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MAKING CENTS OUT OF THE NEWS
Blog #31
(September 22nd, 2011)
Stemming the Financial Illiteracy Epidemic Must Begin at School
By Tom McAllister, CFP®
Going through the financial reports each day, I attempt to filter out the “jargon” of which my investment advisory profession is so fond. This filtering is done in an attempt to clear my own mind, so as to better communicate with you, my readers, along with my clients and prospective clients. I have been told I “filter” well.
I worry, though, that, even when the information is presented in plain English by me or by other professionals, far too few Americans possess the financial sophistication to grasp the gravity of the crises happening in our world. Far too little is taught by our elementary and high schools about finance and economics. Few high school graduates know about capitalism, a cornerstone of our society. Even the most basic money issues, ranging from checking and saving accounts to responsibly managing credit card debt to buying an affordable home with a reasonably-priced mortgage, are absent from most of America’s classrooms. I believe this lack of financial knowledge is a very big deal, causing very big problems.
This widespread lack of financial knowledge is what allows the mainstream media (in fact, even some of the financial media) to comment on economic and financial matters which are well beyond their own comprehension and understanding. A recent example is a journalist’s comment to the effect that Warren Buffett’s secretary pays a higher percent of her income in taxes than Buffet himself. The journalist was illustrating one side of debate about reducing the U.S. debt by “taxing the rich”.
The comment itself is based on fact, but compares apples to oranges. Buffet’s several million dollars a year mostly comes in the form of dividends and capital gains, which are taxed at lower rates. Buffet’s secretary, along with most of the rest of us, pay taxes on earned income, to which a higher percentage rate applies.
A couple of comments of my own by way of explanation as to why capital gains are taxed at 15%, along with dividends from stocks, as compared with earned income, which is taxed at rates up to 35%:
Capital gains occur when we sell an asset for a profit. The money we put into the investment was taxed when we earned the money in the first place. Then any profits are taxed again upon sale.
Capital gains income is NOT adjusted for inflation. We have averaged four percent inflation in the United States since 1970, approximately the point at which we went off the gold standard. At four percent inflation the dollar loses approximately 100% of its value every 15-17 years. Stocks and real estate tend to go up, over time, to reflect this reduced value. When long term equity investments are sold they often reflect no actual increase in real value. On an inflation- adjusted basis these sales can, and do, reflect a loss rather than a gain. Still, capital gains tax applies.
Dividends paid out by regular public corporations are taxed twice, once at the corporate level at up to 35%; and again by the shareholders who receive dividends from the remaining 65% of earnings left over in the corporation after taxes. Thus up to 57.5% of the original earnings of the corporation would be paid to Uncle Sam in income taxes. Congress has determined that the tax on such dividends, levied after corporate income taxes are incurred, should only be 15%, or a total of slightly less than 50% of the amount earned in the first place. Most public corporations do not pay the full 35%, as they take many available credits and deductions allowed under our extraordinarily complex income tax laws. (By the way, who do you think ultimately pays corporate taxes? The consumer, of course! Taxes are a cost of doing business.
Once you take all these factors into account, it begs credulity to claim that Buffet is being treated better than his secretary! As amusing as the misguided journalistic comparison may be, it cannot distract from the challenge at hand: Our schools must begin doing a better job equipping young people to understand our economy and our tax system. Ignorance is no excuse for our educators when it comes to preparing our youth for financially responsible citizenship.
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