Dec 22, 2015

Can We Really Say That the Middle Class is Crashing or Taking Off?

On Sept. 23, 1999, NASA lost contact with the Mars Climate Orbiter as it entered its orbit around the red planet, because the $193.1 million spacecraft disintegrated in the planet’s atmosphere.

A review found that a simple mathematical mistake caused the mission’s failure: Lockheed Martin, which developed software for the mission, reported altitude using U.S. standard measures (feet and miles) while the NASA computers interpreted the reports in metric measure without converting the numbers – thus three feet could become three meters, or almost 10 feet, inside NASA’s computers, and what was mathematically expected to be a perfect orbital insertion instead flamed out in the Martian atmosphere.

I cite this example to note that numbers and reported data aren’t the only things that matter: Metrics matter. Context matters. Conclusions matter.

I think that Pew Research, one of the best polling and data analysis agencies in the country, may have forgotten that lesson in a recent study.

Pew Research, using American census data, has concluded that for the first time since they started measuring socioeconomic class, “middle class”Americans are no longer a majority.

Since the report’s publication, blog posts and articles have proliferated about the demise of the American middle class, Pew even framed the results as evidence that the middle class is “losing ground,” but that may not be what the article is telling us.

For one thing, Pew wasn’t measuring socioeconomic class based on net worth or investible assets, the researchers were measuring income. For their purposes, they defined ‘middle’ incomes as households whose annual net income is between two-thirds and double the national median income for similarly-sized households. While Pew chops their data up by household size, we can use the U.S. Census Bureau median for the sake of ease:

If $51,939 is the U.S. median household income, middle class households make between $34,626 and $103,878 according to Pew's assumptions.

That’s where I have a problem with the conclusions drawn from this research. Let's start by saying that using national averages to convey a sense of wealth and poverty is foolish. Mississippi, our lowest income state with a household median around $36,000, is at 79 percent of the national median, while our highest income state, Maryland at around $69,000, is at 138 percent of the national median. A median Maryland household makes almost twice as much as a median Mississippi household not just because Mississippi has historically high levels of poverty, but also because Maryland families endure astronomical costs of living by comparison to Mississippi families. 

In some places, $35,000 may qualify one for middle income, and $33,000 a year may make one lower income, but there’s no way that a paltry $103,878 should be considered ‘upper income’ no matter where you live. Around 20 percent of households in the U.S. make more money than that.

By comparison, most academic definitions of socioeconomic class have ‘upper’ class consisting of the top 1-6 percent of American households. To be in the top 6 percent, your family would have to make around $175,000 annually – certainly more deserving of upper-class than $103,878 households. To be in the top 1 percent, a household would need a net annual income of more than $250,000.
But that’s a small issue. I think Pew and the pundits may miss the greater message behind the statistics.

The overall decline in American wealth can be attributed to three issues: The Great Recession and its related factors, the baby boom retirement, and an increased focus on wealth inequality as a form of social inequality.

Boomers were the big gainers in income, mainly because they’re living the last years of their working lives and have finally reached peak income. The most competent among them have also been saving in retirement and investment portfolios that are likely paying a nice dividend to replace income that they would otherwise get from bonds or CDs. However, they could also be starting to contribute to Pew’s ‘lower income’ numbers as they transition from income generation to living off of Social Security and retirement accounts.

If I recall correctly, an average retiree lives off of around $40,000 annually, but as retirees age past 70 that number drops to under $30,000 per year. They’re not taking huge disbursements from their retirement accounts, many are living off of social security and little else. As the percentage of the population over 65 and 75 increases, the percentage reporting within Pew’s “lower income” bracket should also increase.

The Great Recession undoubtedly had an impact, especially for younger people. I’m about to turn 35. People my age and younger have been competing for jobs in one of the worst job markets the country has seen since the 1930’s. It doesn’t shock me, then, to find that 18-29 year olds and 30-44 year olds who report ‘upper’ income levels have declined precipitously over the last 45 years. As millennials, the nation’s largest generation, enter the workforce, they’ve had to take lower-income jobs not just because few options existed, but also because boomers have been slow to retire. That’s beginning to turn around.

It’s more controversial to say that our efforts to address social inequality have led to greater inequality of wealth, but it’s hard to deny that some of our educational and economic policies are pushing artificial bubbles and concavities when it comes to affluence.

In the past 40 years, black households have experienced greater income growth than white households, women have experienced greater income growth than men, and the elderly have experienced greater income growth than youth. These three groups are commonly targeted for federal and state entitlements and scholarships over more white, male and young citizens. While there is ample evidence that the economic well-being of these populations is increasing, there’s still a widespread perception that they are socially disadvantaged, thus they continue to receive social welfare at inordinately high rates.

As an aside, there is an argument that these increases and the policies that have allowed them represent a move towards greater equality. Equality is a subjective term. The only thing we should be concerned with is equality under the law – as long as the law extends preferential treatment, greater monetary assistance or support-in-kind to some citizens in lieu of others on the basis of their gender or their minority status, we’re moving away from, not towards equality.

Pew’s message is also wrong. Rather than sliding into poverty, more middle class Americans than ever before are ascending into the upper class.

The proportion of American adults living in the middle-income tier decreased from 61 percent to 50 percent from 1971 to 2015. During that same time, the proportion of households considered lower income increased from 25 to 29 percent, but the proportion of households considered upper income increased from 14 to 21 percent. So 4 percent of Americans went from middle class to lower class by Pew’s definition, but another 7 percent ascended from middle income to upper income in the same time period.

The seven percent are almost undoubtedly part of the sizable segment of the American population known to financial advisors as “the emerging affluent.”

For those of us who have read Thomas Stanley’s and William Danko’s 1995 book “The Millionaire Next Door,” this is even less surprising. Stanley and Danko found that, for the most part, millionaires come from middle class backgrounds and up to 80 percent still live middle class lifestyles – their net worth, however, and the income they derive from it has pushed them past the definition of middle class.

These aren’t eccentric billionaires like Elon Musk or Warren Buffett. They aren’t caricatures of wealth like Richie Rich or Tony Stark. They’re people who own small businesses who are making their ideas work. They’re middle-level professionals who have learned to live simply and to sock money away for the future.

Stanley and Danko’s research found that these, by and large, aren’t the people buying up mcmansions, Ferraris or Armani suits. The most popular car among millionaires? The Ford F150. Why? Because they’re cheap to own, cheap to maintain, last a long time, and are useful for independent contractors, who as it turns out, are the Americans with the most socioeconomic mobility.

Since even Pew, further down their report, mentions that socioeconomic class is more a ‘state of mind’ than a strictly defined income or asset bracket, who is to say that these humble, self-made millionaires aren’t middle class? They live in middle class neighborhoods, buy middle class products from middle class – or even thrift – stores, and their wealth confers no immediate special benefit other than peace of mind.

For another matter, the measurement of income as a sign of wealth is less relevant than ever before, and that in part is due to some of the differences in millennials and to a lesser extent generation X. Millennials aren’t placing as much emphasis on purely generating income, but more on lifestyle independence. Now that the economy is loosening up and the job market is strengthening, fewer millennials are opting for the 35-to-40-year career at a single company or long periods of full-time employment. They’re the force behind the growing ‘gig economy’ where more individuals work part-time, on-call, on contingency or when they want.

As we move away from traditional careers towards a gig economy, I think the number of these emerging affluent, self-made upper-income households is poised to increase. According to Pew, in 2014, 10 percent of American workers were self-employed, and another 20 percent worked for a self-employed person.

Much of this income is recorded as ‘miscellaneous income’ for tax purposes and ends up on a 1099 form, which is where companies report payments to contract, temporary, or contingent workers. In 2014, 91 million 1099 forms were filed, and a lot of them are likely from middle class or upper-middle class workers with side hustles or work-from-home projects.

In the future, income inequality will become even more difficult to measure using Pew’s source data, the U.S. Census Bureau’s Current Population Survey – not because of the research methods behind the survey, which are sound, but because respondents won’t know how to report the money they’re making.

While inputs like Social Security payments, retirement account distributions, interest and ‘miscellaneous’ income are supposed to be reported in the current data, there’s little evidence that respondents are accurately reporting that data now, let alone 10-20 years in the future when it will likely make up a larger portion of their annual income.

The measurements we’re using and the ways we’re interpreting them can’t provide elegant solutions to put us precisely into orbit, but convey very rough, incomplete pictures of reality that, if used as a basis for policy, might hurl us out into space or slam us into Mars.

I’ve digressed several times, so let’s close with a few takeaways:
  • Socioeconomic class is subjective and more related to lifestyle choices than it is to income.
  • Pew might be right in saying that the number of ‘middle income’ Americans is declining, but they’re using an overly-narrow definition of middle income.
  • These assertions are losing meaning not just because they’re subjective, but because the metrics we’re using to support them are becoming meaningless.
  • The American dream is not dead, but it has been redefined by the emerging generations to mean more than the simple accumulation of wealth and property.

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