Macro 109
Up front: going forward, if there’s anything in here that doesn’t make sense or you have a question about, please let me know in the comments so I can address it in as close to real-time as possible. I’m trying to figure out how to make this more of a dialogue and help ensure real learning is happening, and that seems like a good place to start. In a classroom, I can tell when I lose my audience, so this monologue format leaves me wondering where those gaps are that I need to fill.
Yesterday was “tax day”, so we’re circling back to fiscal policy. The government has two main ways they attempt to steer the economy, remember, fiscal policy and monetary policy. Fiscal policy is straightforward: taxation and government spending. If you hear someone say “I am fiscally conservative, but socially progressive”, the first part means they are against higher taxes and bigger government, and the second part could mean almost anything. Whenever I hear that phrase, I think, “well, I’m not honest, but you’re interesting” (credit/blame to Dane Cook). I relate with the concept, but not the packaged description of it.
If you’re someone who pays taxes and pays attention, then you already know that the federal tax filing deadline has been pushed back to July 15 this year. As of the middle of March, the government had already issued 59,000,000 tax refunds with the average amount of $2,973.
What is a tax refund? Let’s focus on that for a minute. If you are an employee, your income taxes are automatically withdrawn from each paycheck. Federal income tax is just one category of automatic “deductions”, other common ones include state and local taxes, social security, and medicare. The “before” and “after” amounts are referred to as “gross pay” and “net/take home pay”. If you are paid $650 a week, let’s say, then your gross pay is $1,300 every two weeks and $33,800 in a year. But, after automatic deductions, the amount on your check (take home pay) will be lower, likely around $1,000 every two weeks and $26,000 in a year.
That $7,800 goes to various government agencies. When you file your taxes at the end of the year, it often turns out you overpaid your federal income taxes, and the government sends you some of that money back. That is the simplest way to explain what a “tax refund” is, so now let’s look at a few complexities.
Why is it so common to overpay? First, if someone owes you money, would you rather they accidentally give you too much, or too little? You would much rather have extra and have to give some back when they figure it out—you don’t want to have to chase them down and try to collect the missing money. The effort and burden is swapped. Second, if they overpay, you can use that money to do things until they ask for it back! Imagine someone accidentally gives you $1,000 and you know they’re going to ask for it eventually, but in the meantime, you may as well put it in a savings account and collect interest. That’s a win-win for you, right? The same goes for the government.
Here’s where it get’s interesting. You can edit your federal income tax deductions—fine tune them—so that they are more accurate and you end up less likely to get a refund, or more likely to owe money. You pay the same amount in the end either way, to be clear, it’s just the timing and optics that matter. In fact, personal finance nerds and behavioral economist elitists and libertarian bros love to mock people who get excited over tax refunds, because those people are celebrating “interest-free loans to the government“. The larger the refund, the more you overpaid in the first place. But, even with more education as to how it works, people are reluctant to give up that refund check.
Consider this. Would you rather get a refund of $1,200 all at once a year from now, or receive $46.15 every other week from now until then? What would you spend that extra $46 on, versus what would you spend the $1,200 on? If you continue down that train of thought, you can start to understand that tax refunds aren’t what they first appear—there is a whole host of fascinating psychological tricks at play.
I’m totally sympathetic to the innocent joy of getting a lump sum that feels like free money, for the record. Ignorance really is bliss, sometimes.. but I choose knowledge. I’m also that guy who, when I’m about to cash out credit card rewards, always selects the option where the company has to send me a physical check. It would be more “rational” and more efficient to immediately transfer the “cash back” to the current balance on the credit card, but I like seeing the check and the feeling that the credit card company is literally paying me (and I like inconveniencing those sorts of companies, if I’m being honest).
This is not what I planned on writing about. Hmm.. maybe this is a two-parter?
It’s Thursday, which means I’m going to recommend a book. Let’s go with All The Pretty Horses! Now that the boys aren’t paying attention, here’s the real recommendation:
..just kidding, that is the real recommendation! And don’t judge the book by its title, boys.
Here’s the goodreads description:
“All the Pretty Horses tells of young John Grady Cole, the last of a long line of Texas ranchers. Across the border Mexico beckons—beautiful and desolate, rugged and cruelly civilized. With two companions, he sets off on an idyllic, sometimes comic adventure, to a place where dreams are paid for in blood.”
I mean, what’s not to like? Cormac McCarthy is an incredible author; movie people may know of him from No Country for Old Men (best picture winner in 2007), and those who have been binge-ing dystopian content during this lockdown could be familiar with The Road. I recommend all his stuff, but due to budget constraints, I’m only giving away two copies this week. Same rules as last week, otherwise. Who wants them?
Okay, so we’re doing this. I’ll continue focusing on the micro aspect of taxes, then zoom out tomorrow.
I roll my eyes when I see viral tweets along the lines of “school should have taught us what credit scores are and how to do taxes and balance budgets instead of x/y/z”. Where do I even begin to tell you how dumb that take is (and this is coming from a teacher who goes out of my way to teach those exact things, for the record).
For starters, if you search “credit score” online you can learn everything you need to know in 10 minutes. What is stopping you? Would you rather complain the rest of your life about how the education system failed you?
How do you think I know these things? I’ll give you a hint, I didn’t learn it in school. But go off! Okay I’m done.
Doing your taxes falls into the category of things that are fairly simple, but built up to be something that seems terrifying. Like writing a senior thesis in high school. Okay I’m really done this time. [shoutout Scottsdale Prep class of 2015]
For most people, especially when you’re just starting out, filing your taxes can be both free and easy. The biggest hurdle is actually our over-specialization and over-reliance on “experts”, and the “experts” have every incentive to convince you it’s difficult and scary so you will pay them to do it for you. If you want a cynical look behind the scenes, you can read about the class action lawsuits filed against TurboTax and H&R Block.
If your gross income is below $70,000, the IRS provides free tax filing software. The companies above are getting sued for hiding this from people and breaking the law in the process. And you don’t need to do much research to conclude they are definitely, 100%, guilty.
While I’m exposing corrupt mega-companies that prey on ignorance, it’s worth mentioning that all those cute mom-and-pop relatable “check your credit score for free” companies like freecreditreport.com or creditkarma or whatever else that had commercials everywhere a few years back are all actually owned by the big three cartel of Experian, Transunion, and Equifax. The cake is a lie.
Legally, each of those companies is required to give you your credit score once a year, and you can do it at www.annualcreditreport.com/index.action. Thankfully, that particular scam artistry has become less prevalent in the last decade, as more and more banks and credit card companies include your credit score as part of having an account with them.
Back to filing your taxes! Assuming the most common scenario for students, you’re a “W-2 employee” with one income stream and little else in the way of property or investments. Sometime in January or February, your employer will send you your “Wage and Tax Statement” (aka W-2), and it’s quite simply the total amount you made with that company the previous year, and how much was deducted in taxes. You take the info from that W-2 and plug it into the free tax filing software (you can import it online at this point), and submit it. You’re done.
If you’re self-employed or own a business or if you own real estate or collect rent or are paid dividends from investments or have offshore bank accounts or other things of that nature, then tax-filing gets more complicated fast, and there is a point where it’s worth paying an expert to do it for you. I’m looking forward to reaching that point, eventually.
As for deductions, you’ve probably heard people talking about deducting random things from taxes and tax write-offs and blah blah blah and, yes, that stuff can get complicated and time-consuming, but it doesn’t apply to the average person. Why? Because there is a “standard deduction“.
The standard deduction for a single person in 2020 is $12,200. This amount is deducted from your gross income and you are taxed on the rest. So, going back to our previous example, if you make $33,800 and claim the standard deduction, you are only taxed as if you made $21,600. Nearly 70% of all taxpayers claim the standard deduction (and that also explains why most people overpay income tax and are due refunds).
It’s just a box you check while filling out your 1040 (ten-forty, the standard IRS form). Boom, standard deduction applied. The only way you would ever want to itemize your deductions is if the total itemization exceeded the standard deduction. [freeze frame: what do I mean by “itemize deductions”? Basically, there is a list of things you can spend money on that will reduce your taxable income. Charitable donations is a common one. You know how when you drop stuff off at Goodwill and they ask if you want a tax form? Well, that’s in case you want to record that donation and claim it on your taxes. That’s the concept of itemizing a deduction. You donated stuff worth $40? Now you can subtract $40 from your taxable income!] Let’s say you gave a bunch of money to a qualifying charitable foundation, totaling $13,800. You could subtract that amount from your taxable income, and now you’re only going to be taxed as if you made $20,000, instead of $33,800. If that is the case, you would choose to itemize your deductions, because 13800>12200.
To summarize.
Step one: find your W-2. It’s likely to be mailed and emailed, unless you opted out of one.
Step two: go to https://www.irs.gov/filing/free-file-do-your-federal-taxes-for-free
Step three: fill out the 1040 form, put in your personal information, and copy/import the W-2 information.
Step four: take the standard deduction.
Step five: hit submit (I recommend taking the time to enter your bank account routing numbers beforehand, it’s the equivalent of a FastPass at Disneyworld)
Step six? get your tax refund! You’re rich! Thank you, government!
Tomorrow I’ll talk about tax rates and give my take on whether billionaires should exist.
