This post is not going to get into values assessments of what governments SHOULD incentivize with tax code, whether people SHOULD be taxed at all, or what government SHOULD do with tax receipts.
This is a post about how to work with what IS in a way that keeps more of your money in your pockets.
Necessarily I'm going to talk primarily about the US tax code, since I know it best. But understand that this basic idea has spread around the world over the last 70 years. The only thing that really varies from country to country is what behavior the government is trying to get citizens to engage in.
The Genesis of Taxation
Originally the idea with taxes in the US was to tax the excess wealth of the very wealthy. It was considered that they gained the most from a military to protect their global shipments of raw materials used to manufacture their products and a national system of highways allowing those products to reach their customers. So they should pay a percentage of their profits above a certain cut off point to fund all of that.
This cutoff point was very high. It basically was so high that all of the rich person's living expenses were likely paid before taxes kicked in at all. But once they kicked in they were high, like 80% of the amount above that cutoff point. The country flourished during this period, with bridges, roads, airports, hospitals, libraries, concert halls and much more being created to benefit the entire populace.
The Corruption of Taxation
Well I guess that is a bit of a value judgment to call it that. But I do think this basic idea that was good went awry when funding WWII caused the government to start looking to the working class for financial support.
Taxes were extended to include people making much less money, but they were taxed at a rate much lower than 80%, and they also were only taxed on amounts that the government considered above what it costs to meet basic living expenses. There was a standard deduction that was actually more than most people were making. So very few people who weren't rich were paying taxes, though suddenly some were.
Then at some point the government discovered that they could control people's behavior in ways laws could not by using tax breaks.
For example, the government likes people to have more children. That's for a variety of reasons, including that people busy raising young children and with many mouths to feed are less likely to shake things up. They have too much to lose and prefer stability. Well governments prefer stability too, so yay big families!
So they increased taxes to where the amount started cutting into basic living expenses for the working class, but then gave more and more of the money back in the form of deductions for every child you had.
They also wanted people to own homes for similar reasons. More to lose. More tied to a given location. Since not enough people could afford to buy homes with cash, the government wanted to support the mortgage industry, so they introduced tax law that allowed you to deduct all interest paid on the purchase of a primary residence.
I could go on and on like this. Basically the government couldn't make it illegal not to have children or to rent housing for life, but they could raise taxes to penalty levels then only give you a reprieve if you did what they wanted you to do. Get married, have kids, buy a house, work a lifetime to pay for those things, and otherwise keep quiet and just vote for one of the people they offer who will maintain that system.
How This Gets Less Sucky
Depending on your values, this is either a really raw deal or a very smart way for government to foster behaviors that are good for the country without making non-compliance actually illegal. It creates a degree of freedom, in that I have been able to opt to simply pay more taxes rather than getting married or having children. That wasn't the conscious calculation, but in the end that's how it's worked out. I had a choice.
There's a lot going on to try to use actual laws to restrict such choices, such as making birth control and abortion harder to get. Even reproductive information being taught in schools is starting to be stamped out. This is the government trying to force people to have more children when they would not if truly free. But for the most part the government in the US tries to simply entice with tax breaks.
While you wouldn't necessarily do whatever the government wants just to save on taxes, you may find that there are some things you are willing to do differently that can save you a lot.
I've saved about $100,000 in the last 5 years just by doing things a slightly different way to save on taxes. How did I know to make these decisions? I had good tax accountants advising me, telling me things I didn't even know to ask about.
Some Random Stuff
Did you know that you can save considerably on taxes in the following ways:
- Selling a house at a profit? You can keep twice as much tax-free if you're married than if you're single.
- Have a house? Add solar for significant rebates on the equipment, plus continue saving by simply having a lower utility bill thereafter
- Have a company? File your federal taxes as an S corp and pay yourself part of your income as bonuses instead of salary to pay less in taxes
This is just a sampling of some of the things the government effectively pays you to do. If you want to know more, make sure you hire a tax accountant who knows what to tell you. The tax code is tens of thousands of pages long, so you don't want them to tell you everything, and you shouldn't bother trying to learn all this yourself. You just need to hire someone who gets that his/her job is to guide you toward behaviors that reduce your taxes, not just take the numerical information you give them and add it up on the forms correctly.
I paid about $3,000 over the last 5 years to get this sort of guidance. I consider that 3% fee on savings to have been well spent.
Have you had such tax guidance? If so, what's your #1 tip for reducing taxes within the limits of current tax law?
(Photo source: Pixabay)