The War for the Middle Class

Pre-election, we heard much about the “middle class” as a recurring theme in defending and attacking positions and proposed solutions to challenges. How do we define the “middle class”?

 According to President Obama’s tax policy, “rich” starts with anyone making $200,000 single or $250,000 on a joint return. Is the upper end of the middle class at that level? Dylan Matthews tackled the question in a Washington Post piece, “What is the middle class?” (9/16/12). Matthews pointed out that only 4% of taxpayers make more than $200,000, so where is the middle?

 If you break income distribution data into percentiles, the 0-40th percentiles represent the lower to lower-middle classes; 40th-60th is middle class; 60th-80th is upper middle class; 80th-99th is upper class. Since the lower classes make under $20,262 and the upper classes above $101,582, the “middle class” is somewhere between $25,000 and $100,000 in annual gross income.

 In reality, “middle class” is an attitude, a state-of-mind. People do not look at what they make. They consider what they get to keep, focusing on what it takes to live. Those in a high tax, high cost of living location like Manhattan or urban California will feel less rich on the same income compared to a person in, say, rural Texas or South Dakota. A couple with joint income of $250,000 with substantial obligations may feel “poor” compared to someone at the same level who has more discretionary income. Couples or individuals who are educating children, struggling with excessive debt, or facing heavy health care expenses, do not feel rich.

The best definition of upper-middle and upper class earners may be those with discretionary income that affords fun in life, a growing net worth, and confidence that financial independence is achievable. The number one worry of those approaching or in retirement is longevity and sustainability of income. Running out of money and being a burden on loved ones is a big fear, with variables being current lifestyle, health status, liquid net worth, and future inflation.

With only 4% of taxpayers making more than $200,000, and the typical American household earning about $50,000, we know that we cannot tax our way out of the debt path that we are on. If the feds reduce support to states and cities, services will be cut and/or taxes and user fees increased. Retirees on Medicare will pay more in premiums, co-pays, and deductibles, with more services rendered by private pay providers as doctors and institutions refuse Medicare and Medicaid patients due to reimbursement cuts and irksome regulations.

 Inflation is a hidden tax on all earners, benefit recipients, and investors. Uncertainty creates market volatility, which is why money has poured into cash equivalents and bonds. In a recent Insightful Investor bulletin, MFS Investment Management studied data from 2002 through 2011. Over that time frame, a 6-month CD averaged a 2.36% yield; the tax rate for joint filers making $100K averaged 25.20% (ignoring state and local taxes); inflation averaged 2.48%. On that basis, the real rate of return averaged a negative -0.71%. Since “reflation” is a likely course for debt-burdened governments, inflation is expected to rise over time. Interest rates are likely to rise, which decreases the value of bonds, currently the refuge of risk-wary investors.

 Post-November 6 Congress and the president will have to deal with the looming fiscal and tax cliff effective January 1, 2013. Be prepared to consult with your financial advisors regarding tax strategies, gifting, income shifting, and timing relative to capital gains or loss carry forwards. Don’t wait until December, as financial planners, CPAs, and tax lawyers potentially will be scrambling.

 When you look at the facts and beyond the political hype, the middle, upper-middle, and upper classes are in the crosshairs of the taxers and spenders. That itch that you feel is a target on your back! Flak jackets, anyone?

 Lewis Walker is President of Walker Capital Management LLC and Walker Capital Advisory Services, Inc., a Registered Investment Advisor (R.I.A.) Securities and certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA).  Lewis Walker and Mike Hostetler are registered representatives of SFA which otherwise is unaffiliated with the Walker Capital Companies.