A Canadian's random thoughts on personal finance

Jun 5, 2010

The penalty for saving

Thicken My Wallet has a post on how the tax system discourages saving. In it, he mentions progressive taxes, the estate tax, and the high taxation of interest income among the reasons for this.

With all due respect, this seems to be a somewhat naive treatment of tax policy.
  • The estate tax prevents a hereditary aristocracy from forming. In Canada, death triggers a "disposition" which leads to capital gains tax, having a similar effect.
  • Dividend tax cuts take into account that the dividend-paying company has already paid some tax.
  • The flat tax is promoted as a way to simplify taxes, but in reality it's just a tax break for the rich. In Canada, our system's complexity doesn't come from its progressive nature, but from the multitude of obscure rules and deductions.
To me, what really penalizes saving is inflation. For some very loosely justified reasons, the central banks of the US and Canada aim for a 2% inflation rate. Deflation is deeply feared as some sort of bogeyman with scant explanation using terrifying terms such as "deflationary spiral" that call to mind the end of the financial system as we know it.

The fact is, before about 1900, deflation was commonplace in North America. Currency kept its average value over long periods because inflation and deflation alternated.

Targeting 2% inflation is just a 2% asset tax. It is analogous to a property tax, which would be fine, except for two very large problems:
  1. Inflation doesn't just decrease assets by 2%; it also reduces debts by the same amount. Therefore, part of this "asset tax" is paid to debtors. The fairness and wisdom of this is debatable.
  2. The beneficiaries of inflation are those who create new money. In our system of banking and fractional reserve, the money goes not primarily to the government, but rather the banks.
If you want to encourage saving, how about a prolonged period of gradual deflation?

The problem, of course, is that there's no way for the government to achieve this. Our government lost control of the money supply in 1935 with the creation of the Bank Of Canada, at which point monetary policy could be relied upon to favour the banks. Banks love debt; inflation favours debt; hence we have nothing but inflation after 1935:

(Source: Bank of Canada web site.)

To really encourage saving over borrowing, the government would need to take back control of the money supply from the banks. Well, good luck with that.

Jun 2, 2010

Don't overestimate the value of your leisure time

Amber Bellaire has written a blog post that justifies spending money on maid services. This is a convenient post in that offers one-stop shopping for a variety of naive fallacies used in such arguments.

The logic goes like this:
Combined, their weekly before-tax income is about $2,000. At this rate, each partner is making about $24 an hour.

If both partners together spend six hours every other Saturday cleaning, that’s 12 hours out of their combined free time being spent on cleaning every two weeks. Multiply that by 24 (because each person is worth $24 an hour), and the couple is spending almost $300 worth of their free time hours cleaning biweekly. That’s $600 a month, or $7,200 per year.
The most striking flaw in this reasoning is that their time is not worth $24/hour. It must be worth less than that, of course, or else they would not be so eager to give an hour of time to their employers in exchange $24. Consider: if their employers were to cut their pay to $23.50, would they quit? If their time was worth $24/hour, they should!

This kind of reasoning is really nothing more than elitism practiced by people with well-paying jobs: if I make $24/hour, and you make $12, then my leisure time is worth twice as much to me as yours is to you. If that's the case, we should all be working around the clock to make sure Bill Gates gets all the leisure time he can.

A second important flaw occurs just a few paragraphs later:
For four hours of cleaning at $22 an hour, you’d be spending $88 to have your house cleaned by the company – saving you $212 worth of your own hours spent on cleaning (300 – 88 = 212) biweekly. That’s a savings of $424 per month, or $5,088 per year.
Here is the common fallacy that spending money is a form of "saving". Saving money means not spending it. It doesn't mean you've spent less than you could have. It doesn't mean earning yourself something that's "worth" money. Saving money is the opposite of spending money. The only way for the couple in this scenario to save money is to use cheaper cleaning supplies.

The proper way to evaluate a maid service is, of course, to compare the alternatives available, just as in any other purchase decision. Using Ms Bellaire's figure of $88 biweekly, the couple in her example would be spending $2288/year on housecleaning services. Here are a few ways to reason about that amount:
  • Using Ms Bellaire's figure of $24/hour, they would need to work an extra 8 hours overtime per month (or 5.3 hours at time-and-a-half) to pay for the maid service. If they're willing to do that, it may be worthwhile.
  • Using opportunity cost, consider that $2288 buys a pretty nice little vacation every year for two people. If you're willing to give that up, the maid service may be worthwhile.
  • Using investment opportunity cost, consider that $2288 spent on a maid this year could have been invested in stocks, where its real value could be expected to double each decade. If you have three decades until retirement, you've just spent over $18k of retirement money on the maid this year. To put this in perspective, note that amount would be greater than the couple's final RRSP contribution.
  • Using the 4% rule, that amount is equivalent by the income produced by an investment of $57,200. If you could imagine saving up that amount, and then cheerfully handing it over to someone for a lifetime of maid service, then it's worthwhile. (The trouble with this argument is that I don't think it will be very convincing to anyone who doesn't happen to have $57k sitting around, because it's too easy to spend imaginary money.)
If you can look at all four of these lines of reasoning and still feel comfortable spending that money on a maid, then go for it.