Tax Deductible

May 07, 2010 By: erik Category: Complaining, Politics 158 views

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The more I research retirement savings plans, college savings plans, and think about my investment portfolio, the more I come across the phrase “tax deductible” or “tax free”. My 401K contributions come out of my untaxed gross salary. The interest gains of my IRA are not taxed. Up to $2500 of my contributions to my daughters college fund are tax deductible. In the US, up to $3000 of stock market losses are tax deductible. Think about what that means. You can lose up to $3000, and the government covers your losses, making your final total the equivalent of someone who did not play the market at all. It’s almost like every American being given $3000 of poker chips to be played on the stock market every year. The term “tax deductible” is like “free money from the government…if you know how to use it”.

As is often the case, a casual comment by my wife has started me thinking and realizing that she’s made a very insightful observation. The whole system is oriented to let the rich avoid paying taxes. Poor people don’t have an extra $3000 they can play with on the stock market. Poor people don’t have an extra $208/month to put towards each kid’s college fund. And the poor certainly can’t pay a tax specialist to find all the loopholes.

I understand that making certain expenses tax deductible is a way for the government to encourage investing in the stock market, giving to charity, and saving for retirement, all of which are undeniably good things for those that can afford to do so to be doing. But reducing tax, thereby reducing the government budget, seems like a bad way to go about encouraging those behaviors.

The whole US tax system is really pretty FUBAR. Although I freely admit that I don’t know how to fix it, so I’ll shut up.

  • michael

    i’m not arguing with your basic premise of the US tax system being broken, but there are two major flaws with your post.

    first, a deduction is not a credit. you aren’t getting $3,000 in risk free investment capital. you are getting your tax rate of that free after you pony up the other $2,000+ in losses first. this is meant to stimulate investment.

    second, these are deductions to reduce the already progressively figured tax burden on the well off. your example poor people are likely paying nothing at all in taxes while receiving substantial benefits from the government. certain activities are beneficial to the general population and the government incentivizes you to take advantage of them by reducing your tax burden.

  • In other news, I realized the other day that while my pants sometimes fall down when I don’t wear a belt, they never fall up.

  • Jake

    Ah, taxes…this post should make for some good comments over the next few days. First off, Michael is right — A tax deduction is very different than a tax credit. But, I like the way you’re playing this..maybe the IRS won’t notice when you file your tax return.

    Also, I hate to break it to you, but the “rich” pay a vast majority of the income taxes collected in the U.S. Of course, you can argue all day long about who qualifies as “rich” in IRS speak, but it is what it is.

    In the end, part of what makes the U.S. such a great place is that any American has the ability to dream big and go out and start his or her own company. Hopefully, over time they will even be able to hire workers, and maybe, just maybe their company will be one of the lucky few that enjoys modest success and makes some money. Better yet, maybe their company will even be so successful that one day it can become publicly listed on a stock exchange and have complete strangers invest their own money in the (hopeful) future profitability of the business. Unfortunately, most new small businesses fail, but this entrepreneurship and way of thinking is critical, absolutely critical, and is something that should be incentivized.

    And incentives is really where the debate lies. In your post you say, “The whole system is oriented to let the rich avoid paying taxes.” I won’t argue that the really wealthy probably don’t fret over paying their taxes, but how do you define rich? The IRS would say that a husband and wife living in the suburbs of New York City making a combined $200,000 is “rich”. It wouldn’t be a stretch to say a very modest 4 bedroom house in that part of the country could cost a half million dollars; in fact that’s probably conservative. Now’s, let’s assume that same husband and wife are in their mid-40’s and have a couple of kids who are getting ready for college. Is this family really “rich”. I have a feeling that would feel rather strongly that they are not. Is it fair to them that their tax rate will likely increase to subsidize the massive deficit this country faces while somebody on welfare will actually get more from the government if they have another child? Seems kind of backwards if you ask me. People must be given incentive to be more successful, not less.

    You also state, “But reducing tax, thereby reducing the government budget, seems like a bad way to go about encouraging those behaviors.” Maybe it’s just me, but reducing the government budget would be a very welcome change from the past 10 years in this country. Increasing taxes on the public doesn’t help the government and it certainly doesn’t help the average American. The government needs to be incentivized to be more efficient with what they already have. It’s just like the average person who has trouble paying off their credit card balance. Do you really think the long-term sustainable solution is to give them money to pay off the debt, or better yet increase the available credit limit on the card they already can’t pay? When you increase taxes, you take more money out of the hands of the very people that would otherwise spend it in the economy and help create jobs. Maybe they’ll go out to dinner, or maybe they will want to spend time with their kids and take them on a vacation. If we’re really lucky, maybe they will spend some of it on a charity they are passionate about. And maybe that charity will contribute to research that one day helps find a cure for cancer. I could go on and on, but you see the point. Whichever they do with their money, businesses become more successful. When those businesses are more successful, they likely will hire more workers, and thus the cycle is far more sustainable.

    I’d write more but I need to get some other stuff done…cheers.

    • Excellent comment, Jake. I recognize the Fiscal Conservative Libertarian “[this is] what makes the U.S. such a great place” talking point. It’s the American dream and what the 19th and 20th century immigrants all talked about on the boat to Ellis Island. What I have never heard anyone explain is just how horribly oppressed entrepreneurs are in other first world countries that really sets the US apart.

      It seems to me at a very shallow first glance, that the US is currently dominated by enormous corporations, and that starting a business, at least in retail (e.g. clothing, food, hardware, computers) in a small town today would be really difficult given all the franchised competition. While looking at European countries, while they are going the way of the big franchised shops, it seems like it would be easier to open a business on a European Main St. But I could be completely wrong about that.

      • Hilltop

        I’d say what (used) to set the US apart in terms of starting/running businesses was far less red tape and less corruption. I’d be interested to see if this was really true as I’ve never opened a business in any country. The talking points are of course that in some European countries there are far more licenses you need to acquire and more regulations that you need to follow. You can get it done, it just takes more time and money. In other countries, there may be less hoops to jump through, but you’re going to need to “play ball” with certain people .

        In any case, I’d say that excludes the corporatism (every post must have an -ism!) that exists in the US today where large corporations are people when they need more rights but are not people when they want less consequences.

        Plenty of free European countries, US isn’t number one. France and Italy are quite low however.

        • Hooray for hard data! Thank you, Hilltop. Very interesting.