savings

Income analysis shows widening gap

A college degree is the single largest predictor of who moves up the income ladder, according to the study. While only 7 percent of those raised in poverty received a college degree, 86 percent of them moved up the income ladder as a result, compared with 55 percent of those who didn't graduate.

The Pew study corroborates findings by other researchers. A 2011 Georgetown University study found that a bachelor's degree can yield earnings of nearly $2.3 million over a lifetime, compared with $1.3 million for a high school diploma.

How much can a degree earn you over a lifetime?
The chart shows that higher education is a big factor in future earning power. A college education yields 74 percent more in earnings over a lifetime than a high school diploma.

The financial literacy advantage

Of course, the potential earnings of a college grad are also closely tied to the chosen field of study. Flurry says that when it comes to career choices, graduates need to go where the money is if the goal is to build wealth. "You hear about starving artists a lot more than you hear about starving corporate executives," he says.

But mastering financial literacy can be an even bigger contributor to attaining wealth, regardless of chosen career or income level, according to Flurry and Prince.

"Certainly there are people who have lots of degrees and are horrible money managers and then there are others with a high school education who become multimillionaires," says Flurry. The key to financial success, he adds, is an understanding of how money flows, through interest rates, stocks and bonds and debt, for example. Once you understand that, you can figure out how to make your income work for you and avoid going backward by sinking into debt.

Prince cites a case study to illustrate why it's more important to use your income wisely than it is to earn a high salary. "I have clients in their mid-70s, a couple who came from Italy to this country. They had two children. The father was a union carpenter and the mother delayed working while the children were young, then worked packing boxes for a pharmaceutical company. They have a couple of million dollars saved up and own a home where they are getting rent from the upstairs while they live downstairs," she says. "They put their children through college, they have no debt and the house is paid for."

Is a higher tax rate the answer?

Raising taxes on the rich and offering programs to the poor to achieve balance is a solution that's often bandied about in the media. The original goal of the U.S. tax system was wealth equality, according to Matthew Gardner, executive director at the Institute on Taxation and Economic Policy. "Congress understood that huge concentrations of wealth have a corrosive power in our country." But for a variety of reasons inequality has always existed and will continue to do so -- it's just that there's no universal agreement on what level of inequality is acceptable, he says.

As billionaire Warren Buffett said when he pointed out his effective tax rate is lower than his secretary's, the current tax code is not set up to even out wealth. At the lower end of the wealth scale, Gardner says, about half of our tax revenue comes from state and local taxes, and these impact low-income families to a greater extent, further taxing them into poverty.

In a less direct way, the tax system is also contributing to a vanishing middle class, says Gardner. "The reason we have had a middle class is that our tax system provides services such as roads, education services and medical care, to allow people to move up the income ladder. When those services are underfunded, it kicks out that platform from under the middle class."

Although it would seem an easy solution to narrow the wealth and income gaps by restoring taxes to levels of the post-World War II period, when the top marginal tax rate was 70 percent-plus and as high as 94 percent, both Gardner and William McBride, chief economist at the Tax Foundation, say we live in a different economy now.

"When the income tax was first introduced in this country, not many people were paying it," says Gardner. Today, with a top marginal rate of 39.6 percent, an increasing share of the population is paying that rate, making it more of a mass tax.

"When you tax high incomes, that will flatten the gap because you're taking money from the rich," says McBride. "Even if you burn the money, it still accomplishes the same thing. But by doing that, you're reducing economic growth and investment. Several studies support that."

Gardner says that ultimately, the tax system can't be the driver for wealth equality. "It can't prevent people from getting rich or prevent poverty or create a middle class or manufacturing sector. It can only help. I think a sensible goal of the tax system is, 'First, do no harm.'"

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