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My Effective Tax Rate

I just got my W-2 for last year, which, when combined with Turbotax or similar, allows me to calculate my income tax rate.

The direct, visible tax rate I’m paying — including federal and state taxes — is about 33.4%.

By any honest measurement, this is far below what I am actually causing to make its way into the government’s coffers. First, my Social Security tax and Medicare taxes are matched by Facebook — 6.2% and 1.45%. I never see this money in my “income”, but Facebook views it as a cost to employing me, so this is exactly equivalent to me paying all of these taxes as a slightly elevated pay rate.

Then there is the VPDI, “voluntarily paid disability insurance”, which, like most government schemes, isn’t really voluntary at all. I can choose to participate in my company’s plan, or I can pay the state — my choice! I of course chose to not pay the state, but essentially this is also a tax (since I wouldn’t carry disability insurance otherwise), albeit one that I get a service out of (of course, some people would claim this of all my paid taxes).

When these are taken into account, my income is taxed at more like a 38.1% rate.

And then, I buy things. I bought a car and paid sales tax on that. Every time I go to the store, I pay sales tax there. Where I live in Palo Alto, the sales tax rate is 9.25%. That’s right, everything I buy, I give another almost 10% to the government. Taking into account the approximate sales tax I paid, using some rough but not unreasonable estimates I made using data from my records (I used reasonable assumptions, such as all gas, dining, and entertainment was purchased in state; shopping was half online; travel was mostly reimbursed and not counted, etc), my tax rate goes up to 39.6%.

We’re at nearly 40%, and that’s just the stuff that’s easy to figure out. I pay more for my housing because of property taxes. I pay all sorts of government taxes when I travel (occasionally they are enumerated and they often add 40% to the base rate).  I’m sure there’s a lot I’m missing too. How much do all of these things add to my total tax burden? I figure it’s almost impossible to tell. And that’s not unintentional.

I have a friend who recently calculated his income tax rate, and it came to about 1/8th of mine because he and his wife (one of whom is currently collecting unemployment benefits) are paying two mortgages. Viewing the unemployment payments as a reverse tax, their effective tax rate is well below 0%.

So the guy who made all the “right” decisions — studying hard and busting my butt to be worth a decent income; working through school to avoid student loans; not buying a house circa 2006 because I did the numbers and decided I couldn’t afford it; saving on my own for retirement — now pays at least 40% of his income to taxes, while others who bought the house, financed the car, and take the revolving door job — get net reimbursed with that money.

God bless America.

Grey Swans

Scott posted a link to an article (text below). I found it interesting and with some good ideas, but also woefully misguided at some points.

Ten principles for a Black Swan-proof world

By Nassim Nicholas Taleb

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks “and hence the most fragile” become the biggest.

This is easy. Nothing is ever too big to fail. That is a term invented by bankers and politicians to justify taxpayers supporting banks. Taleb is on to something about hidden risks, though.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

Nothing actually ever has to be bailed out, or nationalized, but I suppose nationalization would be preferable to the current trend of just giving bad companies money.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

No arguments here. It is interesting that the government, the media, and probably most people still view the ones who created this mess “financial experts”.

4. Do not let someone making an “incentive” bonus manage a nuclear plant or your financial risks. Odds are he would cut every corner on safety to show profits while claiming to be conservative. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

I think this is sound advice to financial companies. I see no need to legislate this opinion, however. Rather, get rid of the corporate safety net, and companies will shape up or fail and die, and the problem will fix itself.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

Seems to be sound advice again, for me and for you. Again, I don’t see any need to mandate this sound advice in law. But some people see the need to outlaw salt, so probably not everyone agrees with me.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

The world somehow survived 4 billion years without banning complex financial derivatives. I know that many people think regulation solves everything (it doesn’t), but I really think the world will survive this too. Let those who learned from this go on without blowing themselves up. Again, I see no need to open the door to unintended consequences by trying to set up rules (that will be circumnavigated) to prevent a one-time occurrence from happening again.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

Many banks were robust in the face of these rumors. They are the ones not receiving any money from the government (That’s why I “love” the bailout(s)). Most of the economy is still fine and has proven to be robust in the face of tempestuous times.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

I agree. Many people seem to be under the impression that the legal and economic system we currently have — progressively more regulations outlawing progressively more things and creating progressively more perverse incentives — makes sense, and that it only fails occasionally. Well, it doesn’t make sense, and it is always going to fail.

Of course, many people disagree with me about what constitutes a fix. So I say to them, go ahead and try out your ideas, just don’t force me to be a part of your fix. Then we can both be happy.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

This is very bad advice. Citizens should make this choice themselves, depending on how much risk they are willing to take on. I think it is generally good to have people invested in a market economy — it is one of the best financial engines ever developed.

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

I like the voluntary part. Market capitalism itself has never been broken. It is the continuous political patching of perceived flaws in the that has created the many perverse incentives of our current wonderful system, somewhere in the murkiness between fascism and capitalism and socialism and stupidity.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

Humans have used their intelligence to out-compete the rest of the natural world. I don’t see why we should model one of the best wealth production mechanisms we have developed yet — the market-based capitalist economy — on a biological world that will continue to become less relevant as technology progresses. This is just useless sentimentalism.

The writer is a veteran trader, a distinguished professor at New York University’s Polytechnic Institute and the author of The Black Swan: The Impact of the Highly Improbable

The writer calls himself a “veteran trader” — ie, a “financial expert”, and wonders if maybe we should take the part of  advice where he says we shouldn’t take the advice of financial experts. As a fellow beneficiary of a relatively free, relatively stable, capitalist market economy, I would urge you to not make the situation any worse.