A Wee Question — Answered!

| Sat Jan. 8, 2011 10:32 AM PST

Yesterday I asked a question about money. Nobody in comments guessed why I asked it, but before I tell you the answer I'll repeat the question. Here it is: Suppose that you lead a comfortable middle-class life. Let's say that you're in your 30s, married, two children, and you make $100,000 per year. I offer you a fair coin flip with the following possible outcomes:

  • Heads: You will be stripped of most of your assets and will earn $30,000 per year for the rest of your life. That's all you get, and neither friends nor family can top it up for you.
  • Tails: You will earn $1 million per year for the rest of your life.

Would you take me up on my offer to flip the coin?

Before I explain further, a caveat: this isn't meant to be a scientific experiment. It doesn't prove anything. There are dozens of reasons why the results are meaningless. But there's no need to dwell too much on that. This is just a (possibly) provocative data point to mull over.

So here's why I asked: I'm writing a piece about income inequality and other things for the next issue of the magazine, and in an email conversation with my editor she suggested that one point worth making is that in America today, "someone making $100K has a lot more in common with someone making $30K than someone making $100 million." Now, there's an obvious sense in which that's true, but I suspect that there's a more important sense in which it's not. Yes, the zillionaire jets around the world and owns a bunch of mansions and has a staff of aides and servants to take care of things. That's really, really nice. But our $100K wage slave also has a comfortable house, gets to fly around the world now and again, probably employs a gardener and cleaning service, has a pretty stable life, etc. etc. Also nice. On the other hand, a household earning $30,000 — which is well above the poverty line — lives a pretty precarious life on a variety of measures.

So how to get at the difference? Well, I figured one possible way is this: if you really were a fairly ordinary upper middle class wage earner making $100K per year, and you had a 50-50 chance of either joining the ranks of the elite or falling down to the bottom of the working class, which seems further away to you? The answer from comments was loud and clear: the bottom of the working class. I didn't count, but I'd say only about 10% of commenters were willing to take the coin flip. The other 90% would stick with their $100K lifestyle.1

So what does this mean? Probably not much. But it's suggestive that in terms of lifestyle, if not political goals, a $100K wage earner actually feels somewhat closer to the zillionaires than to someone barely scraping by. We intuit, correctly I think, that life at the bottom of the working class is pretty damn tough, while life at the tippy top is more exciting, but perhaps not fundamentally different from life in the upper middle class.

So that's that. Politically, I think it's quite possible that our $100K earner has more in common with the $30K earner than the millionaire — though they often don't know it. But in terms of lifestyle, I'm not so sure. How many gold plated bathroom sinks do you need, after all?

1Quite a few people thought that I asked my question in order to make a Kahneman-esque point about loss aversion. Not really. It's true, as Kahneman and Tversky discovered several decades ago, that people generally value losses more strongly than gains. Outside of artificial environments like casinos, if you offer people a fair coin flip where they win or lose $100, they won't take the flip. The fear of losing $100 outweighs the possible pleasure of gaining $100.

But here's the thing: Kahneman and Tversky found that the effect of loss aversion is about 2:1. That is, if you offer people a fair coin flip where they lose $100 on heads but win $200 on tails, they'll take the flip. In my question, however, we're way, way past that: you lose $70,000 on heads but gain $900,000 on tails. That's a ratio of more than 10:1. Obviously it matters that the relative loss is large in my question (70% of your income), but on conventional risk aversion grounds the ratio still should have been high enough to get at least half of you to take the chance. The fact that you didn't suggests to me the marginal utility of money really does decline quite rapidly once you get into upper middle class territory. On a variety of levels, this has a big impact on questions of political economy.

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