It’s always an interesting test to ask some random people how much they had to pay in taxes.
The more knowledgeable ones will usually say they don’t know.
That’s because the ones with less knowledge will tell you how much they paid or how much they got back… but they are simply reciting the settlement amount from their taxes.
If they say they paid $300, they probably mean they had to write a check by April 15th for that amount. They are not counting the actual amount that was taken out of their paycheck in 2013 on top of that.
Some people will say they got money back, meaning they ended up with a partial refund. But they still could have forked over a lot of money in 2013 through withholding taxes.
Unfortunately, not all people who say “I didn’t pay anything; I am getting money back” are wrong. There really are some people who pay nothing and actually receive money.
Surprisingly, almost half of American tax filers are not actually paying any income taxes. Of course, they pay many other taxes.
Tax Freedom Day
There’s another significant date coming up on April 21st. It’s called Tax Freedom Day, and it marks the day the average person has earned enough to pay the total tax bill for the year.
In other words, if you are a U.S. resident, you have to work from January 1st to April 21st just to pay your taxes… if you are average. This includes all taxes — not just federal income taxes.
I think Tax Freedom Day can actually be a bit misleading. It’s actually far worse news than what is indicated.
Tax Freedom Day measures the total taxes collected by the various levels of government. You add up these amounts and divide by the total income of the country. This is the percentage that’s used to determine Tax Freedom Day.
The problem is that the government is actually spending far more than it collects in taxes, particularly at the federal level. We are in an era of trillion-dollar deficits, and this can’t be ignored.
A more accurate calculation for Tax Freedom Day would be to take total government spending at all levels and divide it by the national income. This would put us well into May.
Overall, government spending is a better measure than total taxation because the government is still obtaining these resources in some fashion, even if it’s through debt or inflation.
Every dollar that’s spent by the government is a dollar that can’t be spent by an individual or business. This misallocates resources and can discourage future production. We’re paying for all government spending, even if some of that spending is financed through debt.
We Live in a Different World Today
When I complain about the income tax to some people, they just kind of shrug their shoulders and say, “There’s nothing we can do about it.” Individually, they may be right.
But I like to point out that the United States has not always had a federal income tax. In fact, for more than half of the history of the country, there hasn’t been one.
The 16th Amendment to the Constitution, which allows for direct taxation on individuals, was not passed until 1913. We have only had a permanent income tax for 100 years now.
A common response to this is that we live in a much different world today than we did 100 or more years ago. And my response is that I couldn’t agree more.
If you go back to 1900, the federal government was a very minimal part of most people’s lives. The footprint of the federal government was a fraction of the size it is now. You didn’t have hundreds of agencies writing thousands of pages of rules and regulations every year, and you didn’t have the government encroaching on virtually every aspect of your life.
The point is, if we want to continue to have a federal government that spends nearly $4 trillion per year, we are going to need an income tax or something like it.
I know some people favor other forms of taxation. For example, some people advocate that we get rid of the income tax and replace it with a national sales tax. The accounting would probably be simpler, but who really knows once the lobbyists and politicians get through with it?
But the big question is, how much would the sales tax be?
If it would raise just as much money as the income tax does now, then I don’t see a big benefit in switching. You are still paying the same taxes — just in a different way.
The main problem I have with the federal income tax isn’t that it’s complicated and takes time to prepare each year, although that is a factor. The big issue is the amount of money we are forced to hand over to the government.
Personally, I would prefer getting rid of the income tax and replacing it with nothing. But with that, I am advocating a massive reduction in government spending.
If you don’t advocate a huge decrease in government spending, then you can’t really favor getting rid of the income tax — unless you want to replace it will a high national sales tax or something similar.
Other Countries
While I’m discussing an elimination of the federal income tax, the U.S. could still benefit greatly by reducing tax rates and correspondingly reducing spending.
While the U.S. had incredible growth during the 19th century — most of which didn’t have an income tax — the rates today are quite high in comparison to some places.
The U.S. actually had a top income tax bracket above 90% during a period after World War II. While we are nowhere near that now, it is still quite oppressive in some circumstances. If you live in a high-tax state, you could be paying an income tax rate of greater than 50%.
Meanwhile, there are some countries in the world that are in far better shape than the U.S. For example, the United Arab Emirates does not have an income tax. For the socialists and redistributionists out there who think we need a high income tax, just take a look at Dubai and the wealth that has been created there.
Hong Kong, another wealthy place, has a top rate of 15%. The top rate in Switzerland is less than 15%. Even in Russia, residents pay a flat tax of 13%.
This is not to say that income tax rates are the only thing that affects a country’s wealth. You have to consider regulations, monetary stability, property rights, and a host of other issues. But there is no question that there is a trend happening where the more free market-oriented places have much lower income tax rates.
International Investing
If you are considering investing in any international markets, you should probably consider the politics of the area. You don’t want to invest in a place that has a low regard for property rights. This would include places with high income taxes and those that do not have a relatively stable monetary system.
While I think Europe is a great place to visit, I would be very hesitant to invest money there. As bad as spending and taxation is in the U.S., it is typically worse in most places in Western Europe.
You want to invest your money wisely, since you have probably already forked over a great deal of it to the government, even if you did get a tax refund. Here’s a great place to start.
Until next time,
Geoffrey Pike for Wealth Daily
