6 out of 8 people reading this are idiots

April 15, 2011

Come on, make his job easier

And hopefully, 8 out of 8 noticed that that headline is mathematically inelegant.

It’s Recycle Friday! And under normal circumstances, it’d also be tax day. Instead, you’ve got an extra 72 hours to mail your check this year.

What’s that? You’re not mailing a check? You’re getting a refund? Oh, you poor impressionable thing. Let us set you straight. Come with us back into the archives: a dimly lit corner with a table for two. You and us. We’ve got absinthe on ice (it was a gift from a sponsor) and Sade crooning on the Bose system. Now spend a little quality time with us as we break out a post from last February. Enjoy.

That means you, who’s looking forward to getting a tax refund on April 15. It might not be the dumbest thing you can do with your money, but it’s in the top 8.

Congratulations, getting that check means you let the government (definitely federal, probably state) enjoy your money all year long, as your employer dutifully paid the IRS every two weeks before you got your share. Of what you earned.

Remember that packet of papers the HR wench gave you when you started your current job? They included IRS Form W-4, which orders your employer to withhold some minimum amount of income tax from your paycheck. The implicit message from the government is you’re too stupid to budget, Citizen.

(You also can’t handle saving for retirement, and we don’t want you making too many decisions about your health care either. But those are issues for future posts.)

Many people, 75% of you according to some estimates, gladly choose to have their employers withhold more than enough to cover their taxes from each paycheck, thinking of this as “forced saving” in a gross misinterpretation of the term. The logic goes that rather than come up short on April 15, you can spend the whole year not thinking twice about your eventual tax bill. Best of all, when all those other suckers are lining up at the post office on Tax Day, not only will you not have to, you’ll be “receiving” money from the IRS. You outsmarted the system!

You didn’t.

You don’t want to get a big check from the IRS on April 15. You want to incorporate as a business, and send the IRS small checks on April 15, July 15, October 15 and January 15.

If you’re not an entrepreneur – i.e., if most of your income is still tabulated on W-2 forms rather than 1099 forms – you still don’t want to get a big check from the IRS on April 15. If anything, you want to cut them as big a check as possible.

“As big as possible” meaning not that you should give them all your money minus your living expenses, but as much of your tax bill as you can save until the last possible moment.

Look at it this way. Lots of merchants give cash discounts. The auto repair shop would rather have your money immediately than wait until the end of the month to receive it from MasterCard (after they subtract their cut, of course.) Continuing in that vein, the longer the merchant has to wait for your money, the more they expect. That’s why most invoices call for increased payments after 30, 60, 90 or 120 days, which is obvious.

The IRS has the second part of that down, being only too happy to assess penalties if you’re late.

So does that mean the IRS reduces your tax bill if you pay early?

(Sorry, broke a blood vessel from laughing too hard.)

If there’s no benefit to paying early, why on earth would you do it? Let the time value of money do its work. The longer you can hold on to it, the better it is for you.

Retailers use the annual ritual of receiving a check as a seasonal mating call. Come to our car lot, and we’ll double your IRS refund on the purchase of a new Camry! Turn your refund into a plasma screen!

A million years of human evolution, and our brains still haven’t developed to the point where they can instinctively appreciate the wisdom of deferring things beyond the obvious benefit.

Get the minimum deducted from each biweekly paycheck. (You don’t have to wait until the anniversary of your hire date. You can do this at work today if you want.) Take the difference between that and what you would have had deducted otherwise, and invest it in your 401(k). When it comes time to pay your taxes you’ll have enough to buy that plasma screen or Costa Rican vacation and then some.

If you’re not convinced by this point, then you have no willpower and will have to wait until we release a book called Let Someone Else Control Your Cash. Even worse, in the last few months we’ve seen just how hollow the phrase “full faith and credit of the (United States) government” goes.

For instance, the state of Hawai’i recently announced it was delaying its tax refunds until July 1. This isn’t to commemorate Canadian independence day, we’re guessing.

UPDATE: It isn’t. Make that August. Late August.

That leaves 49 solvent states. Well, except for Virginia. Oh, and Georgia, which kept its citizens waiting until mid-July and beyond last year. You knew New York would be a part of this too, right? How about Alabama? And North Carolina, you can step right up too. Etc.

States routinely budget in billions of dollars, making it easy to assume they have giant reservoirs of cash. They don’t. Californians pride themselves on having an economy that would be the world’s 8th largest were California a nation, but their state government doesn’t even temper the news when it announces it’ll be paying its creditors with IOUs.

America’s largest corporations by revenue are ExxonMobil, Wal-Mart, Chevron, ConocoPhillips, Ford and General Electric. Imagine what would happen if any of them decided to pay vendors or employees with postdated checks. Somewhere between the customer boycotts and class-action suits, the state attorneys general would be among the first to publicly call these companies out.

But remember, it’s businessmen who are evil.

Hmmm…if the state, or IRS, doesn’t owe you money (that was yours to begin with) in the first place, you’ve denied the taxing authority the chance to defraud you or make you wait.

Chances are pretty good that in the next year, your municipality will float a bond issue for more money for your neighborhood firemen. Or initiate a ¼% sales surtax. You’ll vote yes, probably because of the residual effects of 9/11. A few months later, when the firemen have spent all the money on lasagna and mustache grooming and matching blue shirts for their daily trips to the gym, try not to draw a correlation to your delayed tax return. Which you shouldn’t be getting anyway, if you learn how to Control Your Cash.

**This article is featured in the Carnival of Wealth #35**

**This article is featured in the Yakezie Carnival Easter Sunday Edition**

Filed Under: Consumer Debt, Economics, Taxes Tagged With: , , , , , ,

Read this and watch your taxes fall

January 17, 2011

U.S. Commissioner of Internal Revenue Doug Shulman. Never mind that this is apparently his Bar Mitzvah photo, nor that he opted for the festive ultraviolet at Sears Portrait Studio that day. Get a load of this actual quote: "I use a preparer...I've used one for years. I find it convenient. I find the tax code complex, so I use a preparer.”

Taxes are too high, but not necessarily as high as you think.

This post isn’t going to argue about the merits or weaknesses of our tax system, nor about the obscene amounts of our money that our elected officials spend on our behalf – spending that’s inseparably tied to the taxation and that shows zero signs of abating or even decelerating.

Stop 100 people on the street and ask them the difference between an effective tax rate and a marginal tax rate. 97 of them will stare at you and drool. The remaining 3 will know the answer, but won’t give it to you because they’ll be too busy wondering why you’re stopping random people and asking them finance questions.

The concept of marginality shows up in freshman college economics courses but rarely thereafter, even though it’s critical and often misunderstood. Let’s see if we can explain it without charts. Not that they wouldn’t help, but I can write several paragraphs in the time it takes to create a chart. Besides, dropping one in would create at least the semblance of a dreary academic lecture.

“The highest tax rate in this country is 35%! Why should I bother making money, when 35¢ of every dollar goes to taxes?”

3 reasons, in increasing order of importance:

1. That’s tax on income, i.e. wages and salaries. If you get paid in cash, how much of it you declare is your business. Just don’t get stupid and declare none of it. At least not under your real name. Or at least not under your real Social Security number.

2. There are other ways to earn money, namely capital gains. The IRS calls this “unearned income”, as if you were just walking down the street nonchalantly when a giant cartoon bag of money with a dollar sign on it fell out of the sky and hit you on the head. Capital gains are taxed at their own rate, typically lower than income and in some cases, zero.

3. Alluded to above, the difference between “marginal” and “effective”.

We have these things called “tax brackets” in the United States. Make $34,000 a year*, you’re in one bracket. Make $34,001 and that moves you into a higher bracket, meaning one in which you pay a higher percentage of your income in taxes. Make $373,651, that puts you in the highest bracket of all.

There are 6 brackets. The 3 referred to here are the 15%, 25%, and 35% brackets respectively.

Are we going too fast?

So if I make $34,000, I’ll pay 15% of it in federal income taxes, or $5100. If I make $34,001, I’ll pay 25%, or $8500.25. I make $1 more, but it costs me $3400.25. What a rip.

Alright, apparently we are going too fast.

No. One bracket starts where the previous one stops. If you make $34,001, the IRS treats you like someone in the 15% bracket for the first $34,000 of your income. And treats you like a mid-level tycoon for the remaining dollar, one that they charge you 25% to keep.

This is what a marginal tax rate means. You pay 25% only on the marginal income – i.e., the part of your income that gets you in that particular bracket. There, you just dodged a $3400 bullet.

It’s not even that bad. The 15% bracket also refers to a marginal rate. That bracket starts at $8375, which means that if you make $34,000 (or anything greater), you’re not paying 15% on $34,000 of it. You’re only paying 15% on $25,625 of it. The lowest tax bracket is the 10% bracket, which is for any salary or part of a salary under $8375.

So at $373,651, in the 35% bracket, you’re paying the following:

10% on $8350$       835
15% on the part between $8350 and $34,0003843.75
25% on the part between $34,000 and $82,40012,100
28% on the part between $82,400 and $171,85025,046
33% on the part between $171,850 and $372,65066,629
35% on the remaining dollar.35
Total 108,452.10

Is this a big deal? Sure it is. If you were paying 35% on all your income, your tax bill would be $22,000 higher. This total tax bill above represents an effective tax rate of 29% – your total tax as a ratio of your income.

But even the numbers in this example are unduly liberal, because they don’t account for the tax credits and deductions we’re all entitled to – for everything from making mortgage payments to saving receipts for charitable donations. (That’s not even counting the tax benefits available to someone who registers as a corporation rather than as a regular wage earner, instead of merely drawing a salary and letting her boss enjoy said benefits.)

The Beatles wrote a song about marginal rates, “Taxman”. Opening line:

Let me tell you how it will be/
There’s 1 for you, 19 for me.

That’s right – at the time, the highest marginal tax rate in the UK was 95%.

The government set such an absurdly high rate to make “the rich” pay “their fair share”, two subjective phrases that mean nothing. Apparently, whomever thought up such a rate (and its cousin, the 77% marginal rate the United States imposed in the late ‘60s) thought that there existed taxpayers who were

-smart enough to earn lots of money, yet
-too dumb to devise a way around those taxes.

The imposing authorities forget that taxpayers are ambulatory, and that work is voluntary. Why pay 77% in the US when you can pay a lot less by moving to Switzerland or Antigua? Or if you don’t want to pack up and move, then why even bother working beyond a certain point? What incentive is there to contribute anything extra to the nation’s output when you get to keep almost none of that contribution?

Beyond that, plenty of high-income earners put their money in shelters. You know what tax shelters are in theory, but keep in mind that they exist for non-economic reasons. If you’re making good money, you likely don’t put it in a tax shelter to help that money grow, to invest in a new product, or to employ people. You often do it for completely antithetical, defensive reasons – setting up a third party to funnel money through, channeling it offshore, etc. It doesn’t help the economy grow, it just keeps it out of the hands of the IRS. Which is a laudable goal, but a secondary one.

*Assuming you’re single. If you’re married, or recently widowed, or something called “head of household” (long story, and a topic for another day), the cutoff incomes differ.

Filed Under: Taxes Tagged With: , , , , ,

Is a flat tax feasible?

December 29, 2010
US Taxcode

Not enlarged to show texture

Formally, federal tax law is a particular chapter (Title 26) of the United States Code. The federal tax law contains 11 subtitles, which among them comprise 9,833 sections.

The number of words in the tax code? No one knows. Seriously, no one knows. The lower bound seems to be 16,000 pages, and even that’s not definite. A conservative 250 words per page, and that’s 4 million words. Even counting the number of sections is exhausting. They go from 1 to 9873, and counting, but plenty of numbers are missing.

The IRS estimates that it collected $2,691,538,000,000 in the last fiscal year available, 2007. There are three horrible truths enclosed in that statement, the first one being that $2.7 trillion is way too much money to run a government:

-There’s an electronic record of everything. The IRS should be able to calculate how much it collects to the penny, not merely to the nearest million dollars.
-Ditto for the most recent year available. Why can’t the IRS have accurate figures for 2009, or at least 2008?

That’s about $8,900 per person, not counting the hours that go into calculating the tax we each owe.

Thus our recommendation of the diagonal tax. This is what’s commonly referred to as a “flat” tax, but that name implies that we’d all pay the same rate. No serious flat tax plan really works that way, because it makes it difficult for low-income people to ever catch up and build any wealth. The proposal involves a standard deduction for every taxpayer, ideally enough to cover all cost-of-living expenses. Tax collectors then levy a flat tax on the remainder after the deduction, which means the tax is anything but flat.

The Tax Foundation estimates that we spend a total of $25 billion and 21 hours per taxpayer preparing or getting other people to prepare our taxes. 174 million returns a year, that’s almost 3.7 billion hours. Estimate an average wage of $16/hour, that’s another $58 billion in opportunity cost.

There’s more. The IRS has 101,000 employees. Assuming they each work 1800 hours a year, that’s 181,800,000 hours. A diagonal tax form would be the size of the fabled postcard, and wouldn’t require any creature more advanced than a trained chimp to process it. Let’s assume that a diagonal tax could reduce the ranks of the IRS teatsuckers by 90%, and that the average IRS employee makes $20/hour. That’s another $3,272,400,000 we could save. The very act of collecting taxes costs our economy $86 billion a year before one dollar goes to anything other than the IRS’ own continued existence. Granted, that’s only 3% of the IRS’ returns, but it’s a start.

So…how to confiscate that $2.7 trillion by fairer means?

The Census Bureau estimates that 47.37% of all Americans make under $25,000 a year. That’s the set of all Americans, not the subset of tax filers, so we have to account for that. Does $25,000 sound like a reasonable amount to keep exempt from taxes? Let’s make that the standard deduction then and, using the Census Bureau’s remaining numbers, figure out how much income remains taxable.

Can you trust us that we did the math accurately? You can repeat the results yourself. We used this page and calculated how much income remains in each bracket after deducting $25,000 per person. We assumed that the numbers were evenly distributed in each bracket. For instance, the chart says that 9,192,000 Americans made between $25,000 and $27,500 last year. We thus assumed that the average person among those 9,192,000 made $26,250. This might be reasonable and might not, but there’s little room for fluctuation in the numbers. We then repeated the process for every bracket up to $95,000– $100,000.

The taxable income of all Americans making under $100,000 would thus total about $2,251,340,000,000.

Subtracting that from the nation’s gross domestic product, and dividing by the number of people making over $100,000, our conclusion?

If our elected representatives authorized a straight 28% tax, given the $25,000 exemption, the IRS’ tax collectors would take in as much as they do today.

How would that affect you? It’s easy to figure out. If you make $30,000, your tax bill would be $1,400 – an effective tax rate of an eminently livable 4.7%. If you make $90,000, you’d pay $18,200, or barely 20%.

HOWEVER:

You wouldn’t waste your time looking for artificial ways to reduce your tax bill, counterintuitive activities such as tallying up your gambling losses. You wouldn’t have to save a single receipt. Doing your taxes would take 8 seconds. Not only would everything run more simply and efficiently, but more to the point, you’d have incentive to continue working and helping the economy grow.

Right now, the highest marginal tax rate in the United States is 35%. Reduce it to 28%, and it’d be at its lowest level since 1931.

The downside? Politicians wouldn’t be able to curry favor with certain people. Lobbying for a particular industry (which means, by definition, doing so at others’ expense) wouldn’t make any sense. You wouldn’t get punished for not having kids, or rewarded for borrowing money to buy a house – but if you tell the average person that he’s gaining a tax advantage, even if he’s losing a concomitant smaller one, all he’ll think about is the latter. Heck, the authors have a standing bet that at least one commenter will mention that it’s unfair to tax poor and rich people at the same rate, conveniently ignoring the part about the standard deduction. God bless our uneducated country.

**This post is featured in the Tax Carnival #78**

Filed Under: Economy, Math, Personal Finance, Taxes Tagged With: , , ,
« Previous Page
Next Page »