President-elect Biden’s tax plan drew a line at an income of $400,000 for taxing the wealthy. It prompted some comments as confusing income with wealth. Some people have a high income but they aren’t wealthy, because they live in areas with high costs of living or because they have high debt from mortgage and student loans and they haven’t had enough time to accumulate wealth yet. They’re referred to as HENRYs — High Earners, Not Rich Yet. On the other hand, some people with high wealth, especially those who are older and had the time to grow their wealth, no longer have a high income. Increasing taxes on higher incomes won’t affect them.
Meanwhile, Stanley and Danko said in their book The Millionaire Next Door that frugality, not high income, is the key to become wealthy. They said most millionaires became wealthy because they shunned flashy spending. If that’s true, increasing taxes on higher incomes won’t stop savers from becoming wealthy.
What’s the relationship between income and wealth? What percentage of people with a high income are HENRYs, and increasing taxes on them doesn’t really increase taxes on the wealthy? What percentage of wealthy people don’t have a high income, and they will be unscathed by a tax increase on higher incomes? Is The Millionaire Next Door correct in saying that wealth comes from frugality, not high income?
Survey of Consumer Finances
The Federal Reserve does a Survey of Consumer Finances every three years to look at the assets, liabilities, income, and demographic characteristics of U.S. families. I found a small gem at the end of one of their research notes — Wealth and Income Concentration in the SCF: 1989–2019. It shows the joint distribution of income and wealth. I reproduce the table here for easy reading:
Table C. Share of families in income group, by wealth group, 2019 SCF
| Income groups | Wealth groups | |||
|---|---|---|---|---|
| Bottom 50 | Next 40 | Next 9 | Top 1 | |
| Bottom 50 | 0.72 | 0.34 | 0.03 | 0.04 |
| Next 40 | 0.27 | 0.56 | 0.46 | 0.05 |
| Next 9 | 0.01 | 0.10 | 0.47 | 0.41 |
| Top 1 | 0.00 | 0.00 | 0.05 | 0.49 |
| All | 1.00 | 1.00 | 1.00 | 1.00 |
The table divides income and wealth into four groups: bottom 50%, next 40% (top 10-50%), next 9% (top 1-10%), and the top 1%. The table should be read from top to bottom. For example, the last column means that among families in the top 1% in wealth, 4% of them have income in the bottom 50%, 5% of them have income in the top 10-50%, 41% of them have income in the top 1-10%, and 49% of them have income in the top 1%.
To put the percentiles in context, here are the approximate ranges for each group:
| Income Group | Wealth Group | |
|---|---|---|
| Bottom 50 | < $68k | < $121k |
| Next 40 | $68k – $201k | $121k – $1.2 million |
| Next 9 | $201k – $531k | $1.2 million – $11 million |
| Top 1 | > $531k | > $11 million |
Source:
- Average, Median, Top 1%, and all United States Household Income Percentiles in 2020
- Average, Median, Top 1%, and all United States Net Worth Percentiles in 2020
To make the joint distribution table also readable from left to right, I created a hypothetical group of 10,000 families. 5,000 families are in the first column. Their wealth is in the bottom 50%. Multiplying the percentages in the rows puts them into different income groups. Doing the same for all the columns produces this table:
| Income groups | Wealth groups | ||||
|---|---|---|---|---|---|
| Bottom 50 | Next 40 | Next 9 | Top 1 | All | |
| Bottom 50 | 3,600 | 1,360 | 27 | 4 | 5,000 |
| Next 40 | 1,350 | 2,240 | 414 | 5 | 4,000 |
| Next 9 | 50 | 400 | 423 | 41 | 900 |
| Top 1 | 0 | 0 | 45 | 49 | 100 |
| All | 5,000 | 4,000 | 900 | 100 | 10,000 |
The totals don’t add up exactly due to rounding in the original table, but it’s close enough for our purpose. Now we can see a clearer picture of the relationship between income and wealth.
Reading across the “Top 1” row from left to right, we see if increasing taxes on the top 1% in income is used as a proxy to increase taxes on the top 1% in wealth, it has a “hit ratio” of about 50%. 50% of the families in the top 1% of income also have their wealth in the top 1%. The wealth of the other 50% caught by the higher taxes isn’t quite in the top 1% but it’s still in the top 10%. On the other hand, 50% of families in the top 1% in wealth will escape the higher taxes. In terms of paying less in taxes, the sweet spots are in the upper right parts of the table — asset rich, income poor.
When we look at each row, we see, as a group, wealth increases with income. An individual person in a lower income group may save more and have more wealth, but when you’re in a higher income group, you only have to be average. Although having a high income doesn’t automatically put you into the same group in wealth, it at least puts you one group below. 100% of the top 1% income group have their wealth in the top 10%. 95% of the top 10% income group have their wealth in the top 50%. It’s very difficult to advance one group from income to wealth. Only 10% of the “Next 40” income group have their wealth in a higher group. Only 5% of the “Next 9” income group have their wealth in a higher group.
Although income isn’t wealth, at least in these broad strokes, income is clearly the driver for wealth. If your income is there, your wealth isn’t too far behind. If your income isn’t there, it’s very difficult to move up by frugality. Conditioned on having the necessary income, frugality then plays its role. I heard this quote from Morgan Housel on a White Coat Investor podcast:
Wealth, in fact, is what you don’t see. It’s the car that’s not purchased. The diamonds not bought. The renovations postponed, the clothes forgone, and the first-class upgrade declined.
I have a feeling if researchers go to the DMV and randomly select 100 registered Porsche owners and 100 registered Honda owners, they will find the Porsche owners still have more wealth despite having spent more money on their cars.
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Gordon Shedd says
Excellent analysis, Harry! My question is why haven’t any economists or financial press columnists done the same thing? They seem to be too busy dwelling on the latest GDP numbers, or stock market movements, to realize the bigger (and more important) picture–not seeing the forest for the trees, so to speak. My guess is that it would take the entire duration of a PhD program in economics, including the dissertation, to do the analysis that you’ve done (probably in hours or days). As I learned in my own field, no matter what level of education or IQ you observe, fewer than 10% of the group have common sense and can figure out anything new for themselves–the rest need to be told what to do, and (more disturbing) what to think. Maybe you’ve done this analysis because you now have more time on your hands. Whatever the reason that you’ve done it, and they haven’t, your initiative and insight are why we subscribe to your emails. Thank you!
Harry Sit says
Economists know it. It’s too obvious. People also know it intuitively. The data just make it clear.
EarlyRetirementNow says
Nice analysis. I have the exact same feelings: it rubs me the wrong way when I hear people confound income (flow variable) and wealth (a level variable).
@ Gordon: I hold a Ph.D. in economics. Economists work with the SCF data a lot (as well as some other micro-level data from different surveys). There are hundreds (maybe thousands) of published research papers studying the distribution of income/wealth using those data sets. And looking at policy and fairness issues of unequal distribution of assets. Including some of my published work. Just because the media don’t cover it and/or you haven’t found it, doesn’t mean it doesn’t exist.
And, no, it doesn’t take an entire Ph.D. program to create that table. Good analysis, of course, but this wouldn’t get you an econ doctorate. 🙂
Gordon Shedd says
Sorry to have cast aspersions upon economists, and PhD’s in general (mine is in materials science). As usual, all blanket statements are riddled with holes. I do think, however, that Harry’s analysis essentially does equate income with wealth in that, to a very good approximation, one’s level of wealth is preordained by one’s income (especially for those in the 99th percentile), so taxing those with incomes in the highest few percentiles looks like a good proxy for taxing wealth directly. To quote Harry’s post “100% of the top 1% income group have their wealth in the top 10%,” so the intuition of those who confound high income and high wealth seems to be borne out in the data. BTW, I LOVE your SWR analysis and website, and would credit you as a PhD who exhibits common sense and doesn’t adhere blindly to dogma.
Stephen Abney says
Income groups Wealth groups
Bottom 50 Next 40 Next 9 Top 1 All
Bottom 50 3,600 1,360 27 4 5,000
Next 40 1,350 2,240 414 5 4,000
Next 9 50 400 423 41 900
Top 1 0 0 45 49 100
All 5,000 4,000 900 100 10,000
Everyone has to be somewhere. If some high earners don’t yet have high wealth (think a surgeon just starting out), then someone has to fill that hole. Otherwise, I think it is interesting that the Next 40 group is only about 3x as likely to be in bottom 50 as to be in Next 9, given the size of those two groups.
We know that much of the Bottom 50 have no wealth at all. Our beginning surgeon may fit there due to loans, but apparently not enough of those to show up.
KD says
Harry, since you use the labels such as “top 1”, “bottom 50” etc, may be have those label locations in the table congruent with their names…so “Top 1” becomes top row, bottom 50 becomes bottom row ..otherwise the readability of the table conflicts with the labels ..it is jarring to see top 1 label at the bottom and make sense of it in first reading. Just a suggestion. Likewise, “Top 1” will be the leftmost label and “Bottom 50” will be the right most label.
Harry Sit says
The Federal Reserve research note had it that way. The first table is a carbon copy of their table. I’m going with the same labels and format in the second table.
KD says
I understand ..obviously they don’t pay attention to readability …j/k
KD says
If you are bottom 50 of income group, then 72% of you may be in same wealth group; 28% in higher.
If you are next 40 income group, then 34% of you may be in lower wealth group than your income group; 56% in same wealth group as your income group and 10% in higher wealth group than your income group.
If you are next 9 income group, then 50% of you are in a lower wealth group than you income group, 47% in same wealth group as your income group and 3% in higher wealth group than your income group.
If you are in top 1 income group then 45% of you are in lower wealth group than your income group and 55% are you in the same wealth group as your income group.
Basically, it says if you are in bottom 50 income group, there is a decent chance your wealth standing may exceed your peer group.
If you are next 40 or next 9 income group, forget it. It is unlikely you will exceed your wealth standing in your peer group even though you have good income. In fact a third or half likely that you are a slacker in accumulating wealth relative your peers.
If you are top 1 income, then there is 50% chance you will be slacker in accumulating wealth compared your peers.
My wording may not be the most elegant here …but higher the income, more chances of you being a slacker relative your peers in accumulating wealth.
Harry Sit says
As Stephen mentioned in comment #3, the group sizes are different. There are more seats in the Next 40 wealth group for the Bottom 50 income group to advance into than there are seats in the Next 9 wealth group for the Next 40 income group.
EH says
These are interesting charts – thank you. I recall reading that a majority of net-worth wealthy are the elderly who have already exchanged much of their human capital for financial capital in order to generate income in retirement. I would then wager that a majority of the wealthiest in your charts receive most of their income in the form of dividends/interest/capital gains, rather than earned income. So I’m not sure that the statement “wealth increases with income” is always causal – it may be that many years of saving moderate earned income and compounding unearned income can generate wealth that later can be turned into higher unearned income levels in retirement.
Peter Minev says
Very interesting analysis! Can we draw a conclusion that frugality comes second to higher income, when the goal is wealth?
In other words, chances are higher to be wealthy if you have higher income and not so frugal, compared to very frugal but with low income.
Harry Sit says
Yes, I said just that when I shared this post with a tweet.
Peter Minev says
Thanks! I hope you don’t mind me to refer to your post, I plan to write a post of my own on the topic in my blog. I’ll clearly refer to your post.
There are few myths that I debunk. One is exactly that instead of focusing on frugality, people should focus on earning more – and of course I provide many examples including personal. Keeping your spend under control is important but secondary than income growth.
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