since the trend is upward, but would still be interesting. Anyone know of any measures like that?

AMT writes:

Personally I think it's fair to say that the top 20% are rich, but if you want to say top 10-15% that's not objectionable either. Rich is a relative term, after all. But to say 180k isn't seems really pushing it, at about top 8%.

http://money.cnn.com/calculator/pf/income-rank/index.html

The problem here is that basically, most people outside the top 1% define "rich" as "better-off than me." So no one in the upper, or upper-middle class thinks they are rich, even if they are very well off.

Yes, income across the lifetime varies, but it usually doesn't rise and fall very rapidly except for capital gains issues you mentioned. Most people get a raise of single digits. So generally people who make it to the top 10% got there from the top 15%, which they got to after being top 20%. That makes income actually pretty good at comparing how well off people are, except for those relatively rare capital gains aberrations. Basically for all working people it's a pretty solid comparison, except perhaps not business owners...but typically non-super rich ones will have a relatively steady taxable income stream anyway, to avoid higher marginal tax rates. For students and the retired it just doesn't tell you anything.

And I don't think wealth tells you anything about how well-off someone is, it just tells you how much of their income, and consumption was deferred.

Thaomas writes:

OK just to be on the safe side, (and to avoid any increase in the structural deficit) why not pay for all of the decrease in the corporate tax rate reduction [a very good idea, mainly because it will reduce inefficiencies arising from loopholes that create differences between average corporate tax collection and marginal corporate rates] by increasing top personal marginal rates, substituting partial tax credits for deductions of mortgage interest and charitable giving, and reduce the favorable tax treatment of investment income.

Worried about the difference between taxing income and taxing capital?* Average inflation adjusted capital gains over over the holding period and remove the cap on "retirement" savings.

* One advantage of higher rates on personal income and reducing the favorable treatment of investment income would be to get high income taxpayers on board with consumption rather than income taxation.

Zeke5123 writes:

@ Alec

Benefit taxation and ability to pay are often opposed. So, what trumps? Also, why is ability to pay fairness?

Thaomas writes:

Scott, I'm all for taxing consumption progressively, but in the meantime taxing the "rich" surely means at the very least several rnew rates above the current maximum and reducing the limit on tax-free estate transfer (no step-up basis either). As long as rich people get a good deal on their INCOME taxes, they will not push Republicans to support CONSUMPTION taxes.

John Thacker writes:
The GOP is buying into the progressive's view of income inequality. They feel under pressure to avoid tilting the tax plan toward "the rich". In trying to avoid doing so, they'll end up imposing higher taxes on some members of the upper middle class.

Scott, that doesn't really make any sense at all. It's more about the GOP buying into the idea that the total amount of the tax cut has to be limited to $1.5T and not being willing to cut spending, along with buying into the idea that these tax breaks and deductions are distortionary, and that it's better to eliminate the deductions, broaden the base, and use the money to reduce the rates. That's a fact widely agreed upon by economists, except when the GOP proposes a tax plan, in which case economists all fall over themselves to find ways to support the tax breaks. Similarly, plenty of economists talk nice games about supporting progressive consumption taxes and VATs, and then rush to oppose the DBCFT which would have been a progressive consumption tax, neutral with respect to trade.

The tax cut is indeed, broadly speaking neutral to progressive (for the first five years-- the fact that middle class tax cuts expire may be bad, but it certainly doesn't speak to buying into rhetoric on inequality). For every upper middle class income person who doesn't feel rich but will be paying more due to specially large exposure to deductions, there is an upper middle class income person who doesn't feel rich who will be getting a tax cut due to the rate decrease outweighing the deductions. Are you saying that it's better to have a tax code with larger deductions and special treatment, that the other just getting by middle class families deserve it?

Yes, I suppose we might both support cutting spending a lot and then having a larger cut so that everyone gets one. However, under current budget constraints, you prefer the more complicated tax code, choosing one group of upper middle class over another? Certainly a form of preferring the status quo (indeed, the tax proposal ends up with a much, much less complicated tax code than currently; it's only complicated to the extent that people are very familiar with their own tax and thus find any change complicated, especially since they don't know what might go away.) There's a conservative argument for preferring the status quo.

John Thacker writes:

Is the argument that "we cannot get rid of any deduction or targeted tax break (or even 50 at once, like the current proposal) to reduce rates unless we reduce rates sufficiently so that every single person gets a net tax cut, or at least net zero on taxes?" That's certainly a recipe for never, ever simplifying taxes.

Alan Goldhammer writes:

The sooner that we can get complete tax reform coupled with a progressive consumption tax the better it will be for everyone. Robert Frank has written a lot on the progressive consumption tax (Google can be your friend on this).

I'm sick and tired of having to go through and spend hours at the end of the year entering data into Turbo Tax when countries in Europe actually do your taxes for you and you only need to spend ten minutes making sure the government's income numbers are correct. Other than my charitable contributions, the US government has all the necessary data to do this.

I live in a high tax state and take advantage of all the deductions but I'll gladly give those up when all the other tax preferences are zeroed out as well (and this includes the government picking "winners" such as renewable energy which has nice tax credits)

Let's have a fair debate on the spending side of the ledger but reforming the government income side (e.g., taxes) is a no brainer to me.

Maniel writes:

Hi Scott,
If you want less of something, tax it. Do we want a tax that brings about higher consumer prices and lower economic activity?
Milton Friedman tells us that taxes are one of three ways to fund government, the other two being debt and inflation. All three have their issues. Isn’t the elephant (or donkey) in the room, spending?
There seems to be a suspicion about that income is not identical to wealth (can we spell Buffett or Gates?). Why not level and flatten taxes on income from work and from “passive” sources to encourage work and “tax the rich?”

Scott Sumner writes:

AMT, You said:

"Personally I think it's fair to say that the top 20% are rich"

That means that 73% of Americans are rich for at least part of their life. Is that what people mean by rich? When you are socializing at a party, and you tell someone that a former classmate you knew in middle school later became rich, do you mean they later became in the top 20%? I don't think that's how others would take your comment.

John, You asked:

"Are you saying that it's better to have a tax code with larger deductions and special treatment, that the other just getting by middle class families deserve it?"

No, I'm not opposed to progressivity. My main goal is tax reform and simplification.

Alan, I agree.

Maniel, All taxes hit consumption. The question is whether they do so in a neutral way, or whether future consumption is taxed at a higher level than current consumption (as with an income tax.)

Conscience of a Citizen writes:

Folks in just the top 20% or even top 10% of household income are genuinely not very rich.*

It's not just a matter of sanctimonious self-justification by "rich folks" who like to think that people richer than they are are truly "rich" while they themselves are merely "upper middle class."

It's a matter of the logarithmic distribution of income and wealth. The 0.1% take home much, much more than the 1%, who take home just slightly more than the top 10% (who take home very little more than the top 20%. The .01% and above take home much, much, much more than even the 0.1% (click for chart).

That is why the biggest affront to common decency as well as economic logic in the tax code, an abuse which the Republicans propose to perpetuate rather than abolish,** is that the top marginal rate on the very rich is 23.8% (20% "long-term capital gains" plus 3.8% "investment-income surcharge," which is assessed against the "carried interest" (in reality sales-commission/contingency-fee) income of hedge-fund operators) while the top marginal rate on the upper-middle class is 42.8%. Ordinary salesmen and lawyers have to pay the marginal rates for salaries on their commissions/fees, but hedge-fundies are given a special dispensation to pay much less.

Even the numbers I allude to are misleading, because the very rich acquire a lot of "income" (accession to wealth) in the untaxed form of "unrealized capital gains." They can then borrow against those assets to get untaxed pocket money because they haven't "realized" any income by selling assets and leave the loans outstanding until they die, at which time the step-up in basis will permanently avoid taxes on that money.

There's no doubt the tax code wants reforming, but raising taxes on the falsely-called-rich 20% while lowering them on the truly-rich 0.1% and above is neither a useful nor a respectable "reform."


*In America. All the stuff about Americans being richer than people in Namibia is a distraction, most Americans don't live in Namibia).

[html edited: less linkable text per link--Econlib Ed.]

AMT writes:

"That means that 73% of Americans are rich for at least part of their life. Is that what people mean by rich? When you are socializing at a party, and you tell someone that a former classmate you knew in middle school later became rich, do you mean they later became in the top 20%? I don't think that's how others would take your comment."

Yes, I'd say they "ARE," as in currently, rich. They consume (or can consume) a lot relative to other people. They have means/resources. If you equate rich with wealth only and not income, you miss very important detail. I think it's misleading to say that someone with a steady $1 million in income but with zero savings isn't rich, or that they are "poor" relative to the scrupulous person with moderate savings and a low income. Who is living the "rich" lifestyle?
I think the definition should be expansive enough to include the ability to consume through EITHER wealth or current income.

(I want to clarify my previous post, where I said I don't think wealth tells you anything about how well-off someone is, it does, but I meant to say it shouldn't matter for tax purposes because that should have been accounted for when they earned the income (assuming it was not inherited, I won't go into capital gains tax policy issues). But the tax code should do a better job of accounting for lifetime income rather so that people with variable incomes are not punished by higher MTRs in certain years.)

The problem I see is that the point of your post is to basically change the focus from someone's available choices (wealth and income), to the situation they are in from their previous choices (wealth). You might treat people differently based solely on their propensity to save, rather than their actual means.

"In a sociological sense" we should be focusing on who has the means, not solely the savings.

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