Is $250,000 a Year Rich? Let's Break It Down

It's no surprise that working couples in big cities are struggling to raise children while paying off mortgages and student debt. What is surprising is that they're lumped in with the so-called "wealthy" if they jointly earn $250,000 a year.

Is $250,000 a Year Rich? Let's Break It Down
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The "fiscal cliff" has added a new sense of urgency to the tax hikes that President Obama plans to impose on America's wealthiest citizens. Obama starts the meter at $250,000, and it goes up from there. The tax increases on high-income earners would deliver about $42 billion in 2013. They would create a small 0.1 percent drag on GDP, according to the Congressional Budget Office, but their real cost might be much steeper.

Those tax increases aren't the only ones that would kick in next year. In California, new tax propositions will create four new brackets for earners making $250,000 or more. Those taxpayers will see their state income taxes jump between 10.6 percent and 32.2 percent, depending on their bracket. Other states in fiscal straits could follow suit, and Republicans, among others, worry that soaking the rich could weigh on consumer spending and leave the entire economy under water.

Discretionary consumer spending is the engine that drives the U.S. economy. And high-income earners drive it more than middle- and low-income earners. Gallup's daily tracking of consumer spending showed a dip last month among upper-income consumers — an average of $116 per day, down from $126 in September. If that dip continues into the holiday buying season, the economy could suffer a setback.

I'm Wealthy? That's Rich

By most measures, a $250,000 household income is substantial. It is five times the national average, and just 2.9 percent 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.

And $250,000 is a lot of money — especially if you live in, say Peoria, Ill. But if you live in or around New York City, Los Angeles, San Francisco, Boston, Chicago or Dallas, you're not rich — you're simply what's known as "upper middle class." It all comes down to cost of living, a metric that is not considered when the Census Bureau or the Bureau of Labor Statistics calculates the mean earnings of working Americans.

The cost of living in New York, for example, is 105.7 percent higher than that in Peoria, according to New York employers make up some of that difference by typically paying 29.9 percent more than employers in Peoria for the same job with the same type of company.

Meet the Joneses

Two years ago, 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 seven different locales around the country with top-notch public school districts, using national government data on spending.

The analysis assumes that this hypothetical couple — let's call them Mr. and Mrs. Jones — are each on company payrolls, with professional positions. They take advantage of all tax benefits available to them, such as pretax contributions to 401(k) plans and medical, childcare and transportation flexible-spending accounts. 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 percent 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. The worst: Huntington, N.Y., and Glendale, Calif. These are 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.

Consider the tax profile of the Joneses when based in Huntington, a suburb of New York City. Thanks to all of 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 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 very different. Their total tax bill, including the alternative minimum tax 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."

Where Does It Go?

The $250,000 threshold was first mentioned in a campaign speech by President Obama in 2008. "It's an historical accident," Williams says. "I don't think there was any thought given to why $250,000 — (but) it became a mantra." Whether $250,000 represents affluence "depends a great deal upon where you live," he says.

Consider, for example, the grocery 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, $23.41. In New York City in December of 2010, you would have had to shell out 72 percent 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 one of the biggest variables. In Glendale, Calif., the Joneses can live reasonably well — but not extravagantly — in a three- or four-bedroom home valued around $750,000. In Twin Falls, you would only spend about half as much on an equivalent home.

After covering taxes and only essential expenses for housing, groceries, child care, clothing, transportation, and the dog, the Joneses would still be in the red by $1,787 in Huntington. In Plano, Texas, they would have $27,556 to spare. Factor in common additional expenses for a working couple with two children — music lessons, day camp costs, after-school sports, entertainment, cleaning services, gifts, and an annual week-long 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 dry cleaning tab and $4,000 on kids' activities. But when both parents are working, it becomes nearly impossible to maintain the home, care for the kids and dress for their professional jobs without a big outlay.

And costs assumed by the Joneses could be significantly higher if their circumstances change. For example, if they worked for themselves, they would have to foot the bill for all of their medical insurance premium, which averages $14,043. As it is, they pay 30 percent of the premium and their employers pay the rest.

Bottom line: For folks like the Joneses who live in high-tax, high-cost areas, who save for retirement and college, pay for child care to enable two incomes, and pay higher prices for housing in top school districts, $250,000 does not a rich family make.