Can We Prove a 15% Flat Tax is the Most Efficient?

Let’s use a Cash Flow Calculator to tell the whole truth about what happens to an account when it gets taxed. We’ll put in $20 to start, earning 20% over 100 years. Let's for a moment, imagine that the starting year is 1913, the year the tax system started.

We can see below that the account grows to more than $1.6 Billion (yes, with a B) in that span of time, if left to its own devices.

Of course, this assumes no taxes or management fees were taken out during this time. Don't worry, those will come soon. First, what if we simply adjusted the account for inflation? Assuming inflation happens at around 4% on average, the actual account value FEELS like about $32.7 million.

Can you imagine $1.6 BILLION ever feeling like $32 million? Seems like even 4% can have a pretty profound financial impact.

So what effect WILL taxes have on this money? 

The Effect of Income Taxes

It’s interesting to note that income tax was intended to be temporary when it started, was only a rate of 8%, and affected only the upper-income earners. And yet, if we look the Income Tax History chart, the average maximum tax bracket is well over 50%.

 

So, what would happen if we apply a 50% tax bracket to the $1.6 billion? Wouldn't that simply cut the account in half? Unfortunately, that's not even remotely the case. As you can see below, over a billion dollars has disappeared into thin air, and the account balance doesn't even reach $300,000. Thanks to inflation, that'll feel like a measly $5,000.

Interestingly, the government doesn't get that $1.6 billion either. They get about what you get: $275,000.

 

So where did all that money go? It’s disappeared because taxes are predatory or confiscating in nature. Every time taxes are taken out of the account, those tax dollars can no longer earn the 20% rate of return the account is earning. This is also known as opportunity cost, since the tax dollars lose the opportunity to earn interest.

If you drop the tax rate down just 10% to a 40% bracket, look what happens. Not only have you increased your takeaway, you've increased the government's takeaway, too.

 

 

 

as you can imagine, the more we lower the taxes, the more cumulative dollars both you AND the government receive. Because allowing your money to grow and acheive the wonders of compounding provides them with a larger pool of money to tax. So big is this impact, that it hardly matters WHAT the tax rate is, because the government makes more money when they allow people to grow their capital.

For example, lowering the tax rate all the way to 10% leaves you with $308 million and the government with $32 million. That's a far cry from $275,000.

If you lower the tax to 5%, you get $717 million, while the government gets $37.7 million. But if you bump that tax rate back up just a smidge to 6.65%, you come away with $548 million and the government with $38 million. So 6.65% is the threshold where the goverment's “share” starts going down again.

 

So we could surmise that if one is talking about 20% rates of return, a 6.65% tax bracket is the most efficient. According to our studies, if we are talking about a 9% rate of return, a 15% rate of taxation is the most efficient.

So now that you know the whole truth about the matter, what do you do with this information? Focus on accounts that do not get eroded by taxes and/or implement strategies that mitigate the taxation on these types of accounts such as taking dividends, interest and capital gains in cash instead of re-investing them. Additionally, you can use government incentives that help to lower your tax obligation, as our friend Tom Wheelwright shares in his book, Tax Free Wealth.

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