The Rich *Are* Different

by Tom Bozzo

Yesterday, run75441 sent an e-mail to the Bears touching off a bit of a discussion on the perennial question of what constitutes the “middle class” or a “middle-class income.” Run’s touchstone was the AMT, which has been turned by bad legislation (not indexing the zero bracket; interactions with the Bush-era changes to the ordinary income tax) and 40 years of inflation into something that “requires” — in the sense of avoiding the actual or perceived political catastrophe of raising taxes on a (fairly) large number of (mostly) upper-middle income taxpayers with high propensities to vote — annual patches to keep it mainly an upper-upper-middle-income tax. While there are horror stories about middle-income taxpayers with unusual circumstances being hit with AMT (e.g. due to exceptional numbers of exemptions for dependents), the patches mainly serve to keep AMT off the backs of low-six-figure earners who, despite being relatively well-to-do, nevertheless don’t have sufficient income to be in line for tax increases under Obamanomics.

I’ve viewed the $200K or $250K-ish threshold for who’s rich enough to be subject to so much as the statutory income-tax rates of the 1990s as a mutant offspring of behavioral economics and tax politics. It’s a figure that happens to be enough money that people who will never make $100K (but don’t know it) won’t worry that raised upper-income taxes will affect themselves, or something like that. Based on criteria such as ability to pay without major hardship, I’m with Felix Salmon that the boundary of the “rich” is being set too high.

That said, there is an interesting qualitative change in the structure of income that starts to happen around this cutoff for the “rich” which actually suggests that taxpayers above that threshold are rich in most important ways. The most recent (2007) tax stats from the IRS now reflect the peak of the late bubble and show that the $100K-$200K AGI bucket is the last one that more-or-less resembles middle-income categories in their dependence on labor as the all-but exclusive source of income. (Think of pensions and proceeds of retirement accounts as representing deferred wages or salaries.) This graph shows the shares of AGI from some major income sources, and the average incomes for various brackets. (*)

Sources of Individual Income, 2007 SOI Tax Stats
(May be embiggened by clicking here.)

Starting with the $200-500K category, the share of earnings from labor begins a marked decline. By the time you hit mid-six figures, average earnings from income, dividends, and capital gains become high enough to provide middle-class or better incomes without (necessarily) working. Tax returns in the upper-six-figure bucket, on average, show more income from other sources collectively than from salaries, and at the top of the income scale even interest and dividend income exceeds wages and salaries. (**) I suggest that if you can provide yourself with a better-than-average living without working, a very rare luxury indeed, you are in fact rich.

(Revised and slightly expanded.)

(*) That some of the shares sum to more than 100 percent is not an error. Some sources of income, notably nontaxable Social Security benefits, are not part of AGI. If average incomes by bracket are not plotted on a log scale, that line looks like everyone except the super-rich makes nothing.

(**) Moreover, high-earners are negligibly dependent on Social Security and pensions for retirement income, in case anyone wonders about the origins of the long-running war on social insurance.