Inflation and Rising TaxesPrint This Page
Finding tax efficiency is a crucial aspect to reaching a critical mass of investment capital that can give you real financial freedom for life. Without understanding the impact of taxes, true financial freedom is a pipe dream. Remember, you can only spend your after-tax income. Unfortunately, most people when defining their needs for the future are failing to effectively anticipate what taxes will likely be. With $16 trillion in U.S. Government debt and what some now estimate as nearly $100 trillion dollars in unfunded liabilities (Medicare, Social Security, etc.) do you think taxes will be higher or lower in the future? This one is not hard to guess! To understand why being conscious of tax efficient investment opportunities is so crucial, review this simple example below.
A dollar that doubles every year for 20 years grows to $1,048,576. What do you think the number will be if you take the same scenario and assume that gains are taxed each year at 33%? The ending balance is only $28,466!!!!Click to zoom.
Author and economist Milton Freedman once said “Inflation is the one form of taxation that can be imposed without legislation.”
How do we simply define inflation? A “silent tax”. The loss of the purchasing power of your dollar or more simply put the amount of goods your dollars can purchase at any given time. And finally, as former major leaguer Sam Ewing says, “Inflation is when you pay $15 dollars for a $10 dollar haircut you used to get for $5 dollars when you had hair.”
What does this mean to you and I? It means our savings are effectively shrinking along with our paycheck.
The United States is in a precarious position to say the least. With $16 trillion in national debt and an estimated $100 trillion in unfunded liabilities (Medicare, Prescription Drugs and Social Security), it is mathematically impossible for our government to be able to pay these bills without cranking up the printing press and simultaneously make drastic spending cuts.
The word “trillions” gets tossed around quite flippantly so let’s break it down to a more digestible example:
If the U.S. government were a person, he would...
- Have an annual income of $21,700
- Have an annual spend of $38,200
- Have credit card debt of $160,000
- Have a future impending expense of $1,000,000
BUT in recognition of the problem, he has made total budget cuts thus far of $385
Inflation, or the possibility of more rapid inflation, is nothing new. In fact, inflation has been an issue since we removed the gold standard. In 1861, the U.S. government suspended payment in gold and silver, effectively ending the attempts to form a standard basis for the dollar. $1000 in 1861 is worth $26,300 in today’s dollar when using the CPI index. Keep in mind, the CPI doesn’t take into account energy costs and is a flawed calculation by many accounts. Nonetheless, it does represent a mixed "basket" of goods and services and tracks the rate of aggregate price changes annually.
So the big question is, what assets have done well during times of inflation? Well, most stock brokers will tell you that stocks have outpaced inflation. Yes, over the very long haul and during certain periods of time they certainly have. However that is not the case over the past 13 years during which we saw two 40% market drops. If you had wanted to retire in 2009, I would imagine that 2008 changed your plans.
Click to zoom.
In 2009, during the wake of the 2008 crash, the Wall Street Journal published an article titled “Adjusted For Inflation, Dow Gains Are Puny.” The author (E.S. Browning) was making the basic but important point that you must calculate “inflation adjusted returns.” He points out that “using today's dollars and starting at 10,520, the Dow would have to surpass 13,460 to get back to its 1999 level in real, inflation-adjusted terms.” At the time of this writing, the DJIA stands at 13,435.
Said another way, when taking into account inflation, the market has basically been flat since 1999.
The chart below shows nearly 100 years of the history of the DJIA in both nominal and real, inflation-adjusted numbers. Quite staggering.