Cutting Edge Insights
with Dr. Lee

What Really is Your Largest Expense?

Like everything else in life, there are about as many answers to that question as one may imagine.

If you find yourself in a sarcastic mood, you may be tempted to answer “What is your largest expense” with “Raising a child!”  Or, “college tuition!”  Or, “a wedding!”

Not entirely incorrect, but I’m referring to recurring expenses of living.

Ahhh, OK.  In that case, taxes.  Or is it housing?

Like anything else in life, it depends.

It is entirely possible that someone has living expenses – groceries, utilities, some sort of housing payment such as rent, but perhaps this individual accumulates enough deductions with our tax code to in fact pay zero income tax.  In that case, housing would likely be his or her largest expense.

On the other hand, I can’t envision a scenario where someone pays income tax yet has no housing expense.

It seems like the universal application of housing expense might make it the winner. You have to live somewhere.

Yet, I’ve read countless blogs and financial articles that begin with the assumption, “Since taxes are your largest expense,….”

Certainly, it is plausible that the ultra-wealthy may have housing expenses that either dwarf or are dwarfed by their income tax expense.

Further, the semantic possibilities of our beloved English language make it possible to put a slight twist on the words and convey an entirely different meaning.  For example, one of my esteemed references claims that:

“ProPublica reported this week that Warren Buffett pays relatively little income tax, despite huge gains in his wealth.”

First of all, you have to understand that the comparative term “relatively little” actually means $24 million in taxes paid from 2014-2018.

The author of the article is ascribing the term “relatively little” to the 0.1% blended income tax rate that Warren Buffet ended up paying over that same time.

Q:  But my marginal tax rate is 25% (or 35%, or whatever)

A:  Correct – but you’re looking at tax tables of ordinary income – that which is taxed at the highest rates.  And you’re not even including the fact that you and your employer share the 15.3% FICA tax on this ordinary income, and you have a state income tax (4.25% here in Michigan), so your marginal rate could be 50% or higher.  Since there are deductions and since there are marginal rates, your blended or effective rate is always somewhat lower.

Q:  OK, say my blended rate is something like 10%.  Buffet makes billions and his blended rate was 0.1%!! How is that fair?

A:  Buffet didn’t write the tax code.  He simply uses it to his maximum advantage, much as you would if the tables were turned.  One thing he does have is a lot of passive income, which is taxed at lower rates and also subject to offsetting passive losses.  Another thing he likely does is keep much of his income within his corporate entities rather than taking distributions, so he may not be personally taxed on income even though he controls it.

The second problem I have with this type of thinking can be characterized by the words, “…despite huge gains in his wealth.”

We are taxed on income, not net worth.  You can be worth millions or billions of dollars and experience a year with little income and pay little income tax.

Conversely, your net worth could be low and you could have an extremely high income in one particular year, making the converse of that statement true.

Journalists are very adept at picking the right words to evoke the thoughts and emotions they want us to think and feel.

A better way to view this large perceived inequity in the distribution of income between the middle class and the very rich, in my opinion, is by considering (wait for it – profound idea coming here) “How can we learn from these successful people and apply the lessons to our own lives?” But I’ll stop there because my writing is economic in nature, not political.

OK, back to taxes versus housing.

I’m going to go on record and say that housing is America’s largest universal expense because everyone experiences some housing expense.  And, unlike taxes, there are no marginal housing rates.  You receive in proportion to what you pay.

It is easy to underestimate our true housing expenses.  Here is what I include:

  • rent or mortgage payment
  • property taxes, if applicable
  • insurance, homeowner’s or renter’s
  • utilities
  • periodic maintenance (even tenants have to perform some periodic maintenance)
  • capital improvements/deferred maintenance (your roof is failing and that’s $20,000 tomorrow)

Now if we consider the Motley Fool’s characterization of housing, “utilities and household maintenance” are their own separate category at an average of $7,068 per year (2013 data/2017 article).  Housing itself was $10,080 and  the average 2013 income was $63,784.

So, the average American household spent ($10,080 + 7,068)/$63,784 = 26.9% of its pre-tax income on housing expenses in 2013.  But the average family also spent $7,342 on federal income tax during that period, so now we can say that housing expenses consumed 30.4% of the average family’s discretionary income.

That’s a big chunk.  That may or may not even include state income taxes (no, they’re not a housing payment, but if they weren’t included above, the proportion of discretionary income consumed by housing would be even higher.)

I did happen upon more recent statistics compiled in 2020.  The numbers were less detailed, but about the same (proportionally still around 30%).

We know that inflation is here – we continue to keep this topic at the forefront of our attention and topics.  For more information, see our archives at http://CEassets.com/blog.

Will the median home price continue its ascent and eclipse the Q2 2021 value of $329,100?  I suspect incomes aren’t rising fast enough to keep up with that.

How about utilities? I’ve only read of recent increases in rates.

What about insurance? We’ve had no shortage of natural disasters in recent years.  In 2006, the year my family moved into our house, our annual premium was $400.  Now, it’s nearly $2,000.  And we’ve never had a claim.

Construction materials for new homes or remodels are presently at unfathomable highs.

In my opinion, all of this relates back to how much control we want to give to others.

If we’re happy building an average McMansion in an average neighborhood that costs a median price of $372,00 to have built, then I hope we plan on having an excess of jobs that pay six figures to cash flow a mortgage payment on that.

If we want to be at the mercy of the utility companies despite knowing that rates aren’t ever going down, then let’s keep building homes to code minimum (the building code is the worst or minimum way to legally build a home) and keep paying the utility bills associated with that type of construction.

If we’re happy designing and building homes with rooms we never use simply to keep up with the neighbors (because why would we want to build something smaller than we think we need?), we should realize that we’re doing a really good job at it.

But if we think that building sustainably, building green, and building in an energy efficient manner is important, then I have news:  it is.  

In the coming weeks I’ll have more articles specifically targeting how we can engineer our largest expense downward if we begin with the end in mind.

And you’ll realize that it’s really not like learning rocket science to understand and make happen.  (Rocket science is a topic covered extensively here).

As you think about that,

If you decide to do what everyone else is doing, make sure you have a good reason.

Until next time,

Dr. Lee Newton

I give ideas, not advice.

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