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The Life of a Dollar, Taxes and Wealth Creation

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Last night, Biden’s speech was really good, if you are a socialist.  If you are interested in raising standards of living and wealth creation, it was a disaster.  Because the envy game is played so hard, people really don’t understand how wealth is created in the US.

Higher proposed taxes on high-earning people is a stupid idea.  So is raising the capital gains tax.   All proposals like that do is foment envy and tribal thinking.  Proposals like that seek to divide us, not unite us.

Remember, the government can never invest. It can only spend.  Government cannot get an investment return from the dollars it spends, because it doesn’t save or pay down debt with those dollars it simply respends them.  The multiplier effect of government spending as it relates to gross domestic product is close to zero.  Why?  Because it has to get those dollars from taxpayers, or issue debt which is a tax on future earnings, or simply print them which devalues existing dollars since the supply is now greater.

The other thing to remember is all resources are scarce.  If the government is spending on something, it crowds out the private sector.  Very few things are public goods.  When you look at the budget of NY state and the budget of the state of Florida you know something is amiss.

Keynesians will look at the above differently but like ostriches, they have their heads in the sand.

Most people think that if you make $500,000 in one year, you will continue to make $500k per year or more for the rest of your life.  The truth is that very high-income earners have volatile incomes.  Sometimes they make quite a bit, and sometimes they don’t.  For every story you read about someone making millions of dollars on Wall Street or in some other occupation, the iceberg underneath the story is that there are thousands of people in the exact same industry that didn’t make that and are struggling to get by.

But, let’s look at those dollars.  The government doesn’t create them.  The Federal Reserve doesn’t print them and hand them out.  Those dollars are earned through labor.  Someone somewhere values your effort.  The government doesn’t own your effort, you do. You own those dollars.

Additionally, some people assume more risk, so they earn more dollars.  Some people have higher educational levels, or some special skill they acquired so they earn more dollars.  Commoditized skills can’t command the earning power of specialized skills.  That’s why there is so much demand and it costs so much to develop specialized skills.

It can’t be free.  Everything cannot be free.  If everything is free, then there is no value being built.   Communist countries give you a lot of free stuff.  Few people are wealthy there.

What happens to dollars that you earned?  They are taxed.  Federal taxes and state and local taxes.  Once the dollar is taxed, you get to the net dollar earned.  The headline number isn’t what you actually get.  If you are a high earner, it’s likely that you pay a tax accountant to figure out those taxes for you so after all is said and done, you probably keep somewhere around 60% of what you make.  That’s a generalization for argument’s sake. Obviously, each individual is different and someone who lives in New York is going to keep less than someone who lives in Florida.

Once they are taxed and you spend them, they get taxed again!  Sales taxes, excise taxes, gas taxes, water taxes, electrical and energy taxes, property taxes, and other taxes.  The government finds all kinds of ways to claw money out of you with every action you take in your daily life.

What happens to that dollar now if it gets invested?

One thing that can happen is you can lose it all or a part of it.  Losses can be deducted against your taxable income, but it’s really not a deduction you go looking for.  The other thing that can happen is that you get some sort of gain from the investment.

What happens to those gains?

They get taxed again.

If you invest that dollar in the stock market and it is a dividend-paying stock, not only are you taxed on the appreciation of the stock but you are taxed on the dividends paid out.  In addition, the company you invested in is taxed so you are really paying taxes three times on the same gain.  First when you earn it.  Second when the company pays taxes.  Third when you pay taxes on the gain or dividend.

If you sell out of your investment and re-invest again, the process starts all over.

Every action you take to build wealth and invest is taxed by the government.  Even if you put your money in a 401(k) plan, you get the benefit of not paying taxes on gains while the money sits in the 401(k) but as soon as you take it out you are taxed at ordinary income tax rates which are significantly higher than the capital gains tax rate.

Oh, and if you invest the dollars you pulled out of your 401(k) you get triple taxed once again.

The way the American government has structured the tax code, they have made it more difficult to build wealth.  That’s why the only sure things in life are death and taxes.

There is a surefire way to build wealth in America. It’s not rocket science but it isn’t easy to stick to.

  • It’s at a minimum graduate from high school.
  • Don’t have children out of wedlock.
  • If you want to get married, get married and do all you can to stay married.  Divorce is expensive.
  • Acquire some skill in a trade school or in college.
  • Work.  Do not sit at home and collect a government check.
  • Maybe take a little bit of risk, start a business or invest in something.
  • Live as cheaply as you can given the money you make.
  • Do not get into credit card debt.
  • Invest the excess in your business, your home, or the stock market.

Simple to type out and say, hard to do.  If you save $2000 per year in a retirement account for 40 years, you will have close to half a million when you are ready to retire assuming a 7% return compounded over time.  That means if you start working at age 18, by age 58, you will have close to $500k in the bank plus your Social Security to live on. By the way, $2000 per year is only $166 per month.

If you work for a company that matches in your retirement plan, max out your retirement.  If you work and are a member of a union, max out your contribution to your pension.  Invest it 100% in the stock market.  Over time it might go up and down but it will return 7% per year over the long run.

Smart people have done it that way for generations.  It’s why America has the highest standard of living on earth.  Flout those maxims above and you make it harder on yourself.

For those that say they want to pay more taxes as long as they get European style government services, I would say there is a reason why we left Europe in the first place. By the way, you can always file an IRS form and voluntarily pay more.  You might want to brush up on your Alexis de Tocqueville to understand why.

The post The Life of a Dollar, Taxes and Wealth Creation first appeared on Points and Figures.


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