Principles of Wealth #7*

To acquire wealth, it is helpful to know what it is… and what it is not. 

There are many sorts of wealth. This essay is about only one of them: financial wealth.

Financial wealth can easily be defined as net worth – the sum of one’s assets less the sum of one’s liabilities.

You’d think a concept so simple and straightforward would be easy to understand. But surprisingly few people do.

Years ago, at an investment conference, I asked the audience to volunteer definitions of financial wealth. About a half-dozen were proffered, none of which was net worth. The two most popular were having a lot of valuable things and making a lot of money.

Neither one is true.

I bought a Richard Mille watch years ago in Paris.  It was new to the market then, and I was in some kind of spendthrift mood. I bought it on impulse for $35,000.

A few years later, it stopped working. Getting it fixed cost me another several thousand dollars. A few years ago, it broke down again. That brought my total investment in the watch up to nearly 40 grand.

It’s a handsome watch, but it’s not any better looking than several other watches I’ve bought for a fraction of the price. And in terms of keeping time and reliability, it doesn’t compare to a digital Casio I could have bought at the time for $35.

I should be ashamed of myself for buying it in the first place. From a financial perspective, it was foolish. But I didn’t buy it to keep time. I bought it to give me a dose of serotonin – i.e., the thrill of spending money foolishly. And the purchase delivered that.

Since then, several people have complimented me on the watch. Those moments felt pretty good, too. And somehow, the combination of that first thrill and those half-dozen compliments feels like a fair deal to me.

On an ego-gratification basis, I feel like I got what I paid for. But from a net-worth perspective, I would have been better off buying a Casio and investing the rest in real estate.

When we acquire things for emotional reasons, we almost always pay more than they are intrinsically worth. And when we exchange our cash for status symbols, we generally make ourselves poorer in terms of net worth.

Acquiring status symbols is a bad way to build wealth. And having lots of expensive things is not a valid indication of wealth.

That kid driving the red Ferrari? The doctor with the ocean-front mansion? The woman wearing the Oscar de la Renta gown? The look says, “I’m wealthy.” But you can’t know that. The kid in the Ferrari might be making $40,000 a year. The lady in the gown could be in the middle of an expensive divorce. The doctor in the mansion might be worth less than nothing.

No, you can’t measure wealth by the things people have.

What making a huge income?

What about your idiot college friend that is “pulling down 200 Gs a year” selling life insurance? Or that jerk you met in law school that charges $700 an hour for his services?

Alas, that is no indication of wealth either. Earning a big income is certainly a very solid step in the right direction, but it is useful only if a good percentage of that income is saved.

What commonly happens when our income increases is that we reward ourselves by increasing our spending, too. The temptation to do this is almost impossible to resist for most people. And the serotonin hit we get from spending more becomes addictive. Before we know it, our spending has matched or exceeded all that extra income.

Once again, we end up poorer, not richer, despite the appearance – and even the feeling – of gaining wealth.

We cannot escape the simple truth of personal economics: Wealth is net worth, and net worth can only be grown by making more than we spend.

* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost. 

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“People everywhere enjoy believing things that they know are not true. It spares them the ordeal of thinking for themselves and taking responsibility for what they know.” – Brooks Atkinson

Sweden’s Democratic Socialism:

Can We Have It in the US?

Are We Willing to Do What It Takes? 

On Friday, we talked about Sweden – Bernie Sanders’s economic model for what the US could become. As I said then, there’s much to be admired about Sweden’s economy and social welfare system. Swedes enjoy high living standards, low poverty, government funded education through college, universal health coverage, generous parental-leave policies, and much more.

And the Swedish government does this without printing fake dollars and going into trillions of dollars’ worth of debt, like the US government does.

I wondered: “How does Sweden do it? How does it provide so many benefits for its population and yet remain prosperous? And what can we learn from them?”

Let’s start with the best-known answer: Swedes pay a lot in taxes.

Swedish Taxation: It’s Not What You Think 

It’s true. The Swedish government puts a heavy burden on its taxpayers. But here’s something I found interesting. Swedes are generally happy with their tax system because they feel like they are getting a fair shake. Despite paying higher taxes than their American counterparts, working- and middle-class Swedes trust their politicians.

What’s going on?

Like the US, Sweden has a “progressive” income tax. If you make less than 18,000 kroners, you pay no income tax. (Roughly the same as in the US.) If you earn more than 18,000 kroners but less than 434,000, you pay about 31%. If you earn more than 434,000 kroners but less than 509,000 kroners, you pay 52% (32% plus 20%). And if you earn more than 509,000 kroners, you pay 57% (32% plus 25%).

57% is about 20 points higher  than high-income earners pay in the US. And that has given many people – including, presumably, Bernie Sanders – the idea that all those great Swedish benefits are paid for by the rich. In Bernie’s terms, they are paying their “fair share” of the tax roll.

But the fact is that Sweden’s heralded social service programs are paid for, mostly, by working-class and middle-class Swedes. Despite that 57% tier at the top, the overall taxation in Sweden puts the heaviest load on the bulk of the population.

Let’s see how that works.

Income tax in Sweden has three components: a municipal tax, a national tax, and a social services tax.  And as I said, it is designed so that higher earners pay not just more kroners but a lot more, because they are taxed in tiers that increase as the taxpayer’s earnings increase.

If that were the entire tax system, the perception of the rich paying the bulk of the taxes would be true. But Sweden has another very significant source of tax revenue that most Americans know nothing about. They have a national 25% sales tax that is built into the price of almost everything.

Think about that for a moment. This is a tax that applies to everyone: the rich, the middle-class, the working class, and even the poor!

(NOTE: To mitigate the effect on those earning less than 18,000 kroners, there are a few exceptions (e.g., basic foodstuffs) where the sales tax is lower or doesn’t apply.)

If you are making, say, 50,000 kroners a year, you’ll pay 31% of that in taxes, which would be about 17,000 kroners. Then, with the 33,000 kroners you have left, you’ll pay another 25% on everything you buy!

Thus, most working-class and middle-class citizens in Sweden end up paying between 40% and 50% of their income in taxes, depending on their spending.

So that’s one big surprise for anyone that thinks the Swedish model would affect only the top 1% –  or even the top 10% – of US taxpayers. If we used it here, taxes would go up for probably 80% of the population.

Here’s something else that might surprise you (that Bernie may not know): Sweden has no property tax, no gift tax, andno inheritance tax. In the US, these three taxes account for a significant share of the common tax burden. And they are almost entirely paid for by the top 10%.

The bottom line: Swedes pay a lot of taxes – considerably more than Americans that make the same income. And although the top income tax rate in Sweden is 20 points higher than it is in the US, when you consider the national sales tax and the lack of property, gift, and estate taxes, you find that, from a tax perspective, it’s actually better to be rich in Sweden than it is in the US.

Capitalism vs. Socialism: Again, It’s Not What You Think

Sweden has a long and interesting history of free-market Capitalism and social welfare programs.

In the 19th century, Sweden introduced large-scale economic reforms. It reduced the size of the government, deregulated the financial sector, eliminated trade barriers, and lowered taxes across the board. As a result, Sweden became one of the strongest and freest economies in Europe and remained so during the first 60 years of the 20th century.

Feeling flush, it began its grand experiment with Socialism – introducing massive social welfare programs, increasing regulations of and restrictions on business and finance, and imposing new taxes and raising existing ones. Starting in the late-1970s, the Swedish economy began to slow down. Among other things, Swedish exports had become too expensive due to the high wages and payments made by employers into the government welfare-state programs. As economic growth slowed, Sweden found it increasingly difficult to pay for its system of social welfare benefits.

Rather than increase already sky-high taxes, the government publicly admitted that its grand experiment in Socialism had failed. And it immediately set in place a wide range of reforms, including lowering taxes, re-imposing trade barriers, reducing business regulations, and promoting free trade. They also began the widespread turnover of publicly owned and run industries into private hands. This happened in every key sector, including health, education, and banking.

Approximately 90% of all resources and companies are now privately owned, with a minority of 5% owned by the state and another 5% operating as either consumer or producer cooperatives. Sweden is a world leader in privatized pensions, and its pension funding problems are small compared to many other Western European countries. The state owns one bank, which mainly offers mortgage loans.

It’s also important to note that one of the factors in Sweden’s economic success has been its longstanding commitment to avoid foreign entanglements. Following WWI and WWII, unlike many other countries, it didn’t have to struggle to pay back huge war debts.

It maintained its neutrality during the second half of the 20th century, abstaining from involvement in at least a dozen of the proxy wars that followed WWII. As a result, Sweden never developed a military industrial complex, as we did in the US, which means that its defense budget is relatively insignificant in terms of the country’s economy.

(FACT: Only 5% of taxpayer money in Sweden goes to the police and military combined. In contrast, the US military consumes more than 30% of government spending.)

While economic freedom has decreased in the US and the UK in the last 30 years, it has increased in Sweden.

Bottom Line: In terms of its economy, Sweden is about as far from Socialist as an economy can be.

So… Could It Work in the US?

Sweden did not become wealthy through social democracy, big government, and a large welfare state. It developed economically by adopting free-market policies in the late 19th century and early 20th century. As late as 1950, Swedish tax revenues were still only around 21% of GDP.

Rapid growth of taxes, state ownership of businesses, and government regulation in the late 1960s, 1970s, and 1980s led to a large decline in Sweden’s relative economic performance. In 1975, it was the 4th-richest industrialized country in terms of per capita GDP. By 1993, it had fallen to 14th.

To reverse that decline, Sweden again introduced market reforms in almost every sector of the economy. And, again, it worked. Sweden’s relative economic performance improved accordingly.

If we wanted to adopt the Swedish model and provide such social services as (mostly) free healthcare, (mostly) free education, universal retirement benefits, and 5-week vacations, this is what we would have to do:

* Close down the war on poverty.

* Close down the war on drugs.

* End the cold war with China and Russia.

* Drastically shrink the military.

* Decrease tariffs and other trade barriers and encourage more free trade.

* Deregulate industries, almost across the board.

* Abolish minimum-wage laws.

* Do away with occupational licensing.

* Reduce the corporate tax rate.

* Reduce banking regulations.

* Abolish property taxes.

* Abolish gift taxes.

* Abolish inheritance taxes.

* Increase private schooling by instituting a national voucher system for education.

* Reform Social Security from defined benefits to defined contributions.

* Provide private pension accounts in lieu of Social Security.

* Institute a national sales tax of 25%.

* Increase the Social Security tax to 25% and apply it to all taxpayers.

Given the fact that Swedes are, by every survey, happier with not just their lives generally but with their government, their policing, their welfare system, and their taxes, this might be the way to go. For someone like me who believes in personal freedom, limited government, and free-market Capitalism, it is a very attractive prospect. But I’m not sure that if Bernie and his supporters actually understood the economic realities of Sweden they would go for it.

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