Why The Government Doesn’t Want you to Retire Early

Government Doesn't Want You to Retire Early

Hello folks! Thanks for stopping by The Green Swan. Last week I wrote about Taxes and Fiscal Incidence which is a natural lead-in to today’s post on why the government doesn’t want you to retire early. If you haven’t read it yet, I’d suggest you do so prior to reading today’s post as it will help set the groundwork for today’s analysis.

Today I am giving you a very simple rationale as to why the government doesn’t want you to retire early…taxes. Yes, no surprise, they want you to keep working and keep paying taxes. I’m not here to present some crazy conspiracy that the government wants to perpetuate the consumerism and materialistic lifestyle that Americans live in order to drive high spending habits which thereby requires us to work until we no longer can, but if you want to infer that then feel free… 🙂

The Tax Base

To completely avoid the conspiracy theory rhetoric (oh there I go again…), I will stick to the facts today. The government simply wants you to be part of its tax base. For 2016, total government spending (federal, state and local) is estimated to be $6.7 trillion. In my previous post on Taxes and Fiscal Incidence I went into how the government spends this money and how it benefits us as citizens.

Now let’s look at the tax base. For 2016, total government revenue is estimated to be approximately $6.5 trillion. This is derived from approximately $2.3 trillion from income tax, $1.9 trillion from FICA tax (social security and medicare tax), $1.3 trillion from ad-valorem taxes (i.e. sales and property tax), $0.5 trillion in fees and charges, and $0.5 trillion from business tax and other.

Government Doesn't Want you to Retire Early

In sum, approximately 63% of the government’s revenue base is derived directly from individual income and FICA tax. For me personally, as a W2 employee with little other taxable income sources (most of my investment income is in tax efficient accounts such as 401Ks and IRAs), most of the tax I pay is income tax. While sales tax is hard to estimate, my simple guess is that I pay less than $1,000 in annual sales tax. My property tax is just $3,000 per year. Therefore, over 90% of the tax I pay every year is related to my employment which will go away once I retire, and that doesn’t even include the portion of various employment taxes levied on my employer on my behalf (all employers pay an equal amount of FICA taxes that we are levied individually on our pay stub).

Our Lifetime of Fiscal Incidence

As outlined in my prior post on Taxes and Fiscal Incidence, right now my wife and I are “net contributors” to our society. However, for the first 26 years of our lives, my wife and I were “net takers”. And we have benefited substantially at the hands of the government those 26 years, to the tune of over $900K per my rough estimates. Therefore, our debt to society is quite large, although we have made a dent in it the last 5 years as being net contributors.

While we plan to retire early, my wife and I have not set a retirement date and have no immediate plans to retire. But we do expect to reach financial independence (FI) within the next five years, and may ultimately decide to retire within ten years. For the sake of estimating our lifetime of fiscal incidence, let’s assume we retire at age 38 (about seven years from now).

For the next seven years we will continue to be net contributors in a big way, but even so we will still not have fully repaid the debt to society from our first 26 years as being net takers. Hard to put a number on how much we will have chipped away at it, but it is probably safe to assume a range of $200K to $500K in the hole on a combined basis.

Although, let’s not forget, we will only be 38 at that point. The only material tax we will be paying going forward will be property and sales tax which in all likelihood will be less than $5K in today’s dollars. Granted, we will have some investments in traditional retirement accounts which will be subject to income tax at the time of withdrawal (although a good portion of our investments are in Roth style retirement accounts which have already been taxed).

Now let’s factor in our fiscal incidence over the remainder of our life. Say we are blessed to live to be 80 years old. That would amount to 42 years of being a net taker in retirement. If we conservatively assume we are a net taker to the tune of $15K per year (conservative as it assumes no benefit from Social Security or Medicare…who knows what means-based testing will be around then if the programs even exist), that would amount to a total of $630K in value received from the government over the remainder of our lives!

Adding this amount on top of the remaining amount of value received from my wife and my first 26 years and we could be talking about over a million dollars of net value received from the government over our combined lifetimes.

A Vast Early Retirement Movement

As unlikely as it is, let’s now picture a mass movement of Mr. Money Mustache disciples now ready to jump on the bandwagon and retire early just like my wife and I. Societies can’t survive if there are more people benefiting as “net takers” than there are as “net contributors”. As I mentioned above, 63% of the tax base alone is supported solely by W2 related employment taxes. In a vast early retirement movement, much of this tax base would go away and the government would be forced to undertake major tax reform. I’m talking about the implementation of some kind of consumption tax.

What is consumption tax? Consumption tax is a tax on money spent on goods and services (think sales tax, but on everything including groceries, etc.). And if there is a movement where many folks retire early, the consumption tax would need to be implemented and set very high to offset the lost income tax and cover current government spending levels.

A quick internet search for consumption tax and you can find numerous articles on the pros and cons. For example, this Q&A with tax experts by the Brookings Institute. One of the major cons pointed out here is if consumption tax replaces income tax then it would result in a huge tax increase on old people. Old folks (and early retirees…) who already paid tax on income as it was earned and then would also be significantly taxed in their “consumption” stage would take a big hit.

Other folks that would be hit hard…low and middle income households. Since they generally spend as much as they earn, consumption taxes would be high and more disadvantageous than an income tax. Read differently, under the current tax system, these households are paying less tax than the value of benefit they receive from the government. Under a consumption tax, they’d be forced to pay for equal value.

And if you were curious what level of sales tax would be required to replace income tax, the article estimates it at approximately 60%. Boy, that would take some time to adjust to, huh!? And there are a number of other transition issues outlined as well in the article that I won’t get into here.

Bottom line, the transition to an all-out consumption tax is probably just as unlikely as a vast early retirement movement! So early retirees can breathe a sigh of relief…unless FIRE really catches on :)!

Tax Season

So with that said, let’s do our taxes! Hopefully this post has helped get you jazzed up a little more for tax season! Your W2’s from your employer should be ready soon, if they aren’t already, and with that it’s time to get a jump on it. Get started early to maximize your 2016 taxes with TaxAct! Note, that this is an affiliate link. By clicking my link and utilizing TaxAct, I may get a small fee which helps support the operating costs of The Green Swan.

I personally utilize TaxAct’s services myself. It’s easy and much cheaper than hiring someone to do it for you. TaxAct can help simplify the process for you, ensuring you get all the credits and deductions applicable. Taxes aren’t as complicated as they’re cracked up to be! You can do it and here’s to hoping you get a refund!

Thoughts?

Is my analysis sound (or good enough for government work)? Let me know if you think I’m missing anything.

Thanks for taking a look!

The Green Swan

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46 Comments

  1. I’m intrigued by the concept of a consumption tax. It’s very eye-opening about the tax burden that the most wealthy take on to support those of us that aren’t bringing in millions of dollars each year and therefore pay significantly less tax.
    I definitely want to run these calculations for myself to see where my net burden or benefit to society currently stands based on how much I’ve paid in taxes. A lot to think about!

    1. It’s definitely a different way of thinking of your tax burden and a lot can be gained by having the added perception.

      Thanks for stopping by!

  2. Great analysis! That consumption tax idea is scary stuff! Unfortunately, I don’t think we have to worry about the FIRE movement taking off. I accidentally brought it up at work last week and was met with opposition and stares as if I had two heads. And these are smart people earning high salaries and NOT spending all their money on new cars or flashy clothes. Even these people were extremely resistant. Ugh. I feel fortunate to have found this cult. 😉

    Mad Money Monster

    1. Ha that’s funny. I guess it’s just such a foreign idea. It’s been drilled into us that we MUST work until our mid 60s before we can “afford” to retire.

      Thanks for the comment!

  3. First off, I must say that I love how when you highlight a word on your new website it turns green. I’m guessing you did that on purpose? Great little detail to add!

    I really think you nailed it on the head with the last two articles. I agree that if the masses suddenly joined the FIRE movement, there would be major tax reform. Maybe a consumption tax, or some crazy hybrid regressive tax. If all of a sudden everyone under 35 only worked to age 45, they would have to find an extra 20 plus years of income tax/FICA per person. Yikes! The total deficit of just income and FICA tax over the next 30 years would drastically exceed the current almost $20 trillion debt. Maybe we should keep a little more quiet about the FIRE movement so we don’t jeopardize the future of the republic? haha

    You take a very Buffett-esk view on society. He often speaks about how he has a set of skills and those skills allowed him to benefit tremendously from society, and that it is job to give back to society for helping benefit him. I take the same view as well.

    1. Ha it’s all about that green! I’m glad you like that little detail! 🙂

      I’m glad you enjoyed these articles so much! I agree, we should keep the FIRE movement on the hush, someone should tell Mr Money Mustache!

      Yeah I do agree with the Buffett view on society. I think it’s easy to take for granted the benefits we have in a developed society. The education we have throughout our youth is the prime example.

      Thanks for the great comment, Stock Street.

  4. Love the points you bring up in this article. While the government likely has very little thoughts towards this as consumer consumption continues to rise it is very interesting to think about. While consumption tax is one method they may even start taking away tax advantaged accounts and such to get a little extra money in their pocket. Would be interesting to see if this ever happens but I know it won’t be during my lifetime!

    1. That would be another interesting approach, good thought Stefan. A lot of folks would certainly be in an uproar over it, but if the tax base is at peril than I imagine anything would be on the table.

      Thanks for the comment!

  5. I’d say there’s another reason the government doesn’t want fire to catch on or a consumption tax. The power of a country is define by it’s gross domestic product or how much it produces. If you only consume your not increasing the wealth of the overall country. Meanwhile a consumption tax theoretically reduces demand for goods. Less demanding means less production. Again tax revenues hurt but so does the majority of the country. Some one has to produce what you buy after all. If it was wide enough mass early retirement would cause inflation and recession for those still working. Ie your exceptionalness is what makes it possible.

    1. Yeah I hear you. There would be a much more wide-spread impact from a mass movement. We’d likely need more immigration to our country to boost the economy and offset retirees and we’d likely run much more of a foreign trade deficit than we do today.

      Thanks for the thoughtful comment, FTF!

  6. So….my conclusion. I want to FIRE as soon as possible, but keep all of you folks working til you die. DON’T force the gov’t into hitting me with a consumption tax!!

    (BTW, I suspect that will be coming, regardless, as the gov’t will be forced to plug the leaks in the dike from unfunded liabilities). It’ll start small, but don’t fall for it. Once in place, it’ll become the lever by which they balance the $$. Pity those poor folks that retire early. Oh wait a minute, that’ll be all of us in the comment section!

  7. I’m skeptical of conspiracy theories, but I wholeheartedly believe that consumerism does benefit the government. It means more taxes, after all. 🙂

    I always wonder what would happen if the majority of folks retired early. I guess fortunately for us, consumerism is alive and well, and I’m not sure if early retirement will be a popular trend for quite some time. But it’s worth noting that a massive shift to early retirement would fundamentally change our taxes (and how the economy functions in general). A high consumption tax would severely penalize the poor, so I hope it wouldn’t come to that.

    1. I guess we can thank others for their consumerism habits for supporting our early retirement, huh?!

      Thanks for the comment, Mrs Picky Pincher!

  8. consumption tax? as in 21% tax in Belgium on most goods you buy?!?
    despite that, we are as a country facing a hugh problem as soon as the people from the sixties start to retire (in like 5-10 years…)

  9. 60%!? Wow! That’s crazy stuff! But, I doubt there will be a massive FIRE revolution. I’m so entrenched in the community, I sometimes forget that most people don’t even see it as a viable option, let alone something to strive for.

    1. I agree with you Amanda. Nobody seems to have FIRE anywhere close to being on their radar. I think we’ll be fine.

      Thanks for the comment!

  10. I actually like the idea of a consumption tax – assuming that the income tax was being replaced. I remember Hermain Cain running for president and proposing a similar plan. It might not be a perfect solution, but it’s still very intriguing.

    In the meantime, I guess my wife and I will just keep on working and paying taxes until we reach FI in a handful of years… [sigh].

    — Jim

    1. I remember Cain running on that as well and it is intriguing and somewhat logical. I think the degree of change to the tax code would be insurmountable for a consumption tax to be implemented, however. And I definitely don’t want it since I’ll be on my way to retirement in a handful of years!

      Thanks for the comment, Jim!

  11. Nice article! I can’t blame the government for enticing us to work as long as possible. Labor income is easy to track and tax. The government also subsidizes education (=human capital) and wants an ROI on that.
    The good news is that there will never be a widespread early retirement movement. Or, let’s say for every on FIRE there will be 10 or more conspicuous consumers who will do their part of keeping the economy rolling and working until 70+. So, hopefully, the FIRE movement grows but still stays just small enough and under the radar screen to not raise the attention of the IRS and face a crackdown from higher taxes. 😉

    1. Right on, ERN! We don’t need any extra scrutiny from the IRS! I think you’re right, very remote chance FIRE picks up steam nationally. Plus, it would take a long time to change consumerism habits, liking turning the Titanic.

      Thanks for the comment!

  12. When we lived in Germany the sales tax was about 19% and applied to services as well, like oil changes and hair cuts. (Although some things were lower, like food staples.) Although I think a lot of people will be able to earn even more after FI than before. That’s my plan at least. =)

    1. I didn’t realize the sales (or consumption) taxes were so high in Europe! I just thought their income taxes were generally higher. Wow.

      Thanks for sharing, Ms Montana!

      1. Oh, the income taxes are higher too! And the crazy thing is, in 4 years of living there I never once heard a person complain about taxes! Not once. They all seemed to think they were getting a heck of a deal for their money. (and they might be right) Just an entirely different outlook on the issue.

        1. That’s insane! I know in the UK income tax is much simpler process and it is automatically taken out. I wonder if it is the same across Europe and it is just out of sight out of mind type of thing or if there just isn’t much though about alternative tax structures? Strange! Yes, a much different outlook. Thanks for the insights!

          1. Ya, you never see the VAT. It’s added into the price of an item and isn’t broken out on the receipt. So everything was slightly more expensive, but really not that much. You just kind of adjust.

  13. If there ever is a move towards a consumption tax, I wonder if we would see a similar move towards families focusing on living more self-sufficient/sustainable lifestyles like we saw 100-150 years ago in the USA. Mini-homesteads and mini-ranches/farms. I know that is the personal direction we are trying to take already.

    1. Great point! I bet you are right. I know that would be the first thing I’d do. I’d like to do that more myself in retirement anyway.

      Thanks for the comment, TPO!

  14. Both this and the Taxes and Fiscal incidence posts are intriguiging. I hadn’t considered the concepts on “net taker” and “net contributor”.

    I would be concerned about how a consumption tax impacts lower income people, but it seems to be worth a discussion. As many of your commenters have said, it’s not likely that the masses will become Mustachians at once, so society and the government are probably safe for now. But maybe a gradual evolution in that direction would allow the economy and tax structure to adjust.

    Great post!!

    1. I agree Mr. Grumby. From a logical and sustainable point of view, you’d think the government would want to have tax revenue streams from multiple avenues. Similar to how many personal finance experts recommend multiple sources of personal income. If one dries up, another will be there still. We’ll see it evolves over time, something to look for.

      Thanks for stopping by!

  15. I don’t see a mass movement towards early retirement, so I’m not too worried about a decreasing income tax base. That said, I could see a push for some type of consumption tax (like the VAT in Europe or GST in Canada) to augment income taxes. Hopefully ‘essential’ items like food and clothing would be exempt.

    1. Yeah good point. It’s interesting to hear how entrenched the consumption tax (VAT or the like) are already in place elsewhere. It makes you wonder if it will eventually creep into the US more.

      Thanks for the comment, N2S!

  16. That is an interesting thing to think about with being a net taker or adding taxes to help the government. I remember around ’08/’09 when we were first into our new jobs, I’d joke with Mrs. SSC when I’d be trying to talk her into going out and doing anything. I’d say, “Come on, let’s go stimulate the economy!” lol

    I see the FIRE movement gaining less traction than the current tiny house movement, because like others have said, when I’ve brought it up at either company, I get looked at like I’m an alien and just suggested we should all go kick puppies or something. I’ve only found 1 person who was on board with the idea in 9 years. These are smart, financially intelligent people, who do cost and risk analysis every day, but thinking that they could exit the rat race sooner than later is way too outside the box for them.

    1. Haha I like that saying! Did it work in convincing your wife? 🙂

      Wow, interesting to hear stories like that. I’ve never really talked about it with anyone else before. There is one person at work who is pretty up on personal finance, but my guess would be that it isn’t on his radar either. I guess we are all just a small wrinkle in a big pond (perhaps ocean…)!

      Thanks for stopping by, Mr. SSC!

  17. The “tax on the poor” that consumption tax would incur concerns me, though I tend to think it would be advantageous to us since we have pretty low expenses. At least so I think–they’d probably suddenly feel huge with a 60% sales tax.

    It is fun to think about what ifs, like what if there was a mass movement of ER. Being in the PF sphere almost makes it seems possible, but the real world shows it’s nowhere close. Interesting to consider the impacts that would have economically, though.

    1. I agree, a mass movement is nowhere close to the real world.

      Considering our expenses are pretty low as well a 60% consumption tax would be advantageous to us now, but not in retirement when we wouldn’t have much income to be taxed. It is interesting to consider though.

      Thanks for the comment, Kalie!

  18. I would love if we moved to a consumption based tax. It would really incentivize people to save money, although clearly the government is not interested in that as it would grind the economy to a halt. Just look at China trying to encourage their folks to start consuming.

  19. Interesting thoughts JW, you’re right of course. Only a select number of us can retire early, but we’re making it happen so it works for us.

    Australia has a 10% consumption tax (GST), which is a pretty reasonable amount. I’d rather have GST and have the systems that Australia has, than take it away and lose it.

    Tristan

    1. Right on, DDU!

      Yeah 10% is pretty reasonable. Something like that would seem appropriate here. Most states have a sales tax on the single digits but that doesn’t apply to certain items like food.

      Thanks for the comment!

  20. I think the one thing glossed over is how many people don’t actually pay any federal income taxes, or how many people pay very very little and it may be completely legal. Then if you add on the illegal, say cash business, or illegal drug dealers etc, a consumption tax collects those taxes which we are currently missing out on, and I think it is a lot larger than most other people think.

    Even if it wouldn’t benefit me, (I suspect it would not) it just seems more fair to me.
    Suppose I live in my house for 50 years, I still have to pay school tax even though I haven’t had a kid in school for maybe 30 years ? That’s pretty unfair to me, especially in PA where they are rising twice as fast as inflation. At least with a consumption tax you actually choose to purchase something. I know, food a basic needs aren’t really a choice maybe we exclude those, but otherwise it’s up to you how much.

    I am 45, I fully expect means testing by the time I get to 60. My guess is if you total in retirement accounts is over 2 million then either no SS or reduced SS benefits.
    It’s a guess but if you could back in 15 years to this comment please give me the prediction credit !

    Great blog

    1. Thanks for the great comment, Chris. Just to be clear though, a consumption tax still wouldn’t pick up illegal or outgrew black market sales right? Maybe I don’t fully understand how it would be implemented to catch this incremental revenues.

      I completely agree on the fairness point. I don’t think it would necessarily benefit me or early retirees in general, but there is a degree of fairness to consumption taxes that you can’t argue with.

      I’ll have to put a calendar reminder out 15 years from now to cone back and check your prediction! I will take your side on it though. Don’t see how means based testing doesn’t enter the picture.

      Thanks again and glad you enjoy the blog!

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