3/11/2011 6:15 PM ET|
Down and out on $250,000 a year?
It's the new magic number, the supposed threshold of wealth in America. But is a family with that income really rich? Can it even make ends meet?
In the ongoing debate over whether to use tax policy to help resolve the nation's massive deficit, a single number has emerged from the crossfire: $250,000. It's the annual income that President Barack Obama and others have used to define what it means to be "rich" in America today. And while the Bush-era tax cuts were temporarily extended to 2012, when their deadline comes around for the second time, $250,000 will be etched in the minds of policymakers and pundits as the number that separates the middle class from the wealthy.
By most measures, a $250,000 household income is substantial. It is six times the national average, and just 2.9% of couples earn that much or more. "For the average person in this country, a $250,000 household income is an unattainably high annual sum -- they'll never see it," says Roberton Williams, an analyst at the Tax Policy Center, a nonpartisan think tank in Washington, D.C.
But just how flush is a family of four with a $250,000 income? Are they really "rich"? To find the answer, The Fiscal Times asked BDO USA, a national tax accounting firm, to compute the total state, local and federal tax burden of a hypothetical two-career couple with two kids, earning $250,000. To factor in varying state and local taxes, as well as drastically different costs of living, BDO placed the couple in eight different locales around the country with top-notch public schools, using national data on spending.
The analysis assumes that this hypothetical couple -- let's call them Mr. and Mrs. Jones -- both have professional positions at their companies. They take advantage of all tax benefits available to them, such as pretax contributions to 401k plans and flexible spending accounts for medical care, child care and transportation. They have no credit card debt, but Mr. Jones racked up $40,208 in student loan debt in undergraduate and graduate school, and Mrs. Jones borrowed $22,650 to get her undergraduate degree (both amounts are equal to the national averages for their levels of education). They also have a car loan on one of two cars, and a mortgage for 80% of the value of a typical home in their communities for a family of four, which includes one toddler and one school-age child.
The bottom line: It's not exactly Easy Street for our $250,000-a-year family, especially when they live in high-tax areas on either coast. Even with an additional $3,000 in investment income, they end up in the red -- after taxes, saving for retirement and their children's education, and a middle-of-the-road cost of living -- in seven out of the eight communities in the analysis. The worst: Huntington, N.Y., and Glendale, Calif., followed by Washington, D.C., Bethesda, Md., Alexandria, Va., Naperville, Ill., and Pinecrest, Fla. In Plano, Texas, the couple's balance sheet would end up positive, but only by $4,963.
Taxes take a hefty toll. Everything from property taxes and the alternative minimum tax to the taxes added to cell phone bills and the cost of gasoline, when combined, takes a massive bite out of earnings -- in some cases even more than the federal income tax. And it's not likely to get better soon. States and municipalities have been steadily raising income tax rates to help close gaping holes in their budgets. Property taxes are also increasing, even though real estate values have cratered. And sales taxes are hitting record levels, in some areas nearing 10%. Gas taxes, alcohol taxes and hidden surcharges on everything from airline flights and ferry rides to vehicle registrations, rental cars and even sodas have also been stealthily rising.
On top of that, additional tax increases for couples with salaries of $250,000 or more (and single people earning $200,000 or more) are scheduled to go into effect in 2013 under the health care bill passed a year ago. Plus, the Democrats, who supported legislation to raise income tax rates for higher earners last year, will probably push for the same measure when the Bush-era tax cuts expire at the end of 2012.
Thinking about tomorrow
Being in the red on a $250,000 annual salary may still seem surprising. But taking responsibility for their retirement and their children's future is costly. The Joneses are maximizing contributions to two 401k's and to all flexible spending accounts available to them, and they are squirreling away $8,000 a year for their kids' college educations. And their spending is conservative, based on national averages for professional couples with two children. Not included are those hefty run-of-the-mill payouts for charitable deductions, life insurance premiums, disability insurance, legal fees -- or monthly sessions at the hair colorist, or membership at a gym.
As educated professionals, the Joneses buy books, newspapers and magazines; they own computers and pay for Internet access. But they don't take lavish vacations, don't belong to a country club, don't play golf, don't drive luxury cars, don't have a swimming pool, don't buy designer clothes, don't own or rent a second home and don't send their kids to private schools. They don't even shop at high-end grocery markets. (They spend what the U.S. Department of Agriculture defines as a "moderate" amount on food for the average family of four.) In short, they're not "wealthy," even if they're in the top 5% of earners.
In reality, to make ends meet, this squeezed couple would have to cut back on discretionary expenses -- take a pass on a new suit, skip an annual vacation and drop some of their children's activities. Unfortunately, the family would also probably have to save less, at the ultimate expense of their retirement or their kids' educations.
Taxes of every kind
Consider the tax profile of the Joneses when they're based in Huntington, a suburb of New York City. Thanks to all their smart pretax contributions and a fat deduction for mortgage interest and state and local taxes, the couple's federal income tax is only $29,344. But what often goes overlooked is the toll taken by state and local taxes. In this case, it exceeds that of the federal income tax bill: $31,066.
State income taxes, taken alone, are just $10,557. But factor in the gas tax ($2,679), property tax ($15,222), phone service taxes and surcharges ($350), and sales tax ($2,258), and the picture looks far different. Their total tax bill, including the AMT and payroll taxes: $78,276.
"When most people think about taxes, they think first about federal income taxes, then maybe about sales taxes, but there are a lot of taxes out there," says Mark Robyn, an economist with the Tax Foundation, a nonprofit tax research group in Washington, D.C. "It's eye-opening to step back and take a look at the whole picture."
Location is critical
Moving to a state with no income taxes or low taxes in general would help the Joneses' bottom line. In Pinecrest, Fla., a suburb of Miami, they would owe zero state income tax, and pay an annual $10,976 in property taxes, $1,833 in sales taxes and $350 in phone service taxes, for a total state and local tax burden of $13,476. Because they would have no deduction for state and local taxes on their federal tax return, they would have to pay Uncle Sam more than they did in Huntington: $31,768. Still, the total tax burden would be significantly less: $61,621, versus $78,276 in Huntington and $71,683 in Glendale, a suburb of Los Angeles.
But for most people, moving to a low-tax state in midcareer is difficult, if not impossible. People are generally bound to their high-tax states by their jobs. And often it's tough to find high salaries in low-tax states like Florida.
How far the 'big bucks' really go
The $250,000 threshold was first mentioned in a campaign speech by Barack Obama when he was running for president in 2008. "It's an historical accident," Williams says of the number's importance. "I don't think there was any thought given to why $250,000 -- it became a mantra." Whether or not $250,000 represents affluence "depends a great deal upon where you live," he says.
Consider, for example, the tab for the same assortment of ground beef, tuna, milk, eggs, margarine, potatoes, bananas, bread, orange juice, coffee, sugar and cereal. In Twin Falls, Idaho, the cost would be $23.41. In New York City, you would have to shell out 72% more, $40.29, according to The Council for Community and Economic Research. That higher percentage carries across all expenditures, from child care to haircuts.
Of course, housing costs are among the biggest variables. In Glendale, the Joneses can live reasonably well -- but not extravagantly -- in a three- or four-bedroom home valued around $750,000. In Twin Falls, they would need to spend only about half as much for an equivalent home.
After covering taxes and only essential expenses for housing, groceries, child care, clothing, transportation and their dog, the Joneses would still be in the red by $1,787 in Huntington. In Plano, they would have $27,556 to spare. Factor in common additional expenses for a working couple with two children -- music lessons, day camp costs and after-school sports, entertainment, cleaning services, gifts and an annual weeklong vacation -- and the Joneses get deep in the red in Huntington, to the tune of $23,178. In Plano, the best-case scenario, they would still have money to spare, but just $4,963.
Some of the expenses incurred by couples like the Joneses may seem lavish -- such as $5,000 on a housecleaner, a $1,200 annual tab for dry cleaning and $4,000 on kids' activities. But when both parents are working, it is impossible for them to maintain the home, care for the children and dress for their professional jobs without a big outlay.
And costs assumed by the Joneses could be significantly higher if their circumstances changed. For example, if they worked for themselves, they would have to foot the bill for all their medical insurance premiums, which average $14,043. As it is, they pay 30% of the premiums, and their employers pay the rest.
The bottom line: For folks like the Joneses -- who live in high-tax, high-cost areas, who save for retirement and college, who pay for child care to enable them to earn two incomes and who pay higher prices for housing in top school districts -- $250,000 does not a rich family make.
This article was reported by Karen Hube for The Fiscal Times.
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