Wednesday, July 13, 2011

Income ≠ wealth

Income isn’t wealth, but try convincing this to a politician or mainstream journalist.  Many people confuse this issue and become caught up in the class warfare that plagues the political parties.

Income, loosely defined, is a flow.  Contrast this with wealth, which are assets, or a stock.  Assets normally generate income (think municipal bonds), but they don’t have to (think an expensive piece of art).  But again, income, even high income, doesn’t necessarily translate to rich.

Suppose a freshly minted doctor opens his own practice, and earns an annual income of $265,000. Let’s also say this doctor bought a home worth $300,000, and put 20% as a down payment.  And let’s say the doctor borrowed $200,000 to attend medical school.  Is this guy rich?  Well, let’s analyze his net worth. 

His assets (house) are worth $300,000 but his liabilities are $440,000 (student loan of $200,000 + mortgage of $240,000).  He has owner’s equity of $60,000 in his home.  So, while his income looks high at $265,000, he is far from wealthy.  Subjecting our doctor to higher tax rates based on the false premise that he’s rich is bad policy.

So, the next time you hear a pol talk about taxing the rich, ask them to define rich.

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