The Millionaire Next Door

Wealth is not Income; Income is not Wealth

There are a lot of writers, reporters and politicians who need to go back to school.  They continue to confuse income and wealth when talking about taxing the rich.  When I use the term wealth, I am referring to the net worth of a household, i.e. all of its assets less all of its liabilities.  I define household income in a simple way; it is income (realized) that is or should be reported on one’s personal income tax return.  When politicians talk about increasing the tax on the “wealthy,” it sounds, to some people, like a great idea. But what the politicians are really talking about is increasing the tax on high income producers.  In the studies that I have conducted since the late 1970s, I have found that realized income explains about 30% of the variation in net worth.  Simply stated, the typical millionaire next door type realizes an income (median) that is the equivalent of about 8% of his total household’s net worth.  In other words, the millionaire next door type with a net worth of, say, $2 million is predicted to have an annual realized income of approximately $160,000.  Thus, it is not the millionaire next door, the frugal type millionaires, who are going to get beaten up by the new tax proposals. Those who will take the brunt of this increase are highly compensated executives, big income producing professionals (especially two career households), celebrities, athletes, and super star sales professionals, just to name a few.  Many of these people need to generate a big income to fund their hyper-consuming lifestyle.  They are the ones who must have the multimillion-dollar homes, fleets of expensive cars, closets fill with expensive clothes, etc. I often refer to these people as Income Statement Affluent (high income, relatively low net worth).

However, the millionaire next door type is not going to escape all the changes in the proposed tax codes.  In America, one is five times more likely to be a millionaire next door type if he/she is a self employed business owner.  Therefore, the surtax proposed in the new health care plan will in fact impact on many wealthy business owners.  But, this is tax on income, and not on the wealth of the business owner.

There is yet another interesting correlation that I would like to address.  Four out of five decamillionaires indicate having a conservative political orientation.  About 70% of those who generate a realized annual income of over $500,000 per year are of the same political persuasion. So what are we really taxing: income, wealth or political persuasion (or some combination of all three)?

3 thoughts on “Wealth is not Income; Income is not Wealth”

  1. I agree that income is not wealth, but the media and politicians will continue to refer to high income producers as “wealthy.” I was taught that wealth generally refers to capital. A wealthy individual has no need of income other than that provided by his capital, or wealth.

  2. Tom, just found your blog. Fantastic stuff, count yourself along with Greg Mankiw as the two blogs I’ll read each day. My wife and I are both professionals, neither makes crazy money, but combined in the mid $200Ks. Aside from living well below means (total house expenses@15% gross; used cars, et al.), what other strategies have you seen work for two well paid W-2 employees? Cheers, CT

  3. hello Thomas!

    I’ve heard Dave Ramsey talk about you one night last year on his podcast and I was able to take note of the book title he mentioned on air. Luckily, rummaging through my online archives i saw my old notes way back last year, looked it up in google and was taken to this website.

    I find the information contained in this blog very useful in encouraging everyone to go the oppposite direction instead of following the usual path everyone is taking. personally I feel more encouraged to adopt the weird and down-to-earth lifestyle that millionairenext door types are living. i’ve always wanted to have a quality of life where I no longer need to trade a significant amount of my time (or life) to get a linear income. your writings convinced me that living less than what one makes almost always gives one a chance to be a millionare someday.

    keep up the good work…i’ll buy all your books in the near future!


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