Virtually anyone who owns a home in San Francisco, no matter how modest that person's income may be, can join the top one percent instantly just by selling their house.
Really? The selling price must be the same thing as my investment income for that year? Let’s say I purchased a house in 2005 for $3 million that was financed by $2.7 million in debt where I paid interest only. If I sold this house today, I’d be lucky to cover the mortgage. Sure – some folks recently made good income by selling their houses, but something tells me that this does not fully explain the observed variability of income. Sowell continues:
This may help explain such things as hundreds of thousands of people with incomes below $20,000 a year living in homes that cost $300,000 and up. Many low-income people also have swimming pools or other luxuries that they could not afford if their incomes were permanently at their current level.
Gee – the Irvine Housing Blog has another explanation for this one. Finally, let’s check this out:
Most Americans in the top fifth, the bottom fifth, or any of the fifths in between, do not stay there for a whole decade, much less for life. And most certainly do not remain permanently in the top one percent or the top one-hundredth of one percent.
Falling out of the top one-hundredth of one percent for household income basically means I went from being number 9999 to number 10,001. Such a person is not exactly on the street.
Addendum: As I returned to correct one typo, I also have wonder what Sowell really means when he says most Americans do not remain permanently in the top one percent. Could it be that most Americans never get to be in the top one percent in the first place?
6 comments:
Many of us who bought our homes decades ago have seen our home values increase significantly. So are we in a position to cash-in, assuming we don't have big mortgages and the current market does not drop much further? Well, there is the matter of federal income taxes, for which there is substantial relief for permanent deferment of gain (up to $500,000 for a married couple); but state income tax may not provide comparable relief. But then where does such a homeowner go to live? A community with low taxes? Rent? Buy a condo for only a fraction of the net proceeds from the sale of the home? These can be difficult considerations for some, perhaps many, of us. If we are young enough and employable, perhaps we can be mobile. But in retirement, making the decision to sell and cash-in can be difficult. I personally, at age 77, do not wish to live in a community of the elderly. For me, the secret of a long life is living with younger people (not trophies!).
Shag home equity when taxed at all is taxed as capital gains. I don't think that most states have any equivalent of the capital gains tax. My mom bought and sold a lot of real estate for a time in the 80's on her own account and as a broker and I don't ever remember anyone talking about state tax implications other than the reset in property tax exposure via Prop 13.
The decision to sell out and relocate can be difficult, what we have here in Northwest Washington is a tendency to downsize here and buy a second home in Arizona or Eastern Washington alongside people you know from home. There are streets in Yuma named after towns in Western Washington, there are so many people wintering over. We call them 'snowbirds', retirees flock south in the fall and north in the spring.
About thirty-five years ago I went to work at the NYS Dept of Mental Health with the responsibility of conducting psychological evaluations, including intelligence testing, on clients that were later referred to as the developmentally disabled. At that time I was most surprised to find out that the Dept was still using the terms moron, idiot and imbecil.
Fortunately such pejorative terms were soon there after discontinued in the professional analysis of a person's dysfunctions. I now find that those very terms have some reasonable application in daily life. I can't tell you which of those three levels of dysfunction Mr. Sowell falls into, but rest assured that his column implies that he is either the most dishonest columnist on the scene or a total jackass.
What I find all the more disturbing is that this fool is provided with column space so as to communicate his personal stupidity to the community at large. Or, he is just another cog in the disinformation machine. "Most Americans?" Most is a term so vague as to be useless in the kind of analysis the Sowell seeks to foist upon an unsuspecting readership. In fact the least amount of change in income levels takes place amongst the highest and lowest decile rankings in the range, as occurs in most measures of human social activity.
Assuming for the moment that one does enjoy a dramatic increase in home value, what is accomplished by "cashing in" that equity after one purchases a replacement living place? Of course one can always move down a peg to a less desirable location and have a little cash left over. What a break, and not much is left over.
"even though people are moving in and out of those brackets all the time." Sure the middle three fifths are likely to be moving down those brackets, while the people in the bottom bracket have no place to go but up and that's not happening except for a minute portion of the lowest bracket whose incomes border the next higher bracket.
The figure I have been seeing quoted is that if one follows individuals, somehow personal income has gone up 24% since 1996, when I see figures elsewhere that per household disposable real income (or maybe that is just wage income) has declined since 2000. Any explanations on that one?
Barkley
One of the better moments in Robert Frank's book Falling Behind: How Rising Inequality Harms the Middle Class is when he responds to Milton's permanent income claim. This excerpt comes from the chapter "Context-Sensitive Types of Consumption":
Any successful consumption theory must accommodate three basic patterns: the rich save at higher rates than the poor; national savings rates remain roughly constant as income grows; and national consumption is more stable than national income over short periods.
The first two patterns appear contradictory: If the rich save at higher rates, savings rates should rise over time as everyone becomes richer. Yet this does not happen. [James] Duesenberry [author of Income, Saving, and the Theory of Consumer Behavior] suggested that the explanation of the discrepancy is that poverty is relative. The poor save at lower rates, he argued, because the higher spending of others kindles aspirations they find difficult to meet. This difficulty persists no matter how much national income grows; hence the failure of national savings rates to rise over time.
To explain the short-run rigidity of consumption, Duesenberry argued that families look not only to the living standards of others, but also to their own past experience. The high standard enjoyed by a formerly prosperous family thus constitutes a from of reference that makes cutbacks difficult, which helps explain why consumption levels change little during recessions.
Despite Duesenberry's apparent success, many economists felt uncomfortable with his relative-income hypothesis, which to them seemed more like sociology or psychology than economics. The profession was therefore immediately receptive to alternative theories that sidestepped those disciplines. Foremost among them was Milton Friedman's permanent-income hypothesis, which still dominates research on spending.
Friedman argued that a family's current spending depends not on its current income, but rather on its long-run average, or permanent, income. Because economic theory predicts that people prefer steady consumption paths to highly variable ones, Friedman argued that people would smooth their spending--saving windfall income gains and drawing down savings to cover windfall losses. Consumption should thus be more stable than income over short periods. Friedman also argued that a family's savings rate should be independent of its income, leading him to predict the long-run stability of national savings rates.
Friedman dismissed the high savings rates of the rich as a statistical artifact. Because many of those with high measured incomes in any given year will have enjoyed positive windfalls, their permanent incomes will be lower, on average, than their measured incomes for that year. So if they save windfall gains, they will save a higher portion of their measured incomes than of their permanent incomes. The converse holds for those with low measured incomes in any given year, who will have experienced a preponderance of windfall losses that year.
Although this is a tidy story, its fundamental premises are contradicted by the data. As numerous careful studies have shown, for example, savings rates rise sharply with permanent income. Friedman's defenders responded by arguing that rich consumers want to bequeath money to their children. But why should the poor lack this motive? Another problem is that people consume windfall income at almost the same rate as permanent income. To this, Friedman responded that consumers appear to have unexpectedly short planning horizons. But if so, then consumption does not really depend primarily on permanent income.
Strangest of all, Friedman's theory assumes that context has absolutely no effect on judgments about living standards. It predicts, for example, that an investment banker will remain equally satisfied with his twin-engine Cessna even after discovering that his new summer neighbor commutes to Nantucket in an intercontinental Gulfstream jet.
In light of the abundant evidence that context matters, it seems fair to say that Duesenberry's theory rests on a more realistic model of human nature than Friedman's. It has also been more successful in tracking actual spending. Under the relative-income hypothesis, for example, it is easy to understand why a majority of families experience significant retrenchments in living standards when they retire. Under the permanent income hypothesis, this observation is a jarring anomaly. And yet Duesenberry's relative-income hypothesis is no longer even mentioned in leading textbooks.
Relative income hypothesis! Over at Angrybear, I had a few posts on this consumption inequality metric favored by the likes of Mankiw and Sowell as measured consumption inequality has not grown as much as income inequality. The counter was the sharp rise in wealth inequality. Yes - this relative income hypothesis explanation of the differences in savings rate has some merit when one views real world data.
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