Taxation is a topic that’s guaranteed to tip most people over the edge of rational thought.
Let’s see if I can help you make better decisions by slowing down your thinking.
The first thing you need to do is add up all the taxes that you’ve paid in the last year. Your total might include:
- Federal, state and city income tax
- Payroll taxes, worker’s compensation premiums and unemployment insurance contributions
- State, county and city sales and use taxes
- Real estate taxes and rates
- Transfer taxes and stamp duties
- Value-added tax (for my non-American friends)
The first step is painful. It’s a big number for almost everyone.
In fact, this step alone creates a level of pain that drives many smart people to over-react. Wind farm investments, geographic relocation and massive personal overheads are often reactions to a sense of injustice with regard to tax policy.
When I moved to Colorado, I was surprised to discover that it’s a low-cost place to live. In fact, it’s a far, far cheaper to live here than London, Hong Kong or Bermuda – all locations where I’ve paid significant taxes.
Taxes are best considered in light of our total cost of living. The cost of which includes education, housing and healthcare.
At the end of 2000, I left the low-tax environment of Hong Kong and ended up in New Zealand. In New Zealand, my marginal tax rate increased significantly but my core cost of living dropped by 95%.
Years later, working in Bermuda, I spent a small fortune on travel and living expenses to keep my average tax rate down. Eventually, I did the calculation that I’m sharing in this article and had an “a-ha” moment.
Today, in Boulder, my total tax bill (all of the bullets above) is roughly equal to the cost of a single private education in London, Hong Kong or Bermuda. With three kids, the life of an expatriate would be expensive. In fact, I’d have to work so much, I’d rarely see my family.
While an American city with a good school district is a low-cost location – even better was New Zealand. Moving to NZ, I lived with roommates, was covered by single-payer health care and worked for European / North American clients. I read about young people doing similar arbitrage with a bases in Asia, South America or small North American towns.
If you’re motivated then you can find opportunities to optimize your cost of living. Rather than worrying about your marginal tax rate, focus on the best location for your current life situation.
As for the psychological impact of a tax increase, I often let my emotions get the better of me.
To understand your true exposure to tax rates, take your total tax bill and divide it by your net worth. That percentage is the true “take” of taxes from your family.
For example, consider a young woman earning $70,000 per annum. Her total taxes are $17,500 and her net worth is $40,000. With an average tax rate of 25% (17,500/70,000), she’s paying 44% of net worth in taxes each year (17,500/40,000). She has a significant exposure to tax increases.
Compare the above to an older woman who’s been saving for many years. Her gross income is $165,000, her total tax payments are $50,000 and her net worth is $3.5 million. Despite having a far larger tax bill, her taxes represent 1.4% of her net worth. Her exposure to rising tax rates has been limited by decades of living below her means.
Smart savers free their families from exposure to tax policy.
- Taxes are a component of living in a civilized society
- Analyze your cost of living in the largest possible context
- Healthcare, childcare, education, housing and real estate expenses must be incorporated in any discussion of taxation
- To understand your true exposure, consider taxes (and all other spending) relative to your family net asset statement