It’s Over: The Middle Class Is Disappearing

What's me guys? It's Graham here. Apparently, the middle class is quickly disappearing at an alarming rate. In fact, the situation is getting so dire that less than a year ago, Fortune stated that the middle class is bracing for its next financial blow. According to Yahoo, the former backbone of America is finally at the end of an era, with middle class wealth having peaked in February of 2022.

So, in an effort to get to the bottom of what's actually going on, let's discuss exactly why the middle class is shrinking at an alarming rate, whether or not this is something to worry about, precisely how this will affect everybody watching, and what you could do about this to make sure you don't get left behind.

On today's episode of "Stop Spending Your Money on Starbucks." Although, before we start, if you enjoy these kinds of videos and find them helpful, do me a quick favor and gently hit the like button by giving it a gentle tap so as not to crack your phone screen. That's all I ask, and in return for doing that, I'll do my best to respond to as many comments as possible.

So, thank you guys so much, and also a big thank you to KD for sponsoring today's video, but more on that later.

All right, to start, in order to understand what's going on and exactly what's at stake, we first have to talk about who the middle class is. Because just like the dinosaurs, according to some, they could be going extinct.

See, the idea of the middle class being the everyday working American really began after World War II when productivity and GDP skyrocketed. This meant that it was entirely possible for 70% of American families to comfortably survive on one salary, 50% to own their own home, and 50% to own a car, pay for the children's tuition, and save enough to eventually retire with the help of employer pensions.

Although all of this changed in the 1970s, where for the first time, incomes of the middle class began to shrink. Why, you might ask? Well, even though there's not a confirmed cause, it is believed that throughout the 1960s, the United States began losing production quality and productivity dominance to Europe and Japan.

So, we began printing money and loosening policies in an effort to stimulate the economy. Short-term, this helped, but over time it began causing issues, leading to the eventual decision to end the dollar's link to the gold standard in 1971. This single move was said to have sabotaged the great American wealth-building machine.

No longer can one generation of Americans expect to live a better life than the previous one. Shortly after that, the 1970s gas crisis drove up the cost of living. American muscle cars were frequently replaced with European and Japanese cars because they were more efficient.

Pretty soon, we saw the emergence of two-income households, which provided an escape hatch that prolonged the American dream for another generation. After this point, in the 1980s, President Reagan’s tax cuts encouraged free trade and passed laws that would benefit large corporations.

This meant that the middle class was able to shrink upwards to make more money but at the cost of achieving higher education and embracing automation. Over time, this just continued to develop, but at an extreme. More and more people are either being pulled up into a higher bracket or pulled down into a lower bracket. As a result, the middle class has started to shrink.

To make matters worse, college graduate wages have been declining since 2000. Employers have been cutting healthcare for young workers since 1985. Minimum wage would be $18 had it risen alongside productivity and CEO pays, now almost 400 times that of the average worker.

However, in order to understand the magnitude of what's going on and why the middle class will continue to deteriorate over the next few decades, look no further than taxes. From my perspective, if you want to see the biggest difference between the middle and the upper class, we could first start with W2 versus self-employment income.

See, here's the thing: If you're working a normal job with a set schedule and a specific salary, you're getting paid as a W2 employee, which basically means your income and tax withholdings get reported directly to the government. Then you file a form at the end of the year to make sure that you paid the correct amount.

Under this structure, you get paid, pay tax, and then spend whatever's left over. However, if you're self-employed or you run your own business, since technically you are your own boss, you're going to be operating with self-employment income. This means you're allowed a variety of deductions to reduce your tax liability.

Like, for example, do you need a home office? Well, that's a tax write-off. Or what about using a car to drive to and from meetings? Or how about a business lunch? Well, all of those are also tax write-offs. In these scenarios, as long as the expenses are legitimate, the tax structure goes from getting paid, paying taxes, to spending what's left over to then getting paid, spending, and then paying tax on what's left over.

This could be hugely advantageous for anyone who runs their own business. For example, number two: depreciation. Just over a year ago, ProPublica posted an article titled, "If you're getting a W2, you're a sucker," where they detailed some of the available tax strategies that could potentially reduce your tax liability to zero.

For instance, they had the billionaire Steven Ross’s example of someone who's able to use the tax code strategically to pay nothing while showing $1.5 billion of income from 2008 to 2017. In these examples, business owners are able to buy an asset, like a commercial property, a piece of business equipment, or machinery, and then write off the entire cost of that item against their taxes, sometimes known as cost segregation.

This effectively means that if you make a million dollars in profit, you could simply put $100,000 down on a million dollar property before the end of the tax year and then reduce the full $1 million expense against your $1 million in income. Magically, you could profit $900,000 without paying anything in tax.

Of course, the downside is that yes, taxes will eventually have to be repaid back when you sell the building, otherwise what's known as recapture tax. But as long as you never realize those gains, then theoretically taxes could be postponed indefinitely until eventually you die and then your heirs can inherit up to $25 million tax-free.

In terms of how common this is, the Brookings Institute found that households worth $10 million or more benefited the most from being able to make their income disappear, leading to the notion that yes, the rich do continue getting richer.

And finally, we have three: capital gains. Since the majority of wealth is generated by business ownership, when it comes time to actually sell that business, most of those profits are taxed as long-term capital gains, which carries a maximum tax rate of 20% plus a 3.8% net investment tax.

Compare this to the maximum tax rate of 37% on earned income, and you'll quickly begin to see that business owners are able to legally use the tax code in such a way that they have a lot more money left over to save and invest.

However, in terms of what's likely to happen over the next few years and what you could do about it to put yourself in a better position, here's what I think.

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And now, with that said, let's get back to the video.

All right, so in terms of the shrinking middle class, the fact of the matter is rich people have the disposable income to invest, and when interest rates are low or inflation is high, those are the assets that end up going up the most in price. Hence, why the richest 1% make twice as much as the rest of the world.

For instance, low interest rates can stimulate the economy, but it's usually done at the expense of devaluing wages and raising the cost of living. As a result, the people who take advantage of this and borrow money are already the people who have the creditworthiness to begin with.

These borrowers are considered safer; they have collateral, and banks aren't worried about them defaulting on their payments. So, the rich get the first shot at cheap money at pre-inflated prices. From there, as they continue to use and invest cheap money, prices end up going higher, and by the time everyone else begins to invest, there's a lot less room for profit, or at worst leaving people to buy at peak.

However, I will say that not everybody agrees, and depending on the data that you look at, the middle class might not be shrinking in the way that you think. For example, according to the Brookings Institute, the middle class isn't disappearing; it's actually increasing.

As they say, the bottom one-fifth has 25% more income in 2007 than they did in 1979 when you account for government transfers, the value of health insurance, and the decline in household size. They also found that the middle fifth increased by 37% throughout that exact same time frame, and that the middle class is a lot better off today than the middle class of the 1970s, given the abundance of government programs and assistance.

A separate study also reported that yes, the middle class is shrinking, but only because they're moving into higher income groups. Even though this sounds hard to believe, objectively there is some truth to these findings.

Like, from 1971 through 2021, the middle class shrunk as a disproportionate amount became upper class. It's also true that while the United States has the smallest middle class among similar nations, we also have the largest affluent class and poverty class, suggesting that perhaps people are either getting richer or they're getting poorer.

That's why I think it's not so much of an income gap that's contributing to the inequality of wealth, but instead an investment gap. For instance, when the Federal Reserve raises rates, the only people who could take advantage of that were the people who had the investments and disposable income in the first place. Everyone else was left out while inflation reduced the purchasing power of their money.

On top of that, the people with existing investments also tend to have the willingness to take on higher risk for higher returns because they have the reserves to fall back on to ride out any short-term fluctuations. In comparison, someone working paycheck to paycheck can't afford to take on that risk, and anything extra they have is taken on by necessities which are going up in price.

That's why, given all of this, in terms of what you could do to take advantage of the situation and put yourself in the best position possible, here's what I think.

First, understand that your credit score is everything. In this case, your credit score tells banks how likely you are to default on a loan. The higher your score is, the more likely banks are to lend you money. The more likely they are to lend you money, the lower the interest rate you'll receive, and the more money you get to keep back in your pocket.

At the end of the day, if you're not already working to improve your score, begin working on this right now. All you need to do is get a no-annual-fee credit card, put normal expenses on the card every single month, and then pay it off in full by the time it's due.

If you're confused about exactly how to do this, I have an entire 20-minute long video that'll link to down below in the description that tells you how to do this for free. It costs you nothing and might only take you just a few minutes of work a month.

Second, save your money. The way I see it, you could own the fastest Ferrari in the world, but if you don't fill it up with gas, you're not going anywhere. Well, your savings is the exact same way. It makes no difference how much money you're making if you can't save a substantial portion of it to invest when you see an opportunity.

Even when the stock market plummets and everyone is panicking, if you save your money, you're going to have the gas to put in your Ferrari to then go faster than anybody else. Now, I'm not advocating trying to time the markets because no one has any clue when the next market crash will happen.

But having the ability to save money is going to be a huge determining factor in terms of your ability to take advantage of whatever situation comes up and escape the middle class.

Third, invest your money. If there's anything that rich people are good at, it's investing, often during a time where other people won't or are too scared. These are also the people who invest long-term and aren't phased when prices drop. Instead, they'll often double down because their investments just went on sale and they see an opportunity.

This also gives you the benefit of a lower tax rate if and when you eventually decide to sell. Fourth, think long-term. The biggest mistake you could probably make is to get emotional over a stock, to gamble impulsively, or to expect that short-term price fluctuations have any indication of how well something will do over 20 years.

If there's anything that wealthy investors are good at, it's buying with the expectation of holding for a very long time. If prices drop, for example, 20%, it's not a time to panic; it's a time to continue saving more money and buying it at a cheaper price.

Remember, you're investing money that you probably won't be touching for another 15 to 30 years. So, if something goes on sale, take advantage of it. And also, by holding long-term, you're lessening the chances of selling during a time where it's probably not a good time to sell.

Plus, there are so many studies out there that show that time in the market beats timing the market almost every single time.

So, overall, yes, the middle class is disappearing, but the good news is that according to all of these statistics, there's now a greater likelihood of moving up into a higher income bracket than at any other point in history.

That's why I think it's so important to double down in your career skills, stay out of high-interest rate debt, live below your means, invest consistently long-term, and perhaps, if you have the appetite for risk, go and start that side hustle business that you've always wanted to do.

So, with that said, you guys, thank you so much for watching. As always, feel free to add me on Instagram, and don't forget that you can get some free stocks worth all the way up to a few thousand when you make any deposit using the paid affiliate link down below in the description.

Enjoy! Let me know which stocks you get. Thank you so much, and until next time!