A Good Illustration of how Candidate's Tax Plan will impact you

I never am good at illustrating tax impact on an individual. It’s even harder as a Singaporean since alot of our taxes are zero percent or low enough not to account at all.

That’s why i find economist Greg Mankiw’s illustration using himself as a tax payer interesting to highlight here. Notice the reduction in the propensity to save when taxes takes a chunk of future spending off:

Here is a neat summary from the Wall Street Journal:

Let me try to put each tax plan into a single number. Let’s suppose Greg Mankiw takes on an incremental job today and earns a dollar. How much will he leave his kids in T years?

The answer depends on four tax rates. First, I pay the combined income and payroll tax on the dollar earned. Second, I pay the corporate tax rate while the money is invested in a firm. Third, I pay the dividend and capital gains rate as I receive that return. And fourth, I pay the estate tax when I leave what has accumulated to my kids.

Let t1 be the combined income and payroll tax rate, t2 be the corporate tax rate, t3 be the dividend and capital gains tax rate, and t4 be the estate tax rate. And let r be the before-tax rate of return on corporate capital. Then one dollar I earn today will yield my kids:

(1-t1){[1+r(1-t2)(1-t3)]^T}(1-t4).

For my illustrative calculations, let me take r to be 10 percent and my remaining life expectancy T to be 35 years.

If there were no taxes, so t1=t2=t3=t4=0, then $1 earned today would yield my kids $28. That is simply the miracle of compounding.

Under the McCain plan, t1=.35, t2=.25, t3=.15, and t4=.15. In this case, a dollar earned today yields my kids $4.81. That is, even under the low-tax McCain plan, my incentive to work is cut by 83 percent compared to the situation without taxes.

Under the Obama plan, t1=.43, t2=.35, t3=.2, and t4=.45. In this case, a dollar earned today yields my kids $1.85. That is, Obama’s proposed tax hikes reduce my incentive to work by 62 percent compared to the McCain plan and by 93 percent compared to the no-tax scenario. In a sense, putting the various pieces of the tax system together, I would be facing a marginal tax rate of 93 percent.

The bottom line: If you are one of these people out there trying to induce me to do some work for you, there is a good chance I will turn you down. And the likelihood will go up after President Obama puts his tax plan in place. I expect to be spending more time playing with my kids. They will be poorer when they grow up, but perhaps they will have a few more happy memories.

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Kyith

Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

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Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.

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