Ben Franklin told us that “A penny saved is a penny earned.” Unfortunately this has not been true since income taxes were invented in the 1860s. A penny saved is more than a penny earned since earnings are subject to income taxes.
Luis’s Problem in Cents of Mission
As described in the Introduction to Cents of Mission (Business Expert Press, 2015, New York, New York) Luis faces the problem that many families and individuals face today. He was struggling to get ahead given all the financial demands of life. His young child increased those financial pressures. Student loans didn’t help.
It seems to be human nature to want things. Advertisers have perfected stimulating that desire to an art form. Television and other media constantly show us lifestyles that are highly attractive.
The easy availability of credit makes it possible to satisfy these “needs” sooner rather than later. Immediate gratification is very seductive while certainly increasing risk and possible creating problems in the future.
So Luis and Emily are struggling to get ahead and are considering having Emily get a second job. This is when Al plants the idea of looking at things differently.
"Sounds like you’re just turning up the speed on the treadmill. Have you ever thought that Ben Franklin was wrong when he said ‘A penny saved is a penny earned?’”
It’s Only the After Tax Cash Flows that Count in Life
Al was suggesting that getting more income would be a case of working harder rather than working smarter. Every penny earned by working harder would be taxed. On the other hand every penny saved by working smarter on cost management and control would be tax free!
Federal income taxes are progressive. That is to say those higher levels of income are taxed at higher levels. Here are the 2021 tax tables for married couples:
Married Filing Jointly or Qualifying Widow/Widower
Taxable Income Tax Rate
$0 – $19,900 10%
$19,901 – $81,050 $1,990 + 12% of the amount over $19,900
$81,051 – $172,750 $9,328 + 22% of the amount over $81,050
$172,751 – $329,850 $29,502 + 24% of the amount over $172,750
$172,751 – $329,850 $67,206 + 32% of the amount over $329,850
$418,851 – $628,300 $95,686 + 35% of the amount over $418,850
$628,301 or more $168,993.50 + 37% of the amount over $628,300
Note how the incremental tax rate rises from 10% to 37% currently. That is a big difference. Consider the math is Luis and Emily currently have taxable income of $81, 050. They would be paying federal income tax of $9,382.
Now, what if Emily earned $10,000 more taxable income by working a second job. That extra income would be taxed at 22% for an incremental tax of $2,200. Only $7,800 of after tax income remains to help in “winning the cost war” faced by Luis and Emily.
But wait. We can’t ignore the additional taxes required to be deducted from that paycheck. We must include taxes for social security and Medicare. Here’s the tax table for these.
2021 Maximum Taxable Earnings: OASDI–$142,800; Hospital Insurance (HI, also called Medicare Part A)–No limit
Federal Tax Rate: Max OASDI
Employee 7.65% (6.2% - OASDI, 1.45% - HI) $8,853.60
Employer 7.65% (6.2% - OASDI, 1.45% - HI) $8,853.60
Self-employed 15.30% (12.4% - OASDI, 2.9% - HI) $17,707.20
As an employee, Emily must also pay 7.65% as her social security and Medicare deduction. Her incremental taxes now total 29.65%, almost a third of the second job income. Her contribution to the family’s struggle is summarized as:
Incremental Taxable Income from Emily’s Second Job $10,000
Incremental Federal Income Tax - $2,200
Incremental SS/Medicare Tax - $765
Incremental Disposable Income $7,035
The situation may actually be considerably worse for after tax cash flow if Luis and Emily live in a state with income taxes. Furthermore, some states have highly progressive tax rates.
Al’s Point
Rather than taking a second job it may be better to work smarter by carefully managing the existing resources. If Luis and Emily can find savings in their current spending those saving are not taxed.
A Penny Saved is a Penny Earned Kept!
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