Wealth

Part 8 - TAXES, TARIFFS and INFLATION

Inflation is a secret tax on wealth. It occurs when ever the amount of money in circulation increases beyond the needs of the market. 

 Central banks try to control the rate of inflation at around 2% by adjusting the interest rate that the government pays on loans.

Why 2%? Because low rates encourage people to spend money and this promotes economic growth. But it also means that $100 in your bank account in January is worth only $98 by December. 

 If the interest the bank pays on your $100 is 3%, your savings have lost only a real $1 but you will be taxed on the full 3%. And inflation is often higher than 2%. And this permanent loss happens year after year.

The solution? Do not hold more cash that you need for day to day needs and invest in assets like real estate or stocks that increase in value at much more than 2%. Also, often the growth in value of some assets is taxed at a lower rate than interest. 

Real estate is an asset but, in Canada, unless it is your principal residence, any capital gain is taxed.

Dividends, generally paid out monthly or quarterly, are taxed in the year received. In Canada, dividends paid by Canadian companies are taxed at a lower rate than interest payments. Also, only half of capital gains (minus half of capital losses) are taxed in Canada, and this tax is even less in the USA.

One disadvantage of mutual funds and ETF's is that the fund managers may sell stocks that generate capital gains that are taxable each year thereby losing some of your capital. Also if you invest in a fund near the end of a year you might receive a tax liability for the full year. Whereas, if you buy a stock directly, any capital gain is not taxed until you sell it. If you do not sell, you will not pay this tax until you die, when it is presumed sold. 

 NOTE that if you do sell a stock with a significant capital gain you may be able to offset this by selling other stocks with capital losses. This is a way postpone paying taxes and hold on to more cash that you can invest.   In Canada, you must delay buying the same stock for at least 30 days but you can use the gain to buy another stock immediately.

If you have a net capital loss you can carry this to a subsequent year to offset a capital gain. And, in Canada, you can carry it back for three years.

TAX LOST SELLING, to reduce tax on capital gains, occurs near the end of the year and this can be a good time to buy stocks on sale. 

TARIFFS are simply a tax on imports to a country and typically are paid by consumers.

Doug Irwin, a former staffer on President Regan's Council of Economic Advisers, in his book, Clashing Over Economics, describes the problems with tariffs.

While tariffs do provide revenue to the government of the importing country, this is generally at taxpayers expense and at the risk of greater inflation as buyers find goods are more expensive.

Tariffs also restrict the importation of particular goods thus protecting domestic producers of those goods. They may also be used to deter countries from dumping surplus goods at lower prices than local suppliers or as retaliation for reciprocal tariffs.