How Rich Are Top Income Earners?
Income inequality is at the forefront of political discussions as of late. Coming out of the Great Recession, the gap has only widened as the rich have benefited from the skyrocketing stock market while Joe Smith has left his extra money on the sidelines. How much do the top income earners actually make?
Thankfully, professors Guvenen, Kaplan, and Song have examined just that in a study released in 2014. They sought out to examine the pay gap between genders but provided some very valuable statistics overall. For example, the IRS simply reports that the top 1% earned 19% of all adjusted gross income in 2011, but they also paid a whopping 35% of all taxes.
The Tax Argument
Before we get into specifics, is it fair that the top 1% earn so much? Well the argument goes both ways: they earned a disproportionate amount of money sure, but they paid an even more disproportionate amount of taxes. I would argue that, yes, it is fair. In recent years since the aforementioned IRS results, the top 1% have increased their income share by 1% to 20% but their share of total taxes paid has increased by 3% to 38% of total taxes.
Keep in mind, that these are actual paid taxes and not effective tax rates. Contrary to popular belief, the rich pay the highest effective tax rate as well: approximately 23% compared to an average of just over 12% which explains why they pay a higher percentage of total taxes compared to their percentage of total revenue. To expand on this point, the top 50% of earners earned a whopping 88% of total income in 2011 but paid an even more astounding 97% of total taxes!
Top Income Earners by Age
There’s a popular phrase that states that one should not compare their beginning to someone else’s middle. I completely agree, but we must compare to our peers! To be a one-percenter in 2013 it took a whopping $394,000 of earnings before taxes (approximately $220,000 after tax.) The top 0.5% of earners earned $611,000 in 2013. Is this stupid rich? The answer: it’s all relative. If you make $200,000 in NYC or SF then you may not feel rich but if you make $200,000 in Alabama then you’d likely have a nice lake-front home. Compare yourself to your peers instead.
Not only are you comparing different locations and thus different standards of living, but also different age groups. Another point to keep in mind is that the 1% is a very fluid group due to bonuses and windfalls. Approximately 50% of the 1% are new to the club every year. In other words, half of the top 1% this year will no longer be part of the 1% next year.
The chart above (referencing the aforementioned study) shows that a 27-31 year old simply has to make $135,000 per year to be a one-percenter in their age group. This is very easily attainable by bankers, consultants, engineers, lawyers and others with advanced degrees in traditionally high paying fields. Remember, this isn’t the average engineer or banker; it’s the accomplished bunch with degrees from top tier schools that landed great jobs immediately out of college. In 10 short years, a person aged 37-41 has to more than double their salary to remain in the 1% (~$285,000 salary) – see how it gets tough to keep pace?
The One Percent Over Time
The youngest two age groups on the chart below show a decreasing threshold to join the 1% club. It even shows that incomes have flat-lined for the top 1%. Hooray equality! Not so much. The truth is that these studies are based on salaries. The rich don’t get rich by saving. Sure having their own business and earning massive salaries help, but you actually get rich from wise investing and riding a bull market. Don’t believe me? Just look at the chart during the stock market boom of the 90’s and massive growth required for each age group.
Let’s look at a more telling chart from CNBC below. For the total population, a whopping 64% of total attributable income comes from compensation compared to just 39% for the top 1%. The difference is clear: the richer you get, the larger percent of your cash income comes from investments and business ventures. Simply put, the more financial security you have, the more you can invest and risk losing.
The Bottom Line on Wealth Inequality
We should not feel anger that the top 1% earns so much in comparison to the rest of the country. We should aspire to join the club or even just get close to the club. Frankly, you won’t get there just by saving or being frugal. Sure, it helps, but it does not create wealth but instead creates financial security and a “making it work” mindset instead of a wealthy mindset.
While we aspire to join the club, we should be glad that the top earners pay a disproportionate amount of taxes because that means that for every dollar we earn, we retain more than they do. Hell, the bottom 50% of earners hardly pay any taxes at all! Politicians love to squawk about how the rich should pay their fair share when in reality, the rich pay almost double their fair share! If anything, the poor are the ones not paying their fair share, but alas, that’s not politically feasible to mention.
If you take away one thing from all of these statistics, let it be what I just stated: saving will not make you rich, investing will. Again, as I mentioned, rich is a relative term: some consider $200,000 in earnings to be rich while others think it takes $5,000,000. Regardless of your goals, managing your money for income is the key. Once you become financially secure, you’re likely financially literate and thus you are prepared to take the next step which is building wealth.
We live in an age where there are a plethora of tools at your disposal. It has never been easier to read a mutual fund prospectus or adjust your 401k to be more or less aggressive. Tools such as Personal Capital can determine if you’re paying too much in fees. Mint.com is one of my personal favorite tools which helps you keep a budget and shows you your net worth over time. Quite frankly, I don’t really care about the budget as I’m personally focused on building my investment portfolio and net worth. Mint tracks your investment inflows beautifully.
The Goal: Aspire for more and don’t let something as simple as jealousy of others derail you.