What makes a Millionaire, Wealth or Income?

This week Senator Jim DeMint (R, SC) was on Jon Stewart’s “The Daily Show”.  He was defending the Right Wing’s economic policies that overwhelmingly favor rich people.  He said that there are many many misconceptions about the rich in our country, and then made an assertion that demands examination.  He stated that most “millionaires” are only millionaires for one year, and one year only (see quote below).

My first reaction was that this statement is flat out patently false.  But then I realized the rationalization he was using to make such an assertion.  In defining a millionaire, he was making the common mistake of confusing income and wealth.  The distinction between the two is incredibly important.  This distinction is often blurred, which is incredibly unfortunate, because it is at the center of the debates on wealth disparity and tax policy in this country.

If one defines a millionaire as anyone who received a million dollars in annual income, then his assertion may indeed be correct.  It is fairly easy to think of examples of individuals that make a million dollars in one year, but do so for only one year.  Think about the guy that invented the Pet Rock which was a short lived fad back in the 1970′s.  He most likely made a million dollars that year, and I doubt that he ever did again.  Or consider employee numbers 20-50 of a high tech start-up that just launched their I.P.O.  Many of these folk might make a million dollars in the year of the I.P.O. but their annual salaries on a continuing basis are nowhere near seven figures.  Even a small business owner with a healthy on-going annual income might a have single banner year where they make a million dollars.

I believe that a millionaire is more traditionally defined as someone who has a net worth over a million dollars.  In the investment industry, this definition also excludes the value of one’s home.  So a millionaire is someone that has over one million dollars of invest-able assets.  If you make one million dollars in a single year, you are going to pay at least 30% in taxes, and you’ll most likely spend another 10% on living expenses for the year.  So even the frugal one million dollar income earner would have a net worth of about $600,000 at the end of a single year with that income.  Such a person would not be considered a “millionaire” under the traditional definition.

So our friend Senator DeMint is defining a millionaire by income rather than wealth an that does not make any sense.  Any true millionaire with a bit of intelligence and a modestly conservative investment philosophy will remain a millionaire not only for one year, but indefinitely!  Many people who enjoy a one year of million dollar income will enjoy a comfortable life, but they are not millionaires.

There are a good number of reasons that this distinction is so important.  For starters, once you are a millionaire, your wealth can provide enough income for you to live on via investments.  You no longer have to work for income.  You live on “investment income” rather than “earned income”.  Everyone else that is not a millionaire must trade their time for money doing something for someone other than themselves.  In short, they have to have a job.  They must work.  They don’t have any other choice.

I call this precept the “endowment concept”.  Generally an endowment is used to fund a cause using only income earned on the endowment itself.  The principle of the endowment is never spent, and thus the cause can be supported at a certain level forever.  Any individual that has over a million dollars in investable assets is self-endowed.  That person can choose to never work again, and live at a modestly comfortable level in secure manner forever.  In fact, the endowment can be passed on to another generation.  One million dollars can support a single person forever.  Perhaps in some parts of the county such as New York or San Francisco this number is more like 1.5 or even 2 million (based on a 5% return providing $50,000 dollars of annual income).  Granted, this level of income is modest, but it will support an individual, or even a small family in most parts of the country today.  Many folks live on a lot less!

But people should be entitled to live beyond this modest level.  Living larger is part of the American dream.  True indeed, but the the point is that everything beyond this level is by choice.  Most millionaire choose to continuing working in some capacity to become even richer.  But that is their choice.  For those without a million dollars, there is no choice other than to work.

Another reason the distinction between income and wealth is so important is the role it plays in our system of taxation.  A tremendous amount of our tax system is based on income rather than wealth.  That is why it is called an “income tax”.  Government revenue is based on how much people (and corporations) earn in a year, rather than how much wealth they own or control.  Senator DeMint’s assertion is based on this concept.  Much our our tax policy debate centers around setting tax rates and defining the wealthy by income.  In some ways this makes sense.  It would be difficult for example to force a company to sell some factory equipment to settle a tax debt based on the value of that equipment, or to force a rich guy to sell part of a car or business to settle a tax debt based on his total net wealth which includes that car or business.  Taxing wealth is difficult because it is seldom liquid whereas taxing income is easier because annual income is generally liquid.

However, remember our friend the millionaire who lives on investment income rather than earned income.  Thanks in part to the Bush Tax cuts, he mostly pays a tax rate of 15% (the current capital gains tax rate for investment income in place since the Bush Tax cuts) rather that 35% (the top tax rate for people who work for a living).  Why we tax income that people must work for at a higher rate than we tax income that people earn simply for being rich already is beyond me!

The important thing is to understand that the lower tax rate on investment income is the reason the Bush Tax cuts mainly benefit the wealthy.  Tax policy is at the center of this country’s economic problems and is likely to be a major topic in this year’s elections.  During the debate, you will hear many politicians and pundits use the concepts of wealth and income interchangeably as if they were the same thing.  It is critically important that the distinction between income and wealth is recognized and dealt with fairly in public policy.  Let’s hope our leaders truly understand the difference, and consider it when they talk about millionaires and then institute a fair policy of taxation!

Quote of Jim DeMint of “The Daily Show” 1/11/2012
“ There is lot of mis-information about the rich in our country. Fifty percent of the people in our country who are millionaires, are millionaire for one year. So we have this kind of revolving door.  We don’t have this kind of permanant class of millionaires like a lot of other countries.”

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