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Stop using income as a guide to economic class

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Amy Chozick has a fascinating story about politicians struggling to find a vocabulary to describe families who are not poor but who feel their economic struggles are sufficiently severe that they no longer self-identify as middle-class. I don't have any advice to offer political wordsmiths, but the discussion is a good a reminder that household income is a pretty poor indication of a person's place in the American class structure.

This is too bad, because people like to talk about household income for a reason. It's great to have a summary statistic of people's economic situation, and household incomes invite easy comparison. We can tell which quintile you fall into. We can tell whether you are above average locally or nationally. We can even compare you to a German or Mexican household. It's great.

Except that it's terrible. Consider.

Three average households

The median household income in the United States is about $52,000. So go ahead and picture a median-income household. What did you picture?

Did you picture a 25-year-old with a decent job who's maybe worried about student loans but is basically doing okay? Or did you picture a married pair of 45-year-olds who are both full-time workers stuck in kinda crappy jobs? Or did you picture a married couple with one full-time worker and one stay-at-home mom? Or a 65-year-old retiree whose $2.5 million stock portfolio yields him $52,000 a year in dividend income?

These people are all in very different situations. But household income says they are all the same. In fact, it says they are all typical households earning the US median household income.

Two dentists

Or consider two affluent dentists who earned the exact same (large) amount of money over decades of practice in Washington, DC. Both always maintained a high household savings rate, and both are now retired. For one dentist, that currently manifests itself in a Dupont Circle townhouse that's matched with a beach place on the Outer Banks and a ski cabin.

The other dentist sold his Dupont Circle townhouse and moved to a much cheaper place in Arizona. He doesn't own any vacation houses. Instead he's got a much larger stock portfolio, which helps pay for his country club membership and frequent travel to different places around the world.

These people are in essentially the same situation, and simply have different consumption tastes. One finds comfort in a stable routine — rotating among three great homes he owns and has set up exactly to his specification — while the other favors variety. But because the imputed rent (i.e., the rent that you would have had to pay to use the houses if you didn't own them) on the three houses doesn't count as income, household income will say they are in very different circumstances.

Three 22-year-olds

Last, consider three 22-year-olds.

One just graduated with a computer science degree from Stanford, where his parents covered his tuition, and has just taken a low-paid gig on Hillary Clinton's presidential campaign. The other just graduated with a debt-financed marketing degree from Schreiner University in Kerrville, Texas, and got a job with an electrical supply company. Last, you have a guy whose English isn't great because he was already 14 when he moved to the US and who works long hours at a CVS.

It's entirely possible that the first guy has the lowest income, and extremely likely that the second guy has the lowest net worth. But because of "human capital" — the value of fancy sheepskin, the value of computer skills, the value of social connections, etc. — it's the first guy who ranks highest in the class pecking order and the third guy who ranks third.

Pay attention to life-cycle effects and net worth

In any discussion of a broad social phenomenon, a little loss of precision is necessary. But the key things to keep in mind about household income and class are that you always need to supplement with life-cycle analysis and net worthespecially housing wealth, where otherwise similar people are often in very different situations.

Of course, sometimes ignoring life-cycle effects is appropriate. When you're talking about Affordable Care Act subsidies, the question of blunt ability to pay for insurance is very relevant. Consequently, the question of whether a 27-year-old earning $40,000 a year is "really" poorer than a 47-year-old earning $45,000 a year isn't the issue.

But if you're looking for an analysis of the structure of social class in the United States, you really need to know about where people are in life.