The following blog is adapted from Henry S. Brock's "Your Complete Guide to Money Happiness," because he  teaches the WHYTE phenomenon more cleanly than anyone, and nobody thinks of that in relation to multiple taxation.

The Amazing WYHTE Phenomenon- Your taxes are higher than you think.

What is Money?

Before money was invented as a medium of exchange, people traded or bartered their goods. Rice or vegetables were exchanged for meat or milk or honey.

            The initial forms of money were gold and silver; the value of coins increased with size and weight. The US dollar was backed by gold until we eliminated the gold standard in 1964, and since then our dollar has been backed by the taxing authority and borrowing capacity of our government. Even so, the US dollar is recognized throughout the world as the currency of stability and safety, which is one reason why so many people believe it is critical that our budget be balanced and that we have a strong and stable government.

            To define money as a medium of exchange is handy for economists, but it primarily focuses on the fact that money is more convenient than bartering. I prefer defining money as stored labor- that way we recognize that we have traded our labor for money. The more money we have saved, the more labor we have stored. In other words, money is past savings accumulated for future consumption or production.

            Why do I prefer this definition of money? Because it teaches respect for money. It recognizes that someone’s labor was expended in order to acquire money. It equates more directly the efforts we spend for money with the value of that money. Most people will spend money much more frivolously than labor: They’ll spend three hours working for enough money to by dinner at a restaurant, but they’d never consider spending one hour washing dishes at that same restaurant for that same dinner.

            Try translating your purchases into the hours it will take to acquire them. If you believe that you shouldn’t spend your labor for things of little worth, you will start to better respect your money- and use it more wisely.

            One of the great misconceptions about careers and financial success is that success is measured in dollars. In the business world, the score is kept in dollars. But that is a tremendous mistake.

            Why?  When you equate everything to dollars, you look only at the size of your paycheck, when what you should be looking at is your standard of living and your ability to achieve your life’s goals. When you keep score in dollars, your career measuring stick becomes how much money you are being paid instead of whether your career is helping you reach your life’s goals.  

            That raises an interesting question: is work taxable?

            Remember, money is “stored labor.”  The more money you have, the more you have stored of your lifetime accumulation of labor. That’s how most of us achieve our lifestyle. But whenever your work is traded for money, it must first be taxed. So every time you trade labor for money, and then money for lifestyle, some of it is siphoned off into taxes.    

The Amazing WYHTE Phenomenon

“The real price of everything,” writes Adam Smith in Wealth of Nations, “is the toil and trouble of acquiring it.” This is precisely the reasoning behind the WYHTE phenomenon.  I have never seen the WYHTE phenomenon discussed in any of my numerous college texts on finance.  I have never seen it discussed in any magazine, newspaper or professional journal.  And yet the WYHTE phenomenon impacts every one of us every day of our lives.  If you learn to make it work for you, it can be worth many, many tens of thousands of dollars to you over your lifetime.  If it works against you, it can make the difference between a nice standard of living and always living from paycheck to paycheck.

            W-Y-H-T-E stands for “What You Have To Earn.”

            So, how does it work?

            Assume you want to spend $1.00 and you are in a 25% tax bracket. What must you earn to spend that dollar?  Most people, including business owners and even some accountants, would say $1.25. But the answer is $1.33.  Why?

            If you earn one dollar, and one fourth goes to taxes, you have only 75 cents left to spend. If you earn $1.25, and one fourth goes to taxes, you have only 94 cents to spend.  But one-fourth of $1.33 going to taxes would be 33 cents, leaving you $1.00 to spend.

            What if you are in a 40% tax bracket and you want to spend $1.00?  You need to earn $1.67 before taxes in order to have $1.00 left over. As your tax bracket increases, so does the amount you must earn in order to have $1.00 to spend. Those in a 50% tax bracket, for instance, must earn $2.00 in order to have $1.00 left after taxes.

Because we have a graduated income tax system, as our income rises, our tax rate increases. Remember, the only relevant tax rate for financial decision making is your total marginal tax rate.  Your total tax bracket includes federal and state and FICA taxes (plus city and county taxes if they apply).  Your first dollars are perhaps taxed at a lower tax rate of 14 percent, but those first dollars are being used for the basic necessities of life: food, clothing, and shelter. When you make financial decisions, you are using your last dollars.  Whether that decision is to take the family out to dinner one night or to go on vacation, those last dollars are being taxed at your marginal tax rate, which might be 40 to 45 percent, or higher.

So, what does the WYHTE phenomenon mean to us?  Let’s look at an example:

My boy, Danny, comes to me one evening and says, “Dad, I need a new bicycle.”

I respond to him, “Danny, how much is it?”

“Well, Dad, its $100.”

“Sorry, Danny, it’s not worth it.”

“Dad, it is too worth $100!”

“I agree, Danny, it is worth $100”

“What do you mean, Dad? You just said it is worth $100, but then you said it wasn’t worth it.”

         “Danny, listen carefully.  The bicycle is worth $100, but it is not worth $200. And I have to earn $200 to buy you a $100 bicycle.”

A Dollar Isn’t a Dollar

It is important to decide how the WYHTE Phenomenon will fit in your life.  You may choose to take advantage of it in some ways and ignore it and let it work against you in other ways. Realize, however, that the opportunities to let it work for you are abundant. Consider the following, assuming you need to earn $2.00 for every discretionary dollar you want to spend:

            Taking the family to dinner:  You can pay $50 at restaurant A or $30 at restaurant B for a similar meal. So, you think that by going to restaurant B, you will save $20.  But actually, you had to earn $100 to go to restaurant A, while you had to earn $60 to go to restaurant B.  By going to restaurant B, you actually save $40.

            Going on a vacation:  Regularly, you plan your vacation one month or six weeks in advance. You order the necessary tickets and discover the vacation will cost $3,000. But, by planning even further in advance and doing a little extra telephoning, you get your tickets at a better discount and are able to go on the same vacation for $2,000.  To have gone on the vacation according to the original plan, you would have had to have earned $6,000.  By planning ahead, you only had to earn $4,000.  So once again, you were able to maintain the same standard of living while earning $2,000 less that year.

            Shopping the sales: Maybe you don’t believe it is worth your while to drive an extra few miles to buy a pair of shoes on sale. Suppose you buy a $100 pair of shoes for only $50.  You assume you saved $50. But, you had to earn $200 to buy the shoes at the regular price, and only $100 to buy them on sale, for a savings of $100. Are you beginning to see how these things can add up?

            You can think of your own examples of making the WYHTE phenomenon work for you or against you, but remember that it impacts every candy bar or lunch that you buy. Decide in which ways you simply aren’t going to worry about it. Maybe you won’t clip coupons or change your own oil.  Perhaps you could shop some sales or would enjoy planting your own garden.  The point is, if you don’t figure out how it is going to work for you, it is going to work against you.

            The WYHTE phenomenon explains why a farmer and a young district attorney can have a $40,000 difference in take-home income but the same outwardly observable standard of living. Living a mile away from town, the farmer grows his own garden, paints his own fence, makes his truck last 15 years, etc. By doing so, he is able to have the same standard of living on $20,000 a year as the young attorney who makes $60,000 in the county seat.

            Likewise, you might observe a young family with three, four or even five children, where the father is a bus driver and somehow they manage to make ends meet. Yet, another family with only one child and both spouses earning $80,000 a year is somehow just living paycheck to paycheck. The first family buys bulk and probably cooks from scratch, while the second family struggles.

            On occasion, a client will tell me, “Well, I don’t like the WYHTE phenomenon, so I don’t want to do that,” as though it is a recommendation within a financial plan. Whether you like it or not, the WYHTE phenomenon impacts every financial decision that we make-only when we know the truth are we free to make correct decisions.

The way our tax system works-since 1913

 In 1913, the states ratified a new constitutional amendment that would forever affect future generations of wage-earners.

            That amendment gave the US government the power to tax our income.

            Chief Justice John Marshall of the US Supreme Court had denounced such taxation almost a century earlier, claiming: “The power to tax involves the power to destroy.”  What did he mean? He meant that we are in bondage to the extent that we are taxed. What many people often do not realize is that we don’t work for ourselves.  We have a lien on our income, and we don’t work for ourselves until that lien is satisfied in full.

            That lien, simply put, is money owed to the IRS in taxes.

            People will often come into my office and insist that they are completely out of debt.  To prove their point, they will show me a balance sheet with no liabilities. Yet, I’ll observe they have a closely-held business interest in which their basis as almost nothing and has appreciated to $1 million or more. Or, they might have some highly appreciated stocks, bonds, mutual funds, real estate, investment portfolios, and IRA, a pension plan, or a 401(k) plan. And they either don’t understand or they forget that there is a lien on all of those assets. They don’t truly own those assets, nor can they do anything with those assets-consume them, spend them, or even pass them on to their heirs- until that lien is met.

The impact of taxes on the economy

Sometimes the media will attempt to console us by suggesting that we look at countries with tax rates much higher than ours to justify raising our tax rates. Yet, if you go to Copenhagen, Denmark, as I did a few years ago, you will discover that it is full of vacant, see-through buildings.  I am not talking about a mere occupancy problem.  I am talking about vacant! Why?

            The strength of an economy is based on economic incentive.  Unless there is economic incentive, economies do not grow. Lowering tax rates increases the economic incentive to work, invest and grow the economy. Ironically, this will actually raise government revenues. It was President John F. Kennedy who said, “it is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise revenues in the long run is to cut taxes now.”

            When people are stripped of the fruits of their labor, economic incentive is diminished and the economy freezes.

            Once I visited with a contractor who did small home remodeling jobs. As he expressed his work ethic and commitment to quality service, I thought of the small remodeling job I wanted at home.  Then it occurred to me that my wife and I had calculated that we couldn’t do it because of the increase in taxes I’d be paying that year as a result of a recent change in the tax law.

            Which provides more incentive to work hard- to remodel my home, or to pay taxes?  We were excited about the home remodeling, but paying more taxes didn’t provide the incentive.  Which is more economically efficient- for me to hire a worker, or to run my money through the government overhead and then have the government disburse it to him on welfare?

            Many have poked fun at President Ronald Reagan’s economics, suggesting that the well-off simply hoarded their increased earnings and there was no “trickle-down” to the general economy.  But in this case, the contractor was going to go without a job because we would have to pay increased taxes instead.

            When President Clinton proposed his national health care program and talked about businesses funding it, I remember asking my wife, “Julie, where are these dollars supposed to come from?  Our existing health insurance plan costs so much less than the tax would be. Which employee am I going to have to lay off in order to pay the payroll tax to provide health insurance to the rest of my employees? If congress is going to mandate that I provide insurance for my employees through this tax, I have to determine, which of my employees is expendable because I have to support all the others.”

            How have taxes become such a powerful influence over business affairs and personal lives?  It didn’t start out that way. Our definition of government has changed since 1913. We have steadily moved away from a government close to the people to a centralized government. That is one of the reasons we have a massive federal tax system today. Congress passes a law, and the public lets them do it.

            It all begins very innocently.  Perhaps the government assures us a new tax is just temporary-that they just want to pay for a new public works project. But, once the project is finished, does that tax get rescinded? No.

            From this temporary tax, perhaps the government moves on to a permanent property tax increase or even a value-added tax (VAT), like those found in most European countries. A VAT is like a national sales tax which is levied upon each point in the distribution chain: The manufacturer adds a tax when he sell his product to the jobber; then there’s an additional tax when the jobber sells it to the wholesaler, when the wholesaler sells it to the retailer, and again when the retailer sells it to you, the consumer.

            The most insidious thing about such a tax (and a reason that some politicians like it) is that it is hidden in the cost of goods- consumers don’t see it being taken out of their pockets, yet it forces up prices and inflation. It diminishes our ability- our right- to enjoy the fruits of our labor.

            But because of the WYHTE phenomenon, even these taxes are higher and impact you more than most people realize. Remember that you need to earn $2.00 to pay for a $1.00 candy bar?  Well, you need to earn $2.00 to pay $1.00 in taxes due to the double-taxation system of our tax code.

How Much Goes to Taxes?

How large, really, is the tax bite?  How much are we really paying?  Of course, we all pay differently, but add up some of the more common taxes, which include:

1)Federal Income Taxes: ranging from 14 to 36 percent, depending on income.

2)State Income Taxes:  Usually another 6 to 8 percent of income.

3)FICA and Medicare Taxes- Employee portion: 7.65 percent

4)FICA and Medicare Taxes-Employer portion: Same as above.  Did you realize that 15.3 percent of your income is going for this tax alone? What could you do with the money if your employer was allowed to pay it to you?

Now keeping in mind the WYHTE phenomenon, consider these taxes:

5)Sales taxes: 6 to 8 percent of purchases, though you spend money that has already been taxed once.

6)Gasoline Taxes: Average of 42 cents per gallon, though you spend money that has already been taxed once.

7) Property taxes: usually 1 to 1.2 percent of the assessed valuation of your home. Also levied on cars, boats etc… though you spend money that has already been taxed once.

8)Corporate Income Taxes: About five percent of every product or service you buy, though you spend money that has already been taxed once. This also affects any investments you choose to make, another double tax since you either purchased the investment with already taxed dollars, or you will be taxed when you sell.

9)Inflation (Yes, this is a tax! More on this later...): 3 to 5 percent of income, plus 30 to 50 percent of any returns on investments, even though you spend money that has already been taxed once.

10)Estate Taxes: A tax on passing property to your heirs at death. Starts at 37 percent on estates above $600,000 and goes up to 55 percent. (This doesn’t just hit the rich.  That includes home value, life insurance proceeds, investments, all assets. It adds up fast.) Another double tax because everything owned was purchased with after-tax dollars. In fact, estate taxes get hit 5 times. First taxation is when the dollar is earned, second is the inflation erosion, third is the business tax paid on investment, fourth level is the estate tax itself, and fifth is the sales tax when your heirs try to buy something with it.

11)Special Use Taxes, Fees, “Sin” taxes, etc: Too many to detail.

Add them all up.  No wonder it is determined that we work for the government until “Tax Freedom Day,” Which usually occurs around mid-May each year.

Just something to think about.