Why the 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.
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 :)!
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!
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