How Wealth Acts Independently from Income

I often ask people who argue against taking steps to equalize income through taxation this question: How can a person worth $1 billion this year earn $25 million and be worth $1.1 billion next year?

To make the concept easier to understand, I will reduce it to something more easily understandable. I’ll use the example of a person who owns a house worth $300,000, owns a project car worth $10,000, has $10,000 in savings, and has a retirement plan worth $50,000. The person is worth $370,000. Let’s say the person earns $60,000 over the next year. 

The following year, the house is worth $350,000 due to market increases, the project car is completed and worth $30,000, he has $8,000 in savings because some of it was used for whatever it was used for, and his retirement plan is now worth $57,000 with pre-tax contributions matched by the employer and growth. Despite earning only $60,000, and using most of it for living, the person is now worth $445,000. 

Income is subject to taxation; growth in wealth is not.

We can see that the example person’s income had little to do with his or her growth in wealth.

All we have to do now is magnify it.

We could take steps along the way to make the house plural, change the project car with an apartment complex development, increase the savings to $800,000, and change the retirement plan to stock market investments worth $100 million, but let’s jump right to an example that answers the question in the opening paragraph.

Let’s say that half the billion-dollar wealth is comprised of stock market investments. Those investments over the next year will grow 5% and will yield effective dividends of 4%. The growth on the value of $500 million will make it worth $525 million. The income off of it will be $20 million. Let’s say our person does not need this for consumption, and uses it to buy 200,000 shares of initial offering stock at $100 per share. By the next year, this stock splits and is valued at $150 per share. That particular $20 million investment is now worth $60 million, but there will be no taxes due on the $40 million increase in value.

We now have $85 million more wealth on $20 million income. 

We can say that the person has tax free treasury bonds worth $100 million that pay 1.5% that is reinvested. We now have $1.5 million more wealth, and none of it was taxable income.

We can easily make up the $13.5 million missing from the equation and make it all fancy with income in excess of the remaining $5 million by selling some investments that result in capital losses to reduce the income to $25 million and hold the gain in wealth to $100 million.

In the end, it should be clear that income and wealth are two different things that are measured differently. Income is taxed; growth in wealth is not. It is important to understand this when talking about taxation on income. The real measure of a person’s well being is his or her wealth. Those who have the least wealth are the most reliant upon income. Those who have the most wealth are able to manipulate income to exponentially increase their wealth. 

The $7 million more in taxes someone with $75 million income would pay is relatively insignificant compared to the $35 more per month someone making $10,000 would get, or the $200 more per month someone making $50,000 would get, based on what I suggest as adjustments to the rates and levels in the tax code. 

It sounds like a lot of money because it is a lot of money. However, in relative terms based on wealth of our two examples, that $7 million is the equivalent of $2,800 to the person worth $435,000. 

If we were to consider a poor person, and let’s say that person is worth $10,000, it is the equivalent of $63, or roughly $5.25 per month. It is hardly noticeable. However, despite being hardly noticeable in the individual picture, putting that money in the hands of people who will spend it rather than invest it will be noticeable when measuring economic activity.

To people who have no wealth, or owe more than the total of their assets, there is no equivalency. It doesn’t matter whether these people are bums or people who lost assets due to medical catastrophe.

Numbers are impersonal like that.

When we as a society strike blows to those most legitimately reliant upon social support and dismiss them as simply collateral damage in the war on welfare fraud, we are putting a relatively small amount of money ahead of the legitimate needs of members in our society, some of whom may have mined coal for us or lost limbs in combat. The decision to do so does not reflect upon them; it only affects them. It reflects upon us as a society.

We tend to glamorize wealth and those who have it as leaders of society. In reality, most people who are wealthy were born into that wealth and given it through inheritance. That does not make the wealth illegitimate. It does, however, dispel the mythical argument that those who have wealth necessarily earned it. Much of the income earned by people with great wealth is not earned through labor, but through investment. 

Unlike wages, investment income is not subject to Social Security and Medicare taxes. The money that is not paid to help the elderly and the ill goes straight to increased wealth. This does not only apply to the wealthy; the untaxed income on a common person’s retirement account also directly increases wealth. It is not inherently evil; it is simply the way it works.

Income and wealth tend to be confusing to most people. Either can be used to create the other, but they are independent of one another even when doing that because they are measured differently. 

Assets are not relevant to profit or loss, and income is not relevant to net worth. It is that statement that is ultimately the answer to the question of how a person can be worth $100 million more in a year in which they earn only $25 million.