How Taxes Keep You from Building Wealth


 

OLYMPUS DIGITAL CAMERA

No one likes taxes, but everyone likes government services.  Everyone likes the idea of having “free” things, like roads, schools, and health care.  After all, who wants to spend their own money on roads, schools, and health care?

The trouble is, unless you spend your whole life as a bum and never earn a paycheck (yeah, Steevo, I’m talking about you), you will end up paying for these things over your lifetime through taxes.  It may be nice to think that some rich guy with infinite wealth (who earned all of his income oppressing the poor so that you don’t feel bad stealing from him) pays for it all, but the trouble is there are very few very wealthy people around (and almost none who became wealthy through oppression, unless you’re living in a Charles Dickens book).  Even the very wealthy people you think of – Warren Buffett and Bill Gates, for example, aren’t paying a whole lot out in taxes because they have their money in unrealized capital gains, generally shares of stock.  And in case you think you’ll get it when they die, they just form a foundation that then provides lifetime employment and perks like private jets and large, lavish offices for their children.  They are able to pass down their wealth and avoid taxes even in their death.  The foundation can also be devoted to one of their pet causes as well, so even there they get to use their money as they wish and yet not pay taxes.

If you did something that would actually snag their wealth, like a wealth tax (notice that Warren Buffett never calls for something like a 100% tax on all wealth above $1B), they would quickly leave the country and take their money with them even though they are often the ones calling for higher taxes.  (By taxing income and not wealth, it is almost like they’re trying to keep other people from becoming wealthy, isn’t it?)  Even if you could tax these people and get a good share of their wealth, it would only last for a year or less before that wealth was gone.  Even a $100B portfolio can’t stand up against deficits of $1T per year or more, or a budget of $3T budget or more.

No, Virginia, it is you who pays for all of this free stuff.  Remember that even if you don’t pay income taxes, you’re still paying “payroll taxes” — Social Security and Medicare taxes — that eat up about 15% of your paycheck if you include the employer portion.  If you actually pay taxes and are in the 15% bracket, you’re paying something like 30% of your paycheck out before you even get to state and local taxes.   And even then, the new healthcare isn’t free, far from it, with premiums expected to be $2500 per year more per family this year than they were when the law was passed.  In my state, we’re seeing one insurer raise premiums by 60%!

If you look at a cash flow diagram, taxes would fall under the category of “obligated expenses.”  These are things, like a car payment, that you are forced to pay.  You can’t just decide you want to cut these expenses to devote money to other things  or not pay them one month.  You have no choice.  There are other things that you need to buy — such as food — but you are not obligated to buy specific items in these categories.  You have a choice in how much you pay, the quality, and the method of delivery.

And this is the issue with obligated expenses.  They eliminate the flexibility you have in your budget otherwise.  It is especially bad for the middle class to have high taxes as obligated expenses since there is really no way out.  You can pay off a car or sell a house to get out from under those types of obligated expenses, but it is difficult to get your taxes cut.   This means you don’t have the choice to change how things delivered under taxes are provided or what they cost.

For the high earners, this makes little difference since the obligated expenses such as taxes are a very small percentage of their income.  They can pay a $5,000 property tax bill that funds the local public schools, but then choose to send their children to a private school because it offers a better education or provides the religious background that they want.  (Note that virtually none of the people in Congress send their children to public schools because many of the schools around DC are really awful, but the residents of DC have no choice.)  For the middle class, however, it is a real sacrifice to pay $2,000 per year in property taxes to help fund schools and then come up with another $5,000-$10,000 to send a child to private school.  While they may not pay the full price of their public schools in a given year, over their lifetimes they pay more than enough in taxes to send their children to a private school instead, but they don’t have this choice.

For the middle class, however, it is a real sacrifice to pay $2,000 per year in property taxes to help fund schools and then come up with another $5,000-$10,000 to send a child to private school.  While they may not pay the full price of their public schools in a given year, over their lifetimes they pay more than enough in taxes to send their children to a private school instead, but they don’t have this choice.  The same goes for things like health care, roads, and parks.

In America, we’re seeing our tax burdens build as we start seeing the government take over more things like health insurance.  Just as with schools, if you’re forced to pay a good portion of your money to the government to provide healthcare, it is difficult to also pay for other, better healthcare if that provided is inadequate.  You also don’t have the option to cut your healthcare costs by choosing a healthy lifestyle because the choices of those around you sets your healthcare bill.  You may never go to the doctor, but you’re still paying a high premium each year and will pay a high deductible for the times where you do go since there are other people who smoke, drink, consume big gulps, and never walk further than the car each day.  You need to pay for the healthcare whether you use it or not in a given year.  And because the cost is all the same, many people will choose the more expensive procedure or just choose to have more procedures because it doesn’t cost them any more.  This drives up costs for everyone.

These types of costs make it difficult for those in the middle class to build wealth.  The whole idea is that by driving used cars and buying a smaller house, you maybe have a couple of hundred extra dollars left over at the end of the month that you can invest.  If you have high taxes, however, you’ll need to be thrifty just to pay the taxes and still buy the things you need and you’ll still not have any savings.  And even if you do save up some money, it will just mean you’ll pay more for things as government programs start to give out subsidies for those who don’t save and raise the price for everyone else (leading to more people getting subsidies).  With these types of programs, the cost is “whatever you can pay.”

So before you vote for people who want to give you stuff for “free,” realize that you’re just giving up your ability to choose the types of services you want and the price you will pay.  Once a tax and a program is in place, it gets very difficult to change things since there will be people using that service, no matter how bad it is, and won’t be willing to give it up.  Somehow people think that if we don’t have public schools, for example, there won’t be schools.  They don’t realize that they could have schools that are nicer and better that are privately funded for the same cost or less, and that they could send their children there if they weren’t paying for the public ones.  Remember that it is not a choice between having something and doing without.  It is just a matter of choosing whether you want control over what you get or not and whether you want the people providing the service to be concerned with making you happy.  One trip to the DMV will show you what it is like when people get paid whether they have any customers or not.

Contact me at vtsioriginal@yahoo.com, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Comments appreciated! What are your thoughts? Questions?

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s