There are more correct ways than one. Most is installed between wrap and siding,

Who hired the inspector?

What kind of siding is used?

Lapping the house wrap over the flasing is better, but may or may not be covered by a local code requirement.

As far as a 'huge' problem, that depends on the siding and eave design.

I'm with the builder and roofer.

All of the on line sites I found say wrap over the flashing as your inspector says.

Here are two links...

http://www.taxpolicycenter.org/taxtopics/federal-taxes-households.cfm

http://www.hgtvremodels.com/home-systems/roof-step-flashing/index.html

"Trebruchet"

"I'm with the builder and roofer."

And your justification in assuming that the inspector is subordinate?

The inspector is correct. The top of flashing goes behind or underneath the weather barrier. This is pretty much a universal rule of flashing things properly. It applies the same to roofs, walls, windows, doors, shower stalls, etc.

I stand corrected by the linked Tyvek manufacturer's installation instructions which clearly specify "over" the step flashing, however, I disagree with the inspector that this is "a huge issue that will lead to leaks". It will not.

Here is a link that might be useful: Tyvek

But why not do it right? If it DOES become an issue at all down the road, at that point it will be by definition a "HUGE ISSUE."

picture?