The Effects of Taxation and Inflation

cropped-bob-shapiro.jpg   By Bob Shapiro

Jan and John are imaginary friends of mine. They met in High School, fell in love, and decided to get married after graduation, in 1992.

They made a plan which called for sacrifices so that they could be financially independent.

  • They decided they wouldn’t go to college
  • They decided they wouldn’t have children until they were 40
  • They decided to continue their jobs at McDonalds and Burger King, working full time at one and part time at the other – 6000 hours a year between them
  • They would save half their earnings, and make their nest egg grow by 3.5% every year.
  • They expected that, as they gained experience, they would get raises averaging 3.5% every year.

They expected, using these assumptions, that at age 40 in 2014, they would have almost $1,000,000!

Here is their plan:

Initial Plan in 1992

As it turned out, they were able to average raises of 4% a year. Also, on their frequent recreational trips to the library, they became very good at investing. Their returns, even after losses when the dot-com bubble burst and the financial meltdown in 2008, they were able to average a 5% return on their savings. This would have given them a Grand Total when they turned 40, of – get ready – $1,195,374!

Except, they hadn’t included the effects of taxation in their plan. Those taxes – Federal, State, and FICA/Medicare – took a massive bite.

Plan After Taxes

Although they did better that the original plan on wages and return on investment, they lost over 45% (and they lost a third from their original plan), because of taxes.

But, even that isn’t the whole story. They hadn’t thought about inflation. Their $653,462 nest egg earlier this year, after the effects of inflation was only $387,101 in 1992 dollars, using the BLS official CPI figures.

But, the BLS CPI is a lowball number; it greatly understates the erosion of the dollar. If you deflate their life savings, using the methodology which was in place in 1980, then in 1992 dollars, they had just under $100,000!

They had built a fortune compared to 90% of Americans, through sacrificing and through learning how to manage their money. They hadn’t asked for any help from anyone or handouts from the government. They had worked hard, and their reward was that the government, through confiscatory taxation and debasement of the currency, had cheated them out of more than 90% of what they had earned.

Action Item:

  • Cut taxes – this requires cutting spending, because there is no such thing as a tax cut without spending less
  • Stop debasement of the currency – Milton Friedman said that “Inflation is always and everywhere a monetary phenomenon.” So, we need to abolish the FED and return to a Hard Money system, such as a Gold and/or Silver Standard.

3 thoughts on “The Effects of Taxation and Inflation

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