Tuesday, July 15, 2008

Book review: Thomas J. Stanley and William D. Danko, The Millionaire Next Door

The Millionaire Next Door is one of the most interesting books about money you'll ever read, partly for the reasons the authors intend and partly for reasons they unwittingly reveal.

The book's primary insight involves the separation of income and wealth ("wealth" meaning net worth over a million dollars, a standard that may now be out of date). When people speak of the wealthy, they almost always define that category in terms of annual income, which we often infer from the visible signs of wealth, but Stanley and Danko reveal the limitations of that approach. Most millionaires, it turns out, are people who don't have the cars or houses or clothes we associate with rich people. Instead, they tend to be people with medium-high to high incomes whose habitual frugality lets them accumulate a lot of money. The book presents a series of case studies comparing people of similar ages and incomes who have different net worths: on one side are PAWs (prodigious accumulators of wealth), and on the other are UAWs (under-accumulators of wealth). Often, these differences come down to professional lifestyles: lawyers and doctors tend to be in communities where financial showiness is valued, for instance, while owners of blue-collar businesses actively avoid that showiness.

I had heard the broad outlines of this argument from a friend, so it was fascinating but not surprising to read the details. What really got my attention, however, was one of the case studies that compares two doctors, one saver and one spender, who have similar (very high, in this case) incomes. In a departure from the usual concerns of the book, the authors suddenly mention that the spender is very concerned about federal income tax rates, whereas the saver is not. The reasoning: the saver has a great deal of wealth separate from his annual income, and he lives well within his mean. The spender, on the other hand, regards extreme consumption as the sign of wealth, and he has so much debt from houses and cars that he needs almost every dollar of his huge income to keep pace with his consumption.

The book is written by anti-tax conservatives, as is sometimes explicit and routinely implicit in their framing of issues, so they don't dwell on this point. The implications, however, are clear. When people on the left talk about tax rates for "the wealthy," they equate wealth with income. That equation leads to the assumption that "the wealthy" aren't affected by an increase of a percentage point or two in the top marginal tax rate. What the book makes clear is that the wealthy in terms of net worth are almost entirely unaffected by small changes in the marginal tax rate, but there are a lot of wealthy people in terms of income who perceive themselves, at least, as facing fairly dramatic lifestyle changes based on those changes. And that's why--in addition to principled arguments--so many people who appear to be above economic worry are so passionately and personally opposed to even small marginal increases in tax rates.

The valuable thing about the book for liberals is that it's an analysis only conservatives would think to undertake: it examines only medium-high to high income earners to see how income does or does not become wealth. The results are sometimes mind-blowing, no matter your initial perspective.

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